Coin holdings are not a proxy for revenue

Crypto company valuation challenges

One of the things I’m trying to wrap my head around is how crypto startups can create value and liquidity for their investors. Most startups in the space launch an ICO and set the expectation that the value is created in the network. But I see some problems with that.

If we look at tech startups of yesteryear, they created value by growing their networks. Companies with strong network effects created the most value and the fastest. They became the winners we know today.

Typically a company is valued based on their revenue, but that does not necessarily apply to crypto startups. The decentralized nature of their networks means that they won’t take all the revenue of their network. You would not expect them to take the majority of the revenue if they want to stay true to the distributed nature of their networks.

Each company has their own particular network where they created value. Facebook created a network of people, Google a network of data and Amazon network products and distribution. The companies are valued for the networks they own and service.

With crypto, the value is in the network itself and not the company. Coins make that value visible and liquid, but it also has problems. The first problem is what is a network worth? The value is set by the market. The company launching and maintaining this market is just a player in this market. They might own a substantial amount of the coins in reserve, but that creates uncertainty as well because they become a “central bank” on their own network and can influence the market price of the coin when they sell part of their holdings. Of course, there’s an analogy with shares, but the difference is that shares just represent ownership and valuation of the company and not the product or service they provide.

The decentralized nature of crypto networks means there’s a network of players operating on a crypto network. They’re all dependent on the network value. A single entity can’t hold the network “hostage” for the valuation of the transactions running on those networks.

Ultimately, I’m wondering how this is going to play out over time. I expect there’s going to be tension and – funny enough since it’s one of the attributes of crypto networks – trust issues surrounding the valuation and large holdings of coins by centralized companies.

As a crypto company, you’ve got a set of decisions which is going to be problematic down the road. First, you’ve got a large holding of a coin which is theoretically liquid, but in practice is not. You can’t flood the market with coin and destabilize the market pricing for your own coin. Second, your valuation is very tied to your holdings and letting go of those holdings will impact your own valuation.

Where there are problems, there are solutions. It depends very much on the situation and without any major success in crypto, it’s impossible to forecast how this is going to play out. The way we value companies of the past does not necessarily mean the way forward. The only thing I do know, it’s going to be different.

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