So this is a little late to the Skepticism Sunday party, but in my continuing quest to be the least popular member of the community, I’m going to continue to press on issues that others can’t, won’t or would rather ignore due to short term financial incentives.
The point of independent analysis is not to be liked, but to reveal useful insights.
Pricing the future
Polkadot (DOT) is one of top five largest institutionally held crypto-assets alongside Bitcoin (BTC), Ethereum (ETH), Ripple (XRP) and Cardano (ADA) - a member of a ‘blue chip’ fraternity.
As everyone is constantly reminded, there is a vast distance between the valuations of crypto-currencies and the adoption of (network) public infrastructure.
Valuation frameworks allow investors to model the ‘fair value’ of assets - analysis that at its simplest aims to price the future.
For those who have been around crypto for a few cycles will recognise, many attempts have been made to value Bitcoin, using a variety of financial models per Exploring Bitcoin Valuation Methodologies:
There’s no universally accepted way of modeling bitcoin’s future value.
Methods for forecasting prices largely depend on analogies. Is bitcoin like the internet? Then consider network effects. Is it gold 2.0? Then there’s a stock-to-flow model.
Each methodology has its drawbacks, but no model is ever perfect.
As institutional interest increases and ecosystems mature, these frameworks will do too.
Memes will continue to drive speculation in dog tokens, but over the long term, infrastructural adoption will concentrate around protocols that demonstrate meaningful use and sustainable and scaleable revenue models that are able to be valued in more predictable ways.
In simple terms, at some point reality bites.
Valuation frameworks for Public Blockchains
As one of the largest institutionally held assets, DOT gains both a badge of honour and more critical assessment of its relative value.
Funds holding assets, especially those with more conservative compliance and reporting requirements (say a pension fund) have a legal duty to conduct regular due dilligence on their investments.
Even venture capitalists with long time horizons will re-balance their portfolio over time as they receive new information and insights.
Despite people wishing otherwise, the average DOT investor does not engage in deep critical analysis of the asset, but follows trends, marketing and #bullish announcements.
At best holders will engage with technical analysis, attempt to buy and sell into market movements or if they prefer not to day trade attempt to ride out market cycles.
Each market cycle is different
Yes the overall market expands over time, but each time it does, there is an evolving narrative and reason for new capital to enter the space.
Historically that growth has been driven by speculation around unregulated fundraising - ICOs, DeFi and NFTs that sucked in billions in new capital - driven by rapid returns rather than sustained impact.
Just listen to a VC call it like it is:
With regulations now constraining the core drivers of prior cycles, growth moving forward will be dependent on new narratives.
Polkadot the meme token
Polkadot’s launch was driven by a meme - Gavin vs Vitalik at a point when there was huge doubt as to whether Ethereum could shift from PoW to PoS.
The huge demand seen for Edgeware’s lockdrop was testament to this, with ETH holders able to ‘hedge’ the future, placing a bet on both founders.
Like the rest of crypto, its meme value has far exceeded its objective value.
The coretime narrative
Version 1.0 of Polkadot’s technology is complete and now the product is shifting away from an auction model of coretime leases to coretime sales ensuring the Polkadot project will face new headwinds.
If you focus the narrative on a singular ‘metric’ aka coretime, you more accurately value the technology (this is a very good thing long term), but you also open the door to a radical repricing of the network (this is not such a good thing short term).
Remember any price changes directly impact the spending power of the treasuries.
Per Kusama historical analysis - spending, coretime demand and treasury ROI this is the (simulated) value of Kusama’s first coretime:
This is the current (simulated) value of the latest auction:
Since coretime lease is an opportunity cost and coretime sales are direct costs expect coretime to be even cheaper than this.
Now lets look at the latest Messari Report Q2 2023 (funded by the DOT treasury)
Total revenue is the only line that matters.
Once coretime is concretely the metric that orients the value accrual of the network, this line will be all that investors really care about.
When you take the marketcap - total value of all tokens in circulation and divide it by the income, you can calculate a valuation multiple and compare this across other networks.
Valuation frameworks for public Blockchains.
Coinshares are one of the oldest and most experienced institutional investors in the space.
This report is critical reading for anyone interested in where Polkadot is headed. Valuation Frameworks for Public Blockchains - Coinshares
Blockchains quite simply, sell blockspace. Each blockchain has a methodology for pricing transactions that are included in blocks that range from auctions to a target number of transactions per block. However, not all blockspace is valued equally as different chains offer different security guarantees, transaction throughput, dApp ecosystems, and other capabilities as trade-offs.
If we use network fees and coretime interchangably, you can begin to see the problem…
Sadly the nature of token tribalism means critical analysis is impossible, it is disregarded as FUD.
In previous cycles, this strategy worked just fine, since rational pricing was impossible it was all meme.
Tokens ensure the collective delusion is strong - nobody wants to accept reality as it is and actually face the existential issues head on, for pure meme tokens, this means its about continually pushing new partnerships, announcements and pumping the narrative.
For more boring (or useful) technologies such as Polkadot, this won’t work.
Memes are fun, playful and weird.
Enterprise adoption is the opposite.
So what should we do?
It’s very simple really - accept that right now, Polkadot (DOT) and Kusama (KSM) are massively overvalued when we consider their respective incomes to marketcaps.
This is not just a Polkadot problem, this is the whole of crypto.
Consider the difference between the market cap and the income as a ‘hope premium’.
Without closing the gap between hope and reality (income) there will eventually be a repricing… slowly, then suddenly.
Treasuries as common good resources
As treasury funds continue to be spent on projects that do not directly impact coretime income, they will continue to bleed out.
People will continue to argue over subjective value adds and culture will steadily degrade - you can see this happening already as media spending battles to demonstrate its usefulness and ROI.
As prices begin to fall, these issues will compound - it is inevitable.
At some point casting blame will give way to an acceptance that the only metric that matters is coretime income - not adding thousands of new developers, or getting a bunch of active addresses.
Sadly, things will get a lot worse, before they get better.
The faster people face reality headon, the faster change will happen.
Recommendation
For those who’ve made it this far, the recommendation is simple - focus your attention on the business proposition of Kusama and Polkadot.
Understand the product offering and the value drivers.
For DOT/ KSM holders
If you are a DOT or KSM voter, Nay anything that doesn’t consider coretime demand up front. This does not mean ‘killing’ media spending, or tooling, or experimentation, it means nudging talent and technology to collaborate more concretely in service of a common good outcome.
For DOT/ KSM proposers
Figure out how to consolidate your offerings into a ‘full-stack’ proposition with the power to shift the metrics that matter - if you can do this, you will be handsomely rewarded, rather than enduring ever more work, every greater token holder anger and ultimately a short time horizon for your varying endeavours.