Article source: Foresight News

Written by: Eric, Foresight News

What should be the reasonable price of ETH?

The market has provided many valuation models for this issue. Unlike Bitcoin, which has already existed as a substantial asset, Ethereum, as a smart contract platform, should be able to summarize a reasonable and recognized valuation system. However, it seems that the Web3 industry has not yet reached a consensus on this matter.

Recently, a website launched by Hashed provided 10 possible valuation models that are likely to be highly recognized in the market. Among the 10 models, 8 of them show that Ethereum is undervalued, with a weighted average price exceeding $4700.

So how is this price, which is close to the historical high, calculated?

From TVL to staking to income

Hashed listed 10 models are divided into three categories based on reliability: low, medium, and high. Let's start with the low-reliability valuation models.

TVL multiplier

This model suggests that Ethereum's valuation should be a multiple of its DeFi TVL, linking market cap directly to TVL. Hashed adopted the average ratio of market cap to TVL from 2020 to 2023 (which I interpret as the period from the start of DeFi Summer until the less severe phase of the Ponzi scheme) of 7 times. By multiplying the current DeFi TVL on Ethereum by 7 and then dividing by supply, the price is calculated to be $4128.9, indicating a 36.5% upside potential from the current price.

This rough calculation method, which only considers DeFi TVL and cannot accurately derive the actual TVL due to complex Ponzi schemes, indeed deserves its low reliability.

Scarcity premium caused by staking

This model takes into account the Ethereum that cannot circulate in the market due to staking, which increases Ethereum's 'scarcity'. The price is calculated by multiplying the current Ethereum price by the square root of the ratio of total supply to circulating supply, i.e., Price × √(Supply ÷ Liquid), resulting in a price of $3528.2, indicating a 16.6% upside potential from the current price.

This model is developed by Hashed itself, and the square root calculation is intended to mitigate extreme cases. However, according to this algorithm, ETH is forever undervalued, not to mention the rationality of simply considering the 'scarcity' brought about by staking and the additional liquidity of staked Ethereum released by LST, which is also very rough.

Mainnet + L2 TVL multiplier

Similar to the first valuation model, this model adds all L2 TVL and gives a 2x weighting due to L2's consumption of Ethereum. The calculation method is (TVL + L2_TVL×2) × 6 ÷ Supply, resulting in a price of $4732.5, indicating a 56.6% upside potential from the current price.

As for the number 6, although not specified, it is likely a multiplier derived from historical data. Although it accounts for L2, this valuation method still purely references TVL data and is not significantly better than the first method.

'Commitment' premium

This method is also similar to the second model, except it adds Ethereum locked in DeFi protocols. The multiplier in this model is derived from the total amount of ETH staked and locked in DeFi protocols divided by the total supply of ETH, representing a premium percentage brought by 'long-term holding belief and lower liquidity supply'. By adding 1 to this percentage and multiplying by the 'commitment' asset value premium index of 1.5, the reasonable ETH price under this model is derived. The formula is: Price × [1 + (Staked + DeFi) ÷ Supply] × Multiplier, resulting in a price of $5097.8, indicating a 69.1% upside potential from the current price.

Hashed states that this model is inspired by the concept that L1 tokens should be viewed as currency rather than stocks. However, it still falls into the problem that the reasonable price is always higher than the current price.

The biggest problem with the above four low-reliability valuation methods is their lack of rationality due to a single-dimensional consideration. For example, higher TVL data is not always better; if a lower TVL can provide better liquidity, it is actually an improvement. As for viewing the Ethereum not circulating as a form of scarcity or loyalty leading to a premium, it seems unable to explain how to value it once the price actually reaches the expected level.

After discussing the four low-reliability valuation schemes, let's look at five moderately reliable schemes.

Market cap / TVL fair value

This model is essentially a mean-reversion model, calculating by assuming the historical average level of the market cap to TVL ratio is 6 times, exceeding which is overvalued, and not enough is undervalued. The formula is Price × (6 ÷ Current Ratio), resulting in a price of $3541.1, indicating a 17.3% upside potential from the current price.

This calculation method superficially references TVL data, but in reality, it refers to historical patterns, conducting a valuation in a relatively conservative manner, which appears to be more reasonable than simply referencing TVL.

Metcalfe's Law

Metcalfe's Law is a law about the value of networks and the development of network technologies, proposed by George Gilder in 1993 and named after Robert Metcalfe, a pioneer of computer networking and founder of 3Com, in recognition of his contributions to the internet. Its content is that the value of a network equals the square of the number of nodes in that network, and the value of the network is proportional to the square of the number of connected users.

Hashed states that this model has been empirically validated by academic researchers (Alabi 2017, Peterson 2018) for Bitcoin and Ethereum. Here, TVL is used as a proxy indicator for network activity. The calculation formula is 2 × (TVL/1B)^1.5 × 1B ÷ Supply, resulting in a price of $9957.6, indicating a 231.6% upside potential from the current price.

This is a more professional model, also marked by Hashed as an academically validated model with strong historical correlation. However, relying solely on TVL as the only consideration seems biased.

Discounted cash flow method

This valuation model is currently the one that views Ethereum as a company the most. It treats Ethereum's staking rewards as income and calculates the current value using the discounted cash flow method. Hashed provides the calculation method as Price × (1 + APR) ÷ (0.10 - 0.03), where 10% is the discount rate and 3% is the perpetual growth rate. This formula is clearly problematic; the actual calculation should be Price × APR × (1/1.07 + 1/1.07^2 + ... + 1/1.07^n) as n approaches infinity.

Even using the formula provided by Hashed, it is impossible to calculate this result. If calculated at an annualized rate of 2.6%, the reasonable price derived should be around 37% of the current price.

Valuation based on price-to-sales ratio

In the case of Ethereum, the price-to-sales ratio refers to the ratio of market cap to annual transaction fee income. Since all fees ultimately flow to validators, there is no concept of price-to-earnings ratio in the network. Token Terminal uses this method for valuation, with 25 times being the valuation level of growth tech stocks, which Hashed refers to as the 'industry standard for L1 protocol valuation'. The calculation formula is Annual_Fees × 25 ÷ Supply, resulting in a price of $1285.7, indicating a 57.5% downside potential from the current price.

The above two examples show that using traditional valuation methods, Ethereum's price is severely overvalued. However, it is evident that Ethereum is not an application. Using this valuation method seems to be fundamentally flawed.

On-chain total asset valuation

This valuation model seems nonsensical at first glance but makes some sense upon reflection. Its core idea is that for Ethereum to ensure network security, its market value should match the total asset value settled on it. Thus, the model's calculation method is quite simple: the total value of all assets on Ethereum, including stablecoins, ERC-20 tokens, NFTs, etc., is divided by Ethereum's total supply. The resulting value is $4923.5, indicating a 62.9% upside potential from the current price.

This is currently the simplest valuation model to calculate, with its core assumption giving a feeling that something is off, but it's hard to pinpoint what.

Income-bearing bond model

The only high-reliability valuation model among all valuation models, Hashed claims this model is favored by traditional finance analysts who assess cryptocurrencies as an alternative asset class, valuing Ethereum as an income-bearing bond. The calculation method is to divide Ethereum's annual income by the staking yield to calculate the total market cap, with the formula Annual_Revenue ÷ APR ÷ Supply, resulting in a value of $1941.5, indicating a 36.7% downside potential from the current price.

The only one, possibly considered high reliability due to its widespread adoption in the financial sector, has become another example of undervaluing Ethereum's price through traditional valuation methods. Therefore, this could be strong evidence that Ethereum is not a security.

Valuation of public chains may need to consider various factors

The valuation system of public chain tokens may need to consider various factors, and Hashed weighted the above 10 methods based on reliability, resulting in an approximate value of $4766. However, given that the calculation of the discounted cash flow method may be incorrect, the actual result may be slightly lower than this number.

If I were to value Ethereum, my core algorithm might focus on supply and demand. Because Ethereum is a 'currency' with practical use, whether for paying gas fees, purchasing NFTs, or forming LPs, ETH is required. Thus, it may be necessary to calculate a parameter that can measure the supply-demand relationship of ETH over a period based on the level of network activity, then combine it with the actual transaction costs on Ethereum, comparing prices under historically similar parameters to derive a fair price.

However, based on this method, if the growth in activity on Ethereum does not keep pace with the decline in costs, there is reason for ETH's price not to rise. In recent years, the level of activity on Ethereum has actually surpassed that during the 2021 bull market at times, but due to the decline in costs, the demand for Ethereum has not been high, leading to an actual oversupply of Ethereum.

However, the only aspect this historical comparison-based valuation method cannot incorporate is Ethereum's imagination. Perhaps at some point, when Ethereum sees a resurgence of DeFi like before, we will need to multiply by the 'market dream rate'.