Token Terminal - Ethereum Investment Framework

In this episode of Token Terminal, which took place on November 7, 2023, Oskari and Michael discuss Ethereum,the Ethereum Investment Framework, the main components of the research, and its future. Read our notes below to learn more.

Background

Oskari (Host) – Growth and Content at Token Terminal
Michael Nadeau (Guest) – Advisor and Researcher

Intro to the Ethereum Investment Framework

Michael says that the Ethereum Investment Framework is designed to save people time by providing all core concepts and data related to Ethereum. It helps investors understand new concepts introduced by crypto and public blockchains.
He adds that frameworks are crucial for making it easier for investors to enter the space. They help people understand this new asset class, which has many unique aspects.

The inspiration behind the Ethereum Investment Framework

Michael says that he wanted to go back in time and provide his past self with knowledge about crypto. Crypto is a new field with various concepts related to public blockchains, crypto assets, business models, data analysis, etc.
He adds that his strategy is to anchor his analysis on data rather than getting influenced by conflicting views or noise in the space.
Michael says that the framework abstracts technical aspects, making it easier for people from traditional finance backgrounds to understand blockchain operations. It lowers the threshold for entry into the crypto space.

The main components of the investment framework

Michael says that the first step in the investment framework is to understand the business model of Ethereum and its value proposition. He emphasizes the importance of identifying what problems Ethereum solves in the world.
Michael says that he explored critical investment concepts related to Ethereum. Concepts like network effects, Moore’s Law, and parallels between Ethereum’s development and that of the internet are explained in a non-technical manner using analogies.
He highlights that Ethereum has significant network effects. These network effects contribute to the creation of flywheels within the ecosystem.
Michael says that the tech stack is a framework through which value accrues at different layers as the Ethereum ecosystem matures. It is noted that value accrual through the tech stack is subject to change as technology develops.
He adds that the investment framework includes quarterly reports with updated data on technology developments within the Ethereum ecosystem. Data is used to compare Ethereum with other networks, providing a relative valuation perspective.

The evolution of the internet and Ethereum’s place in it

Michael references the book “Technological Revolutions in Financial Capital” as a framework for understanding historical context. He highlights the similarities between crypto and other major technological advancements throughout history.
He adds that the eruption phase is described as the introduction of a new technology, characterized by experimentation and uncertainty. The frenzy period follows, marked by venture capital investments and financial bubbles that often overshoot the current infrastructure’s capabilities.
Michael says that wipeout phases occur when leverage is wiped out, frauds are revealed, and consumers are negatively impacted. Currently, Ethereum is seen as transitioning from the frenzy period to a turning point.
He adds that turning points are typically accompanied by increased regulatory involvement and government participation. He predicts that regulation will enter the crypto industry globally as it becomes more commercialized. Real products, services, regulated markets, and clear consensus on future directions are expected to shape the industry’s evolution.

How the Ethereum Investment Framework compares to other models in the industry?

Michael says that he has reviewed various existing reports and frameworks, including VanEck’s report and Fidelity’s research. Their framework takes into account the history of open-source technology and the fundamental differences between analyzing traditional companies and cryptocurrencies.
He adds that they focus on core concepts first before delving into new key performance indicators (KPIs), benchmarks, and metrics sourced from Token Terminal. Multiple valuation methodologies are proposed to address the lack of consensus on valuing Ethereum.

The role of data in the investment framework

Michael says that Token Terminal is an excellent data provider, offering comprehensive information through easy-to-navigate dashboards.
He adds that key data points include developer activity, smart contract development, daily active users, transactions, layer two scaling solutions, and value-driven protocols. Analyzing transaction flows across different components of the tech stack helps investors understand value allocation within ecosystems. Historical data since 2015 provides a strong foundation for assessing network effects and forecasting future growth.
Michael says that the framework is designed to be comprehensive yet non-technical, allowing anyone to understand it without requiring an advanced finance degree. Token Terminal’s user-friendly presentation of data contributes to the accessibility and usability of the framework.

The influence of economic and financial theories on the framework

Michael says that his investment approach has been shaped by fundamental analysis, cash flow analysis, and core concepts from traditional finance. While traditional frameworks provide a foundation, new concepts unique to crypto investing are incorporated into their framework.
He adds that Warren Buffett and Charlie Munger‘s principles remain relevant in terms of fundamental analysis and identifying competitive advantages.
Michael emphasizes anchoring the analysis to fundamental principles that traditional investors understand. By comparing the business model on public blockchains to concepts like value and fundamental analysis, it becomes easier for investors to grasp the potential of this new space.
He adds that the frameworks developed by token terminal analysts and other experts in the crypto field are creating new ways of understanding and valuing cryptocurrencies.
Michael says that principles from traditional investing, such as those outlined in “The Intelligent Investor” by Warren Buffett, can be applied to the crypto space.
He adds that Token Terminal analysts and other experts are creating new frameworks specific to crypto that may become timeless approaches in the future.

How to best utilize the Ethereum Investment Framework

Michael says that the Ethereum Investment Framework is a PDF document with clickable sections and a table of contents for easy navigation. It includes a glossary of terms and highlights them throughout the document, making it user-friendly for those unfamiliar with certain terminology.
He adds that due to its length (over 100 pages), the framework is designed to be explored section by section, allowing readers to delve deeper into specific topics and revisit them as needed.

Approaches to valuing Ethereum

Michael says that one approach involves forecasting potential cash flows based on revenues since EIP 1559. This analysis applies assumptions and discount rates to calculate net present value.
He adds that another approach is an addressable market analysis that considers potential use cases for Ethereum across industries. It estimates the percentage of industry revenue that could move onto the blockchain and applies a take rate for Ethereum. Both approaches utilize discounted cash flow analysis to determine the value of Ethereum.
Michael says that the report analyzes the growth rates of various industries determines what percentage moves on-chain, and identifies who captures the revenue generated by these industries.
He adds that creating Ethereum as base layer infrastructure, similar to a country, with $ETH as its currency. This approach assesses the applications and economy leveraging Ethereum’s infrastructure. Also, it uses the data regarding Ethereum from Token Terminal to determine the gross domestic product produced by the Ethereum ecosystem. It compares this valuation against other Layer-1 blockchains to assess their strength.
Michael draws parallels between comparing currencies (e.g., USD vs. Euro) and evaluating fundamental demand for Ethereum. He explores factors like constant bids on USD due to its role in accessing oil through the petrodollar market. He relates this concept to Ethereum as “digital oil” where local currency needs to be converted into $ETH to access services within its network.
He adds that he recognizes crypto markets move in cycles. He examines key performance indicators (KPIs), metrics, and innovation growth on-chain during previous cycles. He maps this information to price action in prior cycles to estimate potential valuations in future cycles.
Michael considers the overall cryptocurrency market cap to reach $3 trillion in the 2021 cycle. He determines potential percentages allocated to $BTC and $ETH based on historical trends. He derives token prices based on these allocations.
He adds that he utilizes five different approaches for valuation butdoes not claim any one method as superior. He provides frameworks for individuals to make their own decisions based on presented analysis.

Biggest learnings from the process of creating this framework

Michal says that there is a lack of abundant research or frameworks available for cryptocurrencies compared to traditional assets. It is not wise to rely on existing solutions or easily find answers due to the novelty of the technology.
He adds that there is a need to develop frameworks from scratch and face unique challenges during the research process.
He aims to make analysis interesting and valuable, regardless of one’s stance on crypto. He recognizes that some aspects of analysis may lead to dead ends but persists in refining frameworks over time.

Future plans for other crypto asset frameworks

Michael says that the coverage will be expanded to include other networks such as Solana, Cosmos, and Bitcoin. An objective approach based on data analysis will be maintained, avoiding biases or favoritism towards specific networks.
He adds that future reports may focus on what sets each network apart rather than repeating concepts covered in the Ethereum Investment Framework.
Michael says that the concepts from the Ethereum Investment Framework can be applied to frameworks for other crypto assets. Adjustments will be made to account for the different economics of each asset.
He adds that shorter investment memo style reports will be produced, covering specific networks or topics. These reports will provide concise and focused insights, complementing the comprehensive Ethereum investment framework.
He adds that ongoing development within the layer-2 ecosystem of Ethereum presents a significant area of focus for future research.

The future of Ethereum and the investment landscape

Michael explains that their conclusion about Ethereum becoming a global monopoly is based on the theory of network effects and historical trends. He emphasizes that Ethereum’s success is not solely dependent on being the fastest or flawless blockchain, but rather on its strong network effects and continuous innovation.
Michael adds that the open and permissionless nature of Ethereum, similar to the internet, allows for a global hive mind of talent to solve problems and drive development. He compares Ethereum to the internet, they believe it will continue to grow as a global monopoly due to its open and permissionless system.
Michael clarifies that his view of Ethereum as a global monopoly does not mean it will be the only blockchain in existence. He anticipates three to five major layer-1 blockchains alongside other less significant ones.
He adds that the focus shifts towards understanding how value accrues within these blockchain ecosystems beyond just the dominant blockchain like Ethereum. Exploring how value flows through different stakeholders becomes crucial in shaping the future landscape of blockchain technology.
Michael says that the internet is a protocol that lacks a value capture mechanism. Ethereum, on the other hand, has a built-in value capture mechanism. This difference sets Ethereum apart from the traditional internet.

Check Out These Important Links

Show Information

Medium: Youtube
Show: Token Terminal
Show Title: The Ethereum Investment Framework: History, tech, economics, ETH price targets, and more!
Show Date: November 7, 2023