Understanding valuation through the lens of market capitalization can reveal hidden market manipulation, identify unnoticed potential projects, help model market exits, and detect overvalued projects.

Market value basis

Simply put, market capitalization is the total value of the project's native currency in circulation. The calculation formula is market capitalization = price x supply, but in reality, due to market manipulation, the situation is much more complicated. Supply data is easy to manipulate, so market capitalization can be easily distorted, thus affecting the judgment of project value.

Common market manipulation tactics

1. Create a small liquidity pool: By creating a small liquidity pool when issuing tokens on the chain, a small amount of capital inflow can significantly increase the price, thereby attracting market attention and further introducing more funds.

2. Reduce the circulating supply: A similar effect can be achieved by displaying an inflated supply while the actual circulating supply is much lower than the displayed value. This way, the actual amount of tokens available for trading in the market is small, causing the price to rise and become out of touch with the actual value.

For example, let's say a technically superior token A is listed at a $50 million valuation and 100 million supply. At the Token Generation Event (TGE), only 15% of the tokens are in circulation, 5% are used for community airdrops, 4% are given to the team, 3% are given to VCs/advisors, and 3% are given to partnership agreements. The team can withdraw or lock up 10% of the circulation from VCs, teams, partnership agreements, etc., resulting in less than 5 million tokens being traded on the market, and the price soaring. This is exactly what the team wants to achieve, the hype caused by the price increase brings in more traders until the valuation is seriously overvalued.

This dynamic suggests that many tokens are valued at a higher face value than they are actually worth, and that it is easy to misjudge valuations based on math alone.

Importance of Valuation Models

In a liquid market driven by emotions and with less sophisticated participants, there will always be a disconnect between a project's true value and the market's perception of it. This is in stark contrast to illiquid markets with fewer participants and lower volatility, such as real estate. Given the complexity and volatility of the market, true value cannot be truly determined. We can usually only judge a project's value based on the information at hand, and even if all market participants have the same information, interpretations will vary.

This is why valuation models are important. Models are needed to introduce structure and consistency, allowing for a more accurate assessment of the true value of a project.

Valuation Model Example

1. Cash flow model: Treat utility projects as businesses and use business health to justify market valuations. This approach can not only find overvalued products, but also find undervalued potential projects.

- Find out the price of supply utility (price per resource).

- Use revenue metrics to gauge demand levels (this shows whether you are an early entrant or the technology has reached mass market).

- Estimate the likelihood and duration of future demand given the team’s current trajectory (assess how much and how long the product can organically attract market attention).

These data points can be used to check for overvaluation and extrapolate future valuations.

2. Comparative Valuation Model: Take a product and compare its valuation with similar products. This approach shows the market’s valuation of the product/utility and provides an expectation of the token’s potential upside.

For example, if you are investing in a DeFi token, you can look for similar projects that have been successful in the past, check their all-time highs (ATH), and see the highest price retailers are willing to buy before the bull market ends. If your token is priced significantly lower than these projects, it may be undervalued, especially if it offers enhanced functionality, greater flexibility, and state-of-the-art features.

While these models have their limitations, they introduce structure and consistency when evaluating assets and can help you better plan buy and sell timing and position sizing.

In summary, there are many ways to do valuation, and any method that can help you introduce order, structure, consistency, and predictability into your assessment of assets is worth considering.

in conclusion

You have finished reading this article. I hope these thoughts can help you better understand and apply cryptocurrency valuation models and achieve greater success in your investment process.

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