Valuation Multiples: What are they good for?
Do Ethereum valuation metrics matter?
Do valuation multiples matter in crypto?
Ethereum has attributes of productive assets. It generates profits. The profits accrue to tokenholders. But is it valued as a productive asset like stocks are? Do Ethereum valuation multiples influence the ETH price?
Valuation multiples are a heuristic to assess the value of an asset. Google trades at 30x earnings. Nvidia trades at 230x earnings. It would take 30 years to recoup an investment in Google if its existing earnings continued over the next 30 years. It would take fewer years if Google’s earnings grew. Google is ‘cheap’ relative to Nvidia. Entry price valuation, for example 30x versus 230x, is not the only driver of investment returns, but it’s a big one. Expensive assets, like Nvidia, have high growth expectations baked into their current valuation multiples. The price will come crashing down if they don’t meet those lofty expectations.
Similar valuation multiples can be applied to crypto. Market capitalization divided by total fees is a crypto valuation multiple. The market cap represents the market's current view of an asset's value. The fees are the total revenue generated by the protocol. A blockchain’s revenue is similar to the profits it distributes across the entire network. Therefore, a blockchain’s revenue and earning multiples are the same.
What valuation multiple does Ethereum trade at?
Ethereum is currently trading at 100x its rolling seven day annualized fees. Ethereum’s fee multiple has oscillated between 25x and 235x since the summer of 2022 (see chart below: Since 2022 lows: ETH price and market cap / fees).
Unexpected relationship
The chart above suggests an inverse relation between ETH price and valuation multiple. The time to buy ETH was at the end of 2022 when ETH was priced around $1,200. Yet at that exact time, ETH was trading at a more expensive valuation multiple of 200x fees. By spring 2023, ETH was approaching $2,000 yet its fee multiple decreased to 50-100x.
The inverse relationship between price and valuation multiple is unexpected. An asset is usually a better buy when it's trading at a lower valuation multiple. Multiples are typically low until the asset hits an inflection point. The market realizes the asset is undervalued. The price begins to rise as does its valuation multiple.
The chart below (2010s Bull Market: S&P 500 Index and P/E) illustrates the common relationship between price and multiple. It depicts the 2010s US equity bull market rally until the outbreak of Covid. The S&P 500 was ‘cheap’ at the beginning of the decade trading around 15x earnings. The S&P 500 has traded at an average of 18x earnings since 1928, and 26x since 2000. The inflection point came in 2011 when the US emerged from the Global Financial Crisis and interest rates were near all time lows. Thereafter, prices and multiples began their steady rise.
So, what can we infer from Ethereum multiples?
Are Ethereum multiples an indication that ETH is ‘cheap’ or ‘expensive’?
And how does ‘cheap’ or ‘expensive’ translate into ETH price performance? Is it an indication of a good buying opportunity like the stock market?
Analyzing historical data addresses these questions.
ETH’s price has risen from $10 to over $4,000 in five years. The 400x price move makes observing relationships in one chart hard. Instead, different periods are highlighted to illustrate trends.
The 2017 bull market highlights the inverse relationship between multiples and price. ETH was trading at an astronomical 7,700x fees in early 2017 (see chart below: 2017 Bull: ETH price and market cap / fees). Yet, from a price movement standpoint, that was a great time to buy ETH around $10. ETH subsequently 10x’ed and the multiple collapsed to 100x.
The 2021 bull market evidences the same trend. Buying ETH in early 2020 around $200 when it was trading at 650x fees was a great buy (see chart below: 2021 Bull: ETH price and market cap / fees). ETH increased 24x while its fee multiple compressed to 22x.
Ethereum bear markets exemplifies the same inverse relationship. The time to sell was in early 2018 when ETH was trading at a low of 200x fees and its price was hovering near a peak of $1,000 (see chart below: 2018 Bear: ETH price and market cap / fees). A few months prior ETH had been trading over 3,000x fees (see chart above: 2017 Bull: ETH price and market cap / fees).
Similarly, the time to sell was late in 2021 when ETH was trading at a low of 25x fees and its price was at an all time high over $4,000 (see chart below: 2022 Bear: ETH price and market cap / fees).
Multiple conclusion
ETH price and multiples are inversely related. History suggests its best to buy ETH when its trading at peak multiples and sell when its trading at trough multiples. That means buy ETH when its trading at its highest valuation multiple and sell when its trading at its lowest.
That’s seriously counter intuitive.
That’s not how productive assets, like equities, trade.
What explains the peculiar relationship?
The counter intuitive conclusion could be explained by:
Markets are forward looking.
ETH is not valued on a multiple of fees.
1. Markets are forward looking
Markets, be it equity, commodity or crypto, are forward looking. Prices reflect the expectation of what is to come, not what has happened. Think of it this way: the value of a company is based on its future cash flow.
The market cap / fees multiple reflects Ethereum’s fees at a specific point in time. The fee figure used to derive the multiple is the sum of the last seven days’ fees multiplied by 52 weeks. It does not reflect Ethereum’s future fee potential. The fee figure is not a forward looking metric.
Analyzing historical data corroborates that the ETH market is forward looking. The ETH price increased in advance of rising Ethereum fees, denominated in ETH, in the 2017 bull run (see chart below: 2017 Bull run: ETH price and fees). Note that prices didn’t decline as rapidly as fees at the beginning of 2018.
A similar, but weaker, trend appears during the 2021 bull market. As of May 2021, prices move before a commensurate increase in fees (see chart below: 2021 Bull run: ETH price and fees). However, fees nearly tripled in the summer of 2010 without a corresponding move in ETH price. Additionally, growth in fees led an increase in ETH price at the beginning of 2021. The reversal in what came first could be explained by Covid. People were in lockdown in the summer of 2020. DeFi applications exploded in popularity. Users spent more on Ethereum fees as a result. Yet the investment community was not paying attention to crypto.
The evidence of ETH prices moving in anticipation of growing Ethereum fees is clearest in bull markets. In periods when ETH price declines or trades sideways the relationship is neither refuted nor corroborated. ETH price and fees charts during bear and sideways markets are omitted for the sake of brevity. They can be viewed here.
2. ETH is not valued as a multiple of fees
The market may not value Ethereum as a multiple of fees. The ETH price and fee multiple should move somewhat in tandem if the market did. The logic should hold that a low multiple tends to indicate a more attractive entry price, not the opposite.
Ethereum’s fee multiples have violently oscillated and have trended toward lofty valuation multiples. Ethereum traded between 10x and 8,800x its fees since 2016. The range compressed to 20x to 235x since 2021. The valuation multiples remain objectively high.
Ethereum has attributes of a productive, commodity and store of value asset. Productive assets are valued on multiples of earnings. Commodity and store of value assets are not. The difficulty justifying ETH valuation as a multiple of fees could indicate that ETH is valued more as a store of value than a productive asset.
Here is the wrinkle…
If ETH is not valued as a productive asset, then why do prices move in anticipation of fees growing?
Prices shouldn’t. After all, if ETH is a store of value asset, then the fact that Ethereum fees are growing shouldn’t make much of a difference to its valuation.
But fees do have an impact on price.
How much of an impact?
It’s hard to tell. Several variables affect the ETH price, including macro, regulation and competition. It’s impossible to isolate the different variables to ascertain which is having the greatest impact on price.
…And how I reconcile things
Fundamentals, like fees, matter in crypto and for Ethereum specifically. Fundamentals determine the health and outlook of a network. Fundamentals, in the case of Layer 1 blockchains, only get so far in valuing the network. A large part of a blockchain’s value resides in its money-ness. It’s ability to be a store and transfer of value. It’s ability to secure a network. Protocols and applications built on top of Layer blockchains are more reliant on their productive asset attributes as explained in Token Value Creation: Funnels into one thing.
So you’re not going to derive the price of ETH from its trading multiples. Ethereum’s ‘cheap’ or ‘expensive’ multiples are not indicative of much. But Ethereum’s metrics, namely its fees, drive price movement.
Stay curious.
Thank you to William Scheinman (@0xOpiner) who informed my thinking on Ethereum valuation multiples.
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