VENTURE CAPITAL (CRYPTO TOKEN)
Fundamentally Valuing Uniswap
Opinions expressed are solely my own and do not express the views or opinions of my employer.
We are seeing the altcoin boom again. Euphoria without a consideration for what expectations are priced in to the token price. Prices are currently driven by short-term considerations and momentum. At some point however, cryptocurrency markets too will be mature and judged by its fundamentals. I write this post to show a long-term investor’s framework for thinking about Uniswap’s valuation.
Uniswap tokens will generate cash flow
Uniswap charges a 0.30% fee on trading volume, of which 0.05% can be distributed to token holders when the “switch” is turned on by Uniswap’s governance. When or if that switch will be turned on is unknown. We will assume that switch is turned on, and use a discounted cash flow model to arrive at an estimate of what Uniswap token price is.
Model
You can download the excel and play around with the inputs:
Credits to Mira Christanto of Messari who made a detailed model of both DCF and comparables. Specifically, her calculation of token supply over time was very helpful, as it saved me a lot of time in calculating that myself.
Notes:
- I provide a simplified model in the hopes that it will be reasonably easy to understand for most people.
- Volume: Today’s volume is extremely high, and does not provide an accurate representation of steady-state volume. For example, Coinbase’s annualized volume was around $40B in 2020. However, its current annualized volume is 1.8T, because the market has been in a euphoric state in the last several weeks. Certainly, this will fall as the bull market ends. Similarly, Binance’s annualized volume in 2019 was about $1T but they are now at $12T annualized. This will certainly fall steeply at the end of the bull cycle.
- Assumption: Given Binance’s volume of 1T in 2019 (a “normal” year in terms of volume), my current assumptions puts Uniswap’s volume at 1.6T by 2022. This is likely on the bullish side.
- Toggle: You can toggle monthly growth rates on cells B35–38.
- Cost of Equity: I set this at 20%. There is a whole science to calculating cost of equity (check out Aswath Damodaran’s resources if you want to study this) but it is more practical to think of this as one’s opportunity cost of capital, i.e. what is the rate I can earn in another investment like the S&P 500. At Point72 Asset Management, we used 10% for most equities. Given Uniswap’s higher existential risk, I set it at 20% but it should probably be higher.
- UNI Value: Cells L10 to S10 show what the UNI value should be each year should volume play out like the assumptions.
- Risks: Keep in mind that Uniswap has many existential risks. It uses a very simple AMM model (x * y = k) of which there are many startups working on a more efficient model. Sushiswap almost taking away most of Uniswap’s liquidity by simply copying its code and issuing the SUSHI token as rewards shows how precarious Uniswap can be.
Conclusion
Given bullish assumptions, we arrive at a value of $25 for UNI tokens. Uniswap today trades at $22. However, we are assuming that Uniswap’s volume this year will 10x last year’s volume, and that it will continue to be the dominant DEX. Also, our cost of equity at 20% is admittedly generous. At a 30% cost of equity, its value would be something around $12.
Currently, I see better risk reward opportunities in other tokens. That said, Uniswap’s high valuation is a testament to its success, and they have accomplished an amazing feat in bringing mainstream traction to a DEX.
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