Digital Token Valuation: looking for a New Gold Standard?

Abstract

The economic valuation of digital tokens cannot ignore the valuation and financial effects of their underlying (historically represented by the "gold standard"). The consequence is that, despite various proposed approaches, the valuation of tokens with no underlying (such as bitcoins) and of tokens pegged to fiat money, precious metals or cryptocurrencies is almost impossible. Alternatively, it is possible to make economic valuations of digital tokens linked to decentralized finance projects that incorporate rights to financial returns. A digital token of such category includes the right to future returns, allowing to use traditional evaluation techniques. The choice of market or income approach depends on the token's liquidity and the project's stage of development. An additional parameter depends on whether the token is directly exchangeable with fiat currency or not. However, the formulas must be adapted to the specific characteristics of decentralized finance. Investors can take an active or passive role and, therefore, have a different view about the expected return on their investment. In this paper, we investigated even if this classification is a further discriminating factor in the choice of method of valuation.

Full text

Digital Token Valuation:
looking for a New Gold Standard?
Andrea Cesaretti and Roberto Moro-Visconti
January 23, 2023
Abstract: The economic valuation of digital tokens cannot ignore the valuation and financial effects of their
underlying (historically represented by the “gold standard”). The consequence is that, despite various
proposed approaches, the valuation of tokens with no underlying (such as bitcoins) and of tokens pegged to
fiat money, precious metals, or cryptocurrencies is almost impossible.
Alternatively, it is possible to make economic valuations of digital tokens linked to decentralized finance
projects that incorporate rights to financial returns. A digital token of such a category includes the right to
future returns, allowing to use of traditional evaluation techniques. The choice of market or income approach
depends on the token's liquidity and the project's stage of development. An additional parameter depends on
whether the token is directly exchangeable with fiat currency or not. However, the formulas must be adapted
to the specific characteristics of decentralized finance. Investors can take an active or passive role and,
therefore, have a different view of the expected return on their investment. In this paper, we investigated even
if this classification is a further discriminating factor in the choice of method of valuation.
Keywords: #DeFi #blockchain #token #cryptoasset #market valuation
Contents – 1. Introduction – 2. Valuation of Cryptocurrencies - 3. The digital token underlying - 4. Valuation of the
Digital Tokens linked to the DeFi projects – 4.1. Income Approach – 4.2. Market approach – 5. Valuation of Non-backed
Cryptocurrencies locked-up in staking - 6. Conclusions.
1. Introduction
The research question of this paper is concerned with the evaluation of digital tokens,
attempting to demonstrate which approaches could be used in analogy to traditional corporate finance
appraisals. Much depends on the correct identification of what a digital token represents, especially
considering its underlying asset, whenever it can be identified.
A digital token represents a specific amount of digital resources that can be owned, assigned
to another, or redeemed later.
Digital tokens are either intrinsic or created by software and assigned a certain utility.
What follows is a macro classification of digital tokens.
a) Cryptocurrencies: these are tokens that have no counterparty and can be transferred via
blockchain transactions. A cryptocurrency behaves like a currency even if it does not exist
in physical form (like paper money). Generally, it is not issued by a central authority even
if several countries are studying a national cryptocurrency. The cryptocurrency family
includes:
a. Non-backed Cryptocurrencies: these are digital tokens with an intrinsic value since
their price is not anchored to assets with official values such as fiat coins, gold, or other
exchange-traded commodities. Bitcoin, Ether, Litecoin, etc. belong to this category.
b. Backed Stablecoins: these are tokens of the cryptocurrencies family where the price is
pegged to fiat money or exchange-traded commodities (such as precious metals or
industrial metals). Apart from the lower volatility, unlike other cryptocurrencies,

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stablecoins have one of the properties of the currency: the value reserve. Examples of
Stablecoins are USD Tether, designed to maintain a value equal to the US dollar, and
Paxos Gold backed by gold.
c. Crypto-Collateralized Stablecoins: these are digital tokens whose collateral is a
cryptocurrency instead of a fiat or a commodity. An example of Crypto-Collateralized
Stablecoins is DAI. DAI’s price is pegged to the US dollar and is guaranteed by a mix
of other cryptocurrencies that are deposited in smart contract safes every time a new
DAI is minted.
d. Algorithmic Stablecoins: in this case, the collateralization is done on the blockchain.
Instead of supporting the currency with some resources, an "algorithmic central bank"
is created that manages supply and demand based on rules encoded in a smart contract.
Examples of Algorithmic Stablecoins are Frax and Ampleforth.
b) Utility Tokens: these are digital tokens that give the holder the right to receive a specific
service or good from the issuer or from a third party who has signed a commercial
agreement or where the holder has the right to participate actively in a DeFi project for
example by placing the token in a liquidity pool. One of the most important utility tokens
is ETH, considering that it is used to power smart contract agreements. Another example
is the BNB token, which fuels the Binance Smart Chain and offers discounts to traders on
the main Binance exchange.
c) Security Tokens: these are tokens that incorporate the right to receive a specific payment
or a future payment or tokens. Examples of security tokens are Sia Funds, Bcap
(Blockchain Capital), and Science Blockchain.
d) Governance Tokens: these are digital tokens that give the holder the right to vote by
participating in a DAO. A decentralized autonomous organization (DAO) is an
organization constructed by rules encoded as a computer program that is often transparent,
controlled by the organization's members, and not influenced by a central government. In
general terms, DAOs are member-owned communities without centralized leadership. A
DAO's transaction records and program rules are maintained on a blockchain. Examples
of governance tokens are Curve DAO, Uniswap DAO, and Aave.
However, the above classification of digital tokens should not be considered rigid because a
digital token can belong to several categories simultaneously. For example. BNB token, as
anticipated, is the fuel of the Binance Smart Chain and offers discounts to traders on the main Binance
exchange. Therefore, it is classifiable as a utility token. However, it can be included in different online
platforms allowing the holder to earn periodic percentage returns. In addition, an investor can buy a
BNB token only in the expectation of its appreciation in the secondary market. In the latter two cases,
the BNB token can be considered a security token since there is the co-existence of: (i) capital use;
(ii) a promise/expectation of the return of a financial nature; (iii) the assumption of a risk directly
related to and related to capital use.
Like the BNB token, the ETH is classifiable in several categories. It is a Non-backed
Cryptocurrency when required to buy thousands of ERC-20 tokens. It is a Utility Token when it is
used to power smart contract agreements and it is a Security Token when the investor put it into
staking or trades it in the secondary market. Finally, the ETH token can be classified as Backed
Stablecoins. ETH is the fuel for the entire Ethereum ecosystem where most decentralized finance
projects reside. Since it is only the decentralized finance that produces wealth within the Ethereum
blockchain, we argue that decentralized finance is the underlying of the ETH. The further

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consideration is that, since ETH is the fuel of the Ethereum ecosystem, as the DeFi consolidates, the
ETH will increasingly assume the function of utility token rather than cryptocurrency.
Consequently, the classification of most digital tokens does not depend on their nature, but on
their use at the free choice of the holder.
This study will show that the two traditional approaches (Fazzini, 2018) used in corporate
finance to estimate the value of a firm – Discounted Cash Flows, belonging to the family of the
income approaches or market comparables – can be used even with digital tokens, even if many
adaptations seem necessary.
The digital properties of the tokens, including their blockchain features, embody scalability
potential that can be represented by power laws such as Metcalfe’s. These features may influence the
basic valuation parameters, starting from the EBITDA. Other traditional firm evaluation approaches
(the balance sheet approach, the mixed equity/income approach, etc.) that are still used in Continental
Europe, seem unable to capture – and express in market value terms – the peculiar feature of tokens.
To the extent that tokens, with their digital features, can be expressed considering even their
underlying, they show some similarity with either derivatives or holding companies, even if these
somewhat intriguing comparisons are too undefined to represent a real convergence.
2. Back-to-the earth: Functional analysis and business planning as a prerequisite for valuation
The choice of the correct approach and parameters depends on a bottom-up analysis of the
business plan of the target firm (Moro-Visconti, 2022). This helps in the estimate of trendy
parameters (operating and net cash flows; economic margins, etc.) and in the functional analysis that
eases the selection of comparable firms.
The functional analysis is traditionally used for transfer pricing purposes (OECD, 2022). It
analyzes the functions performed (considering assets used and risks assumed) by associated firms in
a transaction, providing an overview of value creation within the supply chain. Transfer pricing
guidelines, with their analytical exposure, provide useful insights for the performing of functional
analysis even beyond the specific transfer pricing case, so representing a valuable albeit
unconventional best practice benchmark for evaluators.
The sequential steps from functional analysis to business planning and firm valuation are
synthetized in Figure 1.

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Figure 1. – Functional analysis, business planning, and firm valuation
Business models incorporate market trends and contain the input factors for firm valuation
(consistently with Figure 1.), as shown in Figure 2.
Figure 2. – From Market Trends to Business Models and Firm Valuation
These general valuation methodologies need to be applied to digital tokens, whenever
possible. Sensitive data are extracted from business models (that depend on functional analysis) and
embedded in business plans. Valuation parameters are economic (revenues; EBITDA; EBIT; pre-tax
profit; net profit), financial (EBITDA; operating cash flows; net cash flows), and asset-based (Equity
Value, Net Financial Position, Enterprise Value). These forward-looking raw data are included in
Market trends
• digitalization
• ESG-compliance
• sustainability upgrade
• value co-creation
• platform intermediation
• technological innovation
• sources contained in market
statistics / outlook / white
papers ...
Business Models
• competitive pressures
• coopetition
• supply chain reengineering /
disruption
• big data-driven augmented
business planning
• sources: market driven
internalized data
• sensitivity / scenario analysis
• economic and financial
margins (EBITDA ...) /
accounting data
Firm Valuation
• value chains
• Discounted Cash Flows (D CF)
• market multipliers /
comparables
• intertemporal appraisal
• impairment test / periodic
valuation refresh
Functional
analysis
Business
planning
Firm
valuation
Comparables;
industry/ market
survey
Economic/
financial/strategic
drivers
Top-down
approach
Bottom-up
feedback

Andrea Cesaretti – Roberto Moro-Visconti, Digital Token Valuation
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composite formulation (Discounted Cash Flows, etc.) that provide the best estimate of the firm’s
value.
A main thesis of this paper is that digital tokens need to be compliant with these general rules,
should we assess their potential value. If they are not, then they are worthless, since rational investors
accept to buy and sell firms (or assets, tokens, etc.) only if they can expect to extract some future
value (especially in terms of expected cash flows). A core issue in the evaluation of digital tokens is
represented by the very fact that they represent a shell (box) that is – in itself – potentially worthless,
unless we consider the embedded value of its underlying asset. The relationship between the “box”
and its contents is, however, uneasy to analyze (as shown in the token definitions).
A further complication is represented by the fact that it is not always clear if and to which
extent the “box/shell” token adds value to its underlying. This dilemma is similar to that concerning
derivatives or holding companies. The value of a derivative depends both on its underlying asset
(stock, commodity, interest or currency rate, etc.) and on its very nature (speculative or defensive, if
detained for hedging purposes).
Holding companies are represented by a legal “shell” that controls one or more underlying
stocks. A holding discount typically occurs, since the holding company's market capitalisation is
often lower than the sum of investments it holds. This discount is due to inefficiencies or frictions
like limited Free float of a holding company, tax inefficiencies associated with the Holding company,
and the additional administrative costs any Holding company incurs. A rational investor may so be
tempted to buy at a discount the holding company, sell off at a premium its contents and lock in a
profitable arbitrage that would soon decrease the discount, reaching par value - but this does not
normally happen, representing a conundrum in appraisal theories.
Something similar may happen with digital tokens, raising an amletic concern: do they really
add value to their underlying contents? (if not, they may be useless or, even more, damaging, as they
destroy value).
Information asymmetries should be considered in this analysis, since they increase the overall
risk of the package (“shell” token + underlying asset). Empirical evidence shows that the returns of
the tokens are not always in line with the trend of their underlyings. The risk profile may be mitigated
or exacerbated, influencing the comprehensive valuation. Should we ask investors what is behind the
digital token they buy and sell, we may get embarrassing or confused answers: many of them simply
do not know what the token really represents, and they are happy with their ignorance, but only if
prices go up and speculative bubbles seem far away.
3. Asset Class Valuation
Investors choose an asset class that refers to a set of items with some features in common.
Historically there have been five main types of asset classes:
a) Stocks (equities)
b) Bonds
c) Cash equivalents (money market vehicles)
d) Real estate
e) Commodities

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Cryptocurrencies are considered a further asset class, even if the question is still debated (see:
https://www.wealthmanagement.com/opinions/opinion-crypto-not-asset-class), as many investors do
not consider it a currency and realize that it has no independent value or inherent utility.
Asset classes can be comprehensively considered within a balance sheet that expresses the
assets and liabilities of a firm, as shown in Figure 3.
Figure 3 – From the balance sheet to the asset classes
The comprehensive valuation of a firm typically considers either the Enterprise Value (equity
+ bonds = financial debt) or the residual Equity Value, ultimately belonging to the shareholkders.
Should cryptocurrencies be considered an asset class, they would be allocated within the
assets (invested capital).
4. Cryptocurrency Valuation
Table 1 contains a taxonomy of the main cryptocurrencies, with some evaluation hints. This
classification is fully consistent with the aim of this study, since it contributes to explain the nature
of the digital tokens that embeds the cryptocurrencies.
Table 1 – Cryptocurrency features and valuation
Cryptocurrency typology Value
Non-backed
Cryptocurrencies
Their value is equally influenced by the level of demand, the level of
the ownership concentration in the market, and the trading volume of
the exchanges or exchange-like entities such as online wallets, OTC
desks, and large institutional traders whether the subsequent use of the
token is staking or pure portfolio investment (Moro-Visconti &
Cesaretti, 2022).
Due to their extreme volatility, from an investor’s point of view, the
valuation methodology is that of very short-term technical analysis.
Some authors have proposed to evaluate bitcoin based on the growth
of the network on the assumption that, assuming user growth is a
leading indicator, one can forecast how the price will react as the
network adds more participants (Maesa, D. D. F., Marino, A., & Ricci,
L., 2017). Since the nodes of the network should be the addresses of
the users
(
Swan
,
2019)
, b
uilding a model based on user growth isn't
Real estate
Commodities
Liquidity
Other assets
(intangibles, etc.)
Stocks
(equity)
bonds
Assets =
Invested Capital
Liabilities =
Raised Capital

Andrea Cesaretti – Roberto Moro-Visconti, Digital Token Valuation
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as straightforward as it may seem. As pointed out by the same authors,
the challenge is determining how many individuals use bitcoin: an
address could be for an exchange that represents countless users.
Then, a single person can have multiple addresses, which would lead
to overcounting.
Other authors speculated on the use of a modified Exchange Equation
Model by John Stuart Mill. The original equation shows the
relationship between the money supply, the velocity of money, the
price level, and an index of expenditures. It assumes that the total
amount of money in circulation is always equal to the total value of
goods and services on the market. The modification of the model for
cryptocurrencies consists in considering, instead of the GDP, (for
example) the request to use bitcoin for cross-border remittances or the
request to use ether to pay gas fees for computing resources in the
Ethereum network (Burniske, 2017). The limit of this theory and its
consequent inapplicability lies in the fact that the Exchange Equation
Model is based on the assumption that money serves as a means of
exchange while cryptocurrencies such as bitcoin and ether have lost
over time the feature of the payment system and (especially the
bitcoin) have become a speculative tool and, as for ether, the fuel of
the Ethereum network ecosystem (Moro-Visconti R., Cesaretti A.,
2022)
.
Backed
Stablecoins
Their price is designed to be pegged to fiat money or exchange-traded
commodities (such as precious metals or industrial metals).
Consequently, the expectations of their price are the same as that of
the fiat currencies or exchange-traded commodities to which they are
anchored. When investors expect a hit in the crypto market, they put
their money into stablecoins to protect their assets. The centralized
entities operating this type of stablecoins must generate revenue and
do so through the yield on their cash e
quivalents.
Crypto-Collateralized
Stablecoins
The value of these stablecoins is pegged 1:1 to a fiat currency (e.g.,
the US dollar).
The stabilization mechanism for on-chain collateralized stablecoins
relies on the option of the holder to redeem the stablecoins for the
collateral assets on demand.
The right to redeem at par value to the official currency of
denomination is not always ensured, meaning redemptions are
dependent on reserve valuation or must be made in kind.
Due to the high volatility of the reserves which are cryptocurrencies,
on-chain stablecoins are typically over-collateralized and their
stabilization mechanisms rely on the continuous valuation of
collateral.

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Algorithmic
Stablecoins
Also, the value of these stablecoins is pegged 1:1 to a fiat currency
(e.g., the US dollar).
While other stablecoins (USDC or Tether) are fiat-backed, these
stablecoins are not backed by real assets. Instead, their value is backed
by sisters’ digital tokens created in the same blockchain of the
stablecoins.
To create these stablecoins, the sister digital token must be burned.
If the value of this kind of stablecoins drops (for example, because
investors liquidate positions), new sister cryptocurrencies must be
minted for them to be burned so new stablecoins can be created. This
creates a chain effect from the stable coin’s price falling to the sister
cryptocurrency price falling as well. This is what has happened to
Luna crypto since May 2022.
The conclusion is that, despite what they claim, these stablecoins are
not stable, but their value is variable like cryptocurrencies, and it is
equally influenced by the level of demand, the level of ownership
concentration in the market, and the trading volume.
5. The digital token underlying
The economic valuation of digital tokens cannot ignore the valuation and financial effects of
their underlying (if and when it exists), synthetized in Table 2. Following the methodological premise
of section 2, whenever the underlying is missing, the digital token has to be appraised considering
only “itself”, as an empty shell/box.
Table 2 – Digital tokens and their underlying
Digital Token Underlying
Non-backed
Cryptocurrencies
None. However, the underlying of Ether could be the entire
decentralized finance ecosystem managed in the Ethereum
network on the observation that ether is the gasoline of that
network
.
Backed
Stablecoins
Fiat money or exchange-traded commodities (such as precious
metals or industrial metals).
Crypto-Collateralized Stablecoins Reserves in cryptocurrencies.
Algorithmic Stablecoins Reserves in sisters’ digital tokens are created in the same
blockchain as the stablecoins.
Digital Tokens linked to the DeFi
projects Market or income approach.
A backed currency is a form of currency that comes with a guarantee that it can always be
exchanged for a predetermined amount of another asset. The most common assets to back a currency
with are gold and silver, but a currency can be backed by anything. Starting in 1879, the U.S. dollar
was backed by gold, largely due to gold’s fungibility and scarcity, important characteristics of money.
Since President Richard Nixon's decision to suspend US dollar convertibility to gold in 1971, a
system of national fiat currencies has been used globally.
Fiat money can be:
•
Any money that is not backed by a commodity.

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•
Money declared by a person, institution or government to be legal tender, meaning that it
must be accepted in payment of a debt in specific circumstances.
•
State-issued money which is neither convertible through a central bank to anything else
nor fixed in value in terms of any objective standard.
•
Money used because of government decree.
•
An otherwise non-valuable object that serves as a medium of exchange (also known
as fiduciary money).
Backing a currency is done by the currency's issuer to ensure its value. Bitcoin and fiat
currencies are not backed by any other asset. The big difference is that a fiat currency is a mean of
exchange to buy any possible physical asset, whereas bitcoins have different features. The difference
between use value (utility) and exchange value (proportion at which a commodity can be exchanged
with other commodities) matters in valuation, and is difficult to adapt to cryptocurrencies (are they
useful or exchangeable?).
Non-backed Cryptocurrencies
have no underlying while, as anticipated, Backed Stablecoins
are pegged to fiat money or exchange-traded commodities (such as precious or industrial metals).
Crypto-Collateralized Stablecoins and Algorithmic Stablecoins are theoretically pegged to fiat
currency.
As regards the latter cases (stablecoins pegged to fiat currency), their valuations should
depend on forecasting the future value of money that, in its turn, requires cross-estimates of many
interacting economic variables. Stablecoins are backed by fiat currency that, as anticipated, … is not
backed. Even if fiat currencies are not backed anymore, after the end of the gold standard, they are
entitled to be exchanged with real goods, and so are – indirectly – stablecoins.
As anticipated, Fiat money is not backed by a physical commodity, such as gold, recalling the
“gold standard” the system, abandoned in the Depression of the 1930s, by which the value of a
currency was defined in terms of gold, for which the currency could be exchanged. Nowadays, fiat
money is a government-issued currency, it is backed by the government that issued it. The value of
fiat money is derived from several factors that can coexist like the relationship between supply and
demand, inflation, possible devaluation, exchange rates, interest rates, money velocity, economic
growth, political stability, and also from the trust that people have over the government. There is no
utility to fiat money in itself. Fiat currencies only have value because the government maintains that
value. Since fiat money is not a scarce or fixed resource like gold, central banks have much greater
control over its supply, which gives them the power to manage many of the above-mentioned
economic variables.
The bottom line is that all those cryptocurrencies cannot be valued. They can also be priced
against other currencies (Damodaran, 2017).
The same conclusions can be drawn for the stablecoins pegged to gold. The price of gold is
closely linked to some of the above-mentioned economic variables. Gold is a hedge against inflation
and therefore its price reacts to changes in inflation. Interest rates are inversely correlated: generally,
the price of gold falls when rates rise. Gold is considered a safe haven. Therefore, geopolitical crises
have a positive impact on its price. Moreover, the price of gold is determined by the demand for
industrial uses and the global production of jewelry.
Finally, the lack of liquidity in the stablecoins market should be stressed. At the time we write,
the total value of the stablecoins locked in the DeFi is 137.03 billion dollars according to
Defillama.com compared to the total marketable value of U.S. Treasury debt is 22,117.6 billion
dollars.

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6. Valuation of the Digital Tokens linked to the DeFi projects
Before proceeding further, a clarification about the cryptocurrency ether (ETH) is necessary.
ETH is the fuel for the entire Ethereum ecosystem, in particular for smart contracts. Consequently,
the ecosystem of decentralized finance can be considered it's underlying because it produces wealth
within the Ethereum blockchain. The quality of ether as a fuel for the network can make this
cryptocurrency observed as a commodity (Damodaran, 2017). In any case, this does not solve the
problem of the difficulty of its valuation. In addition to what has already been said about gold,
including the law of supply and demand, prices can also be influenced by speculation. Investors in
commodities purchase or sell them according to their expectations about future price trends.
While the above factors make market valuation of cryptocurrencies difficult if not impossible,
the situation changes concerning digital tokens related to decentralized finance projects.
Identification of a methodology for the evaluation of digital tokens related to decentralized
finance projects (in particular, utility tokens and security tokens) allows for expressing a judgment
also on the total value of such projects providing useful indications of investment.
The DeFi world has introduced new paradigms in traditional finance and in all areas where
parametric protocols can be applied. For these new technologies to bring real value, it is necessary to
evaluate and select the most effective purpose appraisal techniques, avoiding the illusory
methodologies applied to the Dotcoms at the end of the last century. For this reason, the most effective
evaluation techniques remain those of traditional finance suitably adapted to the DeFi. A security
token includes the right to future returns and, this feature allows to use of evaluation techniques of
traditional finance suitably adapted to the DeFi.
More specifically, the choice of market or income approach depends on the token's liquidity
and the project's stage of development. An additional parameter that influences the choice of one of
the two approaches, is whether the token is directly exchangeable with fiat currency or not.
If the token market is sufficiently liquid and the token is directly exchangeable for fiat
currency, it is reasonable to apply the market approach. On the contrary, when the token cannot be
exchanged directly in fiat currency but requires an intermediate passage of exchange with other
cryptocurrencies as well as if the liquidity is poor (e.g., in the early stage of a project), then it is
certainly preferable to use an income approach.
As anticipated. in a DeFi project, the investors in the token are divided into two categories.
The ones in the first category take an active role because they use the protocol while the ones in the
second category take a passive role by investing in the token only in the expectation of its appreciation
without having a real interest in the project. This classification is a further discriminating factor in
the choice of method as passive investors certainly consider it more useful (because it is faster) to use
a market method.
Interestingly, the property rights (right to rewards and dividends) do not depend on the
category of tokens, but on their use (in stake or not) at the free choice of the holder. These tokens are
utility tokens because they contribute to the operation of the DeFi protocol, but they can assume the
character of security tokens for example when the investor put them in a liquidity pool in exchange
for a reward and/or dividends.
In the US to qualify a token as a security, it must pass the Howey Test based on 4 points: (a)
A party invests money, (b) In a common enterprise, (c) With the expectation of profiting and (d)
Based on the efforts of a third party. The "Howey Test" is a test created by the Supreme Court for
determining whether certain transactions qualify as "investment contracts." If so, then under the

Andrea Cesaretti – Roberto Moro-Visconti, Digital Token Valuation
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Securities Act of 1933 and the Securities Exchange Act of 1934, those transactions are considered
securities and therefore subject to certain disclosure and registration requirements.
For the sake of completeness, however, it should be remembered that some authors argue that
the tokens of decentralized finance do not pass the Howey Test (and, therefore, are not secure)
because their value isn't generated by the efforts of others (Kim, 2022).
In some De.fi. models, the token also gives the holder who participates in a DAO
administrative rights (to cash in dividends, etc.) and voting rights. In this case, the token also assumes
the function of a governance token.
Tokens in passive investors' wallets do not have property rights because they do not entitle to
staking rewards and dividends. We wondered whether this difference affects the valuation criteria
and/or whether the value of tokens is different depending on the type of investor. We have observed,
however, that the difference between the tokens of the (active) investors participating in the project
and those of the passive investors is not comparable to the difference between company shares of
different categories where some types of shares have fewer rights and their price is discounted (as in
the case of non-voting shares to which a discount for lack of those rights -DLVR- must be applied)
(Much and Fagan, 2005; Smith, and Amoako-Adu, 1995). As said, the property rights do not depend
on the category of tokens, but on their use (in stake or not) at the free choice of the holder.
Consequently, the evaluation criteria for tokens should be the same for both categories of investors.
A further consideration confirming this conclusion is that the price of the token is equally influenced
by the level of demand, the level of the ownership concentration in the market, and the trading volume
of the exchanges or exchange-like entities such as online wallets, OTC desks, and large institutional
traders whether the subsequent use of the token is staking or pure portfolio investment (Moro-
Visconti and Cesaretti, 2022).
The De.fi. ecosystem is represented by a distributed network whose architectural design
replicates a blockchain, with no hub (central/hierarchical) nodes. Network analysis may so be ideally
used to consider the scalability properties of evolving networks.
6.1 Income approach
As anticipated, an income approach is preferable when the token cannot be exchanged directly
in fiat currency but requires an intermediate passage of exchange with other cryptocurrencies as well
as if the liquidity is limited (e.g., in the early stage of a project).
The income (economic margin) that refers to the token can, however, undergo several
passages, referring to different underlyings. This value chain represents these steps, along which the
economic margins eventually accrue. The appraisal is uneasy, especially when the chain is long and
its nodes incorporate information asymmetries that increase overall risk.
Income approaches are based on the discounting of future revenue streams. They include both
economic and financial margins, starting from their common denominator (the EBITDA, which
represents the economic/financial marginality derived from the income statement). Most income
valuations are based on cash flow forecasts, remembering that liquidity is an ideal proxy for value
(“cash is king”).
Discounted cash flow (DCF) valuation is used to estimate the value of an investment based
on its expected future cash flows. DCF analysis attempts to figure out the value of an investment
today, based on projections of how much money it will generate in the future from the perspective of
investors. In the case of the digital token, the unlevered DCF formula shall be applied with the

Andrea Cesaretti – Roberto Moro-Visconti, Digital Token Valuation
12/20
appropriate adaptations. The following core question arises: which is the real liquidity created by the
token?
The formula for calculating the value (also) of a DeFi project based on the cash flows
generated is as follows:
 = 


( 
(1+ )+ 
(1+ ) )
w = value of the digital token
CF = Cash flow (dividends + rewards for active investors) at the year t
c = discount or required rate of return
TV =
  =


 ()

p = constant growth rate expected for dividends, in perpetuity.
The DCF formulation is expressed by the Operating Cash Flow (Free Cash Flow to the Firm
- FCFF), before financial debt service, discounted using the Weighted Average Cost of Capital
(WACC). This brings us to the estimate of the Enterprise Value.
The alternative between FCFF and FCFE depends on the structure of the token: should we
consider a “levered” case where the token represents an asset counterbalanced by equity + financial
debt, then we should refer to operating cash flows.
Alternatively, Net Cash Flows (Free Cash Flow to Equity - FCFE) can be discounted at the
cost of equity (traditionally proxied by the Dividend Discount Model or the Capital Asset Pricing
Model) to estimate the Equity Value. This latter alternative is possibly more useful in the evaluation
of tokens since they do not represent a comprehensive firm, but possibly an asset class that is not
levered.
The perpetuity growth rate (p)
Following classical literature, the perpetuity growth rate (p) typically lies between the
historical inflation rate and the historical GDP growth rate. Assuming a perpetuity growth rate more
than GDP growth implies that the project's growth will forever exceed the economy’s growth.
Recent world events show that indicators of GDP growth rate and inflation rate may undergo
unexpected changes that make the choice of the perpetual growth rate even more difficult.
The moment we write, OECD forecasts an inflation rate in the Euro area which ranges from
8.7% in the first quarter of 2023 to 4.9% in the fourth quarter of the same year and the European
Commission expects a GDP growth rate of 0.3% in the same area for the same year. Consequently, a
conservative rate of 2.0% seems to be appropriate.
The discount or required rate of return (c)
There is currently no adequate risk rate in the digital asset market that can be used as a
benchmark, therefore the expected annual returns in equity funding rounds for venture capital should
be used as a tentative proxy. In those cases, the annual expected returns range from 25% to 50%
(Cochrane, 2021 - Todaro, 2018) therefore the discount rate should be chosen within this range
depending on the estimated degree of risk of the project.

Andrea Cesaretti – Roberto Moro-Visconti, Digital Token Valuation
13/20
Criticism of the Total Value Locked (TVL) ratio entry in the formula
While the Gordon Growth Method (Gordon, Myron J., 1959) to find a Terminal Value is the
most suitable metric for DeFi projects, the choice of growth rate is challenging because the DeFi
sector is still young, and no historical indicators are available.
Moreover, like all investment scenarios, the decision to contribute to decentralized finance is
also influenced by factors such as inflation, interest rate levels, credit crunch, and, of course, more
profitable investment opportunities making forecasting a constant presence of investors difficult.
Yet, the trend of crypto assets is influenced by the portfolio policies of institutional investors
who make massive investments (despite some formal aversion to the crypto world) and then balance
the portfolio at the end of the year creating spikes and collapses in the value of tokens that create
doubts and perplexities in the retail market especially as observed between the end of 2021 and the
beginning of 2022. Moreover, as said, the price variability of tokens is influenced by the level of the
ownership concentration in the market and by the trading volume of the exchanges or exchange-like
entities such as online wallets, OTC desks, and large institutional traders (Moro-Visconti & Cesaretti,
2022).
In effect, according to coinmarketcap.com, the DeFi Pulse Index (DPI) (a capitalization-
weighted index that tracks the performance of decentralized financial assets across the market) gained
214,3% from January to November 2021 and then fell by 78.8% in November 2022. Also, according
to defillama.com. the Total Value Locked (TVL) in the DeFi ecosystem lost 74,5% (from 160.99
billion dollars at the end of November 2021 to 41.09 billion dollars at the end of November 2022).
Furthermore, the growth rate of a business is not uniform over time and should be modulated
according to the different stages of development (start-up, growth, maturity, renewal, or decline).
Finally, as it happened with the DeFi trading platforms Bancor in June 2022, platforms
through which tokens can be pooled can suspend the right to put them in staking (and to withdraw
them) at times when the market is unstable or hostile as well as for malfunctions or hacker attacks.
All these circumstances, combined with the poor maturity of the DeFi sector, make us believe
that it is not appropriate to include the Terminal Value in the formula or not.
Accordingly, the formula of the DCF
equity
should be used in its simplified form:
 = 


( 
(1+ ) )
w = value of the DeFi project
CF = Cash flow (dividends + rewards for active investors) at the year t
c = discount or required rate of return
Once the present value of the cash flows has been determined, the calculation of the market
value (W) of the company may correspond to the:
(a) unlevered cash flow approach (to estimate the Enterprise Value):
 = ∑



+  − 

Andrea Cesaretti – Roberto Moro-Visconti, Digital Token Valuation
14/20
(b) levered cash flow approach (to estimate the Equity Value):
 = ∑




+
where:
∑


⁄ = present value of operating cash flows (FCFF)
∑



⁄ = present value of net cash flows (FCFE)
TV = terminal (residual) value
D = initial net financial position (financial debt - liquidity)
WACC = average after-tax cost of a company’s various capital sources (cost of collecting
external capital), including common stock, preferred stock, bonds, and any other long-term
financial debt.
Applying this index to two popular tokens (Sushi and Uniswap) and assuming the following
data taken from coinmarketcap.com:
- t = 10
- CF = reward per token in stake on the assumption that they remain constant
- Sushi’s CF per token = $ 0,9554 x 0,045 = $ 0,043
- Uniswap’s CF per token = $ 4,99 x 0,07 = $ 0,349
- c = 38% (average between 0.25 and 0.50)
one gets:
- value of the Sushi project per token: $ 0,11
- value of the Uniswap project per token: $ 0,89.
6.2 Market Approach
If the token market is sufficiently liquid and the token is directly exchangeable for fiat
currency, it is reasonable to apply the market approach, referring to comparable transactions.
While the previous methodology allows us to calculate the value of a DeFi project at present,
the following formulas allow us to compare its relative value with its competitors or its previous
performance.
In the case of comparable companies, the approach estimates multiples by observing similar
firms (Fernandez, 2001). The problem is to determine what is meant by similar companies. In theory,
the analyst should check all the variables that influence the multiple. These classic considerations
have to be adapted to the digital token context.
In practice, companies should estimate the most likely price for a non-listed company, taking
as a reference some listed companies, operating in the same sector, and considered homogeneous.
Two companies can be defined as homogeneous when they present, the same risk, similar
characteristics, and expectations.
The calculation is:
- A company whose price is known (P
1
),
- A variable closely related to its value (X
1
)

Andrea Cesaretti – Roberto Moro-Visconti, Digital Token Valuation
15/20
the ratio (P
1
)/(X
1
) is assumed to apply to the company to be valued, for which the size of the
reference variable (X
2
) is known.
Therefore:
(P
1
)/(X
1
) = (P
2
)/(X
2
)
so that the desired value P
2
will be:
P
2
= X
2
[ (P
1
)/(X
1
)]
According to widespread estimates, the main factors to establish whether a company is
comparable are:
- Size;
- Belonging to the same sector (see for instance the Statistical Classification of Economic
Activities in the European Community, commonly referred to as NACE);
- Financial risks (leverage);
- Historical trends and prospects for the development of results and markets;
- Geographical diversification;
- Degree of reputation and credibility;
- Management skills;
- Ability to pay dividends.
Founded on comparable transactions, the basis of valuation is information about actual
negotiations (or mergers) of similar - i.e., comparable - companies.
The use of profitability parameters is usually considered to be the most representative of
company dynamics.
Among the empirical criteria, the approach of the multiplier of the EBITDA (Earnings Before
Interest, Taxes, Depreciation, and Amortization) is widely diffused, to which the net financial position
must be added algebraically, to pass from the estimate of the enterprise value (total value of the
company) to that of the equity value (value of the net assets). The formulation is as follows:
W = average perspective EBITDA * Enterprise Value / sector EBITDA =
Enterprise Value of the company
And then:
Equity Value = Enterprise Value ± Net Financial Position
6.3. The Total Value Locked (TVL) ratio
As said, in DeFi projects, investors can take an active role (they use the protocol) or passive
(they invest in the token only in the expectation of its appreciation without having a real interest in
the project and this leads to an increase in market capitalization).
The TVL, therefore, reflects the real appreciation of the market for the project itself and, for
this reason, is an important indicator of its value.
The TVL ratio, in its turn, is an indicator of whether a particular DeFi project is overvalued
(ratio > 1) or undervalued (ratio < 1).

Andrea Cesaretti – Roberto Moro-Visconti, Digital Token Valuation
16/20
  =  
  
Where:
-   =     .
Market Capitalization is analogous to the free-float capitalization in the stock market.
- Maximum Circulating Supply is the number of tokens that will ever exist in the lifetime of the
project. It is analogous to the fully diluted shares in the stock market.
Applying this index to two popular tokens on 29 December 2022 gives the following results
applied to data taken from coinmarketcap.com:
ℎ 

   = $ 212.315.366
250.000.000 = 0,85 = 
 

   = $ 3.795.124.717
1.000.000.000 = 3,80 = 
Consequently, the Sushi token is more attractive to investors.
6.4. The Market Cap to Total Value Locked Ratio
The market capitalization expresses the market value of a listed stock. It can be used as an
ideal proxy for the estimate of the market value of a digital token.
Total value locked is a metric that is used to measure the overall health of a DeFi protocol.
There are three main factors that are taken into consideration when calculating and looking at a
decentralized financial services' market cap TVL ratio: calculating the supply, the maximum supply
as well as the current price.
The market cap to TVL ratio is calculated by dividing the market cap of crypto by its total
value locked (TVL).
Even the Market Cap to TVL ratio is an indicator of whether a particular DeFi project is
overvalued (ratio > 1) or undervalued (ratio < 1).
The TVL and the market cap of a project are both indicators of market value. However, they
are not the same even if it is advisable to look at both indicators. While a market cap is a simple way
to show the value of one company, based on its one stock type or cryptocurrency, a TVL can show
the value of a project, based on its inner workings across different locked assets.
     =   ($)
   ($)
Applying this index to the same two popular tokens on 29 December 2022 gives the following
results also applied to data taken from coinmarketcap.com:
ℎ      = $ 212.315.366
$ 2.287.403.208 = 0,09 = 

Andrea Cesaretti – Roberto Moro-Visconti, Digital Token Valuation
17/20
      = $ 3.795.124.717
$ 3.336.088.430 = 1,14 = 
This index confirms that the Sushi token is more attractive to investors.
6.5. The Price to Earnings Ratio (P/E)
A P/E (price-to-earnings) ratio is a metric that compares a company's share price to its annual
net profits. This ratio can be used to compare companies of similar size and industry to help determine
which company is a better investment. This ratio is commonly used for listed securities and represents
an investment benchmark.
A high P/E ratio indicates a growth forecast in the value of tokens according to operators. In
contrast, investors prefer lower P/E ratios because they indicate that the price of the token is
affordable. In the case of decentralized finance, the formula must be adapted as follows:
P/E ratio = Current Token Price / Dividend + Rewards per Token
Applying this index to the same two popular tokens on 29 December 2022 gives the following
results also applied to data taken from coinmarketcap.com:
ℎ 


P/E ratio = 0,9554 / 0,045 = 21,23
 


P/E ratio = 4,99 / 0,07 = 71,29
Consequently, at the date, it seems that the market predicts a higher growth of the value of the
Uniswap token than that of Sushi.
7. Valuation of Non-backed Cryptocurrencies locked-up in staking on a Proof-of-Stake (PoS)
network
Crypto staking is the process of locking up crypto holdings in order to obtain rewards or earn
interest. Cryptocurrencies are built with blockchain technology, in which crypto transactions are
verified, and the resulting data is stored on the blockchain.The purpose of blocking tokens on a Proof-
of-Stake (PoS) network is to propose, attest, and add blocks to the blockchain. It is a revenue-
generating task for the benefit of the validators chosen by the protocol to submit a new block to the
chain. The staking yield can be calculated as follows:
   =   
   − %    ℎ
Where:

Andrea Cesaretti – Roberto Moro-Visconti, Digital Token Valuation
18/20
  
=        
   
And
    =
=(  
+   )    ℎ  24 ℎ  365 
As anticipated, such staking is a revenue-generating task and, consequently, the valuation of
the token could be based on yield flows. The problem is that much of the information needed to apply
the model is uncertain or unknown:
- the transaction fees are usually voluntary payments by the users,
- it is particularly difficult to predict the number of new tokens issued because this measure is
based on the total stake in the network,
- variables like “Blocks per hour”, “Validator Staking Balance” and “% Loss due to Slashing” are
necessarily unknown (Slashing is a mechanism to give penalties for breaking protocol rules. They
result in the reduction of the validator’s locked tokens or its rewards.
8. Conclusion
The main approaches to evaluating companies commonly used in practice are:
- The balance sheet-based approach, is simple and complex;
- The income approach;
- The mixed capital-income approach;
- The financial approach;
- Market approaches and valuation through multiples.
The balance sheet based and the mixed approach are not applicable to digital tokens that
represent an asset class, not a firm with a comprehensive balance sheet, composed of assets versus
liabilities and equity.
The central element in determining the value of a firm is the estimate of its future ability to
generate an income or financial flow capable of adequately rewarding its shareholders after debt
service.
Among the approaches used by operators to identify the market value of the firm, the financial
and income approaches are the most appropriate to represent the expected fair remuneration of
shareholders. This also holds for digital tokens, as shown above.
The economic valuation of digital tokens cannot ignore the valuation and financial effects of
their underlying. The consequence is that, despite various proposed approaches, the valuation of
tokens that do not have an underlying (such as bitcoin) and of tokens pegged to fiat money, precious
metals, or cryptocurrencies is almost impossible. Alternatively, it is possible to make economic
valuations of digital tokens linked to decentralized finance projects that incorporate rights to financial
returns. In those cases, an income approach is preferable when the token cannot be exchanged directly
in fiat currency but requires an intermediate passage of exchange with other cryptocurrencies as well
as if the liquidity is poor (e.g., in the early stage of a project).

Andrea Cesaretti – Roberto Moro-Visconti, Digital Token Valuation
19/20
Various circumstances, combined with the poor maturity of the DeFi sector, make us state
that it is not appropriate to include the Terminal Value in the formula. On the contrary, if the token
market is sufficiently liquid and the token is directly exchangeable for fiat currency, it is reasonable
to apply the market approach. Two methods can be applied. The Total Value Locked (TVL) ratio
reflects the real appreciation of the market for a DeFi project and, for this reason, is an important
indicator of its value. Usually, investors prefer to adopt the method of the Price to Earnings Ratio
(P/E). They prefer the lower P/E ratios because they indicate that the price of the token is affordable.
However, in the case of the DeFi projects, the traditional formula must be adapted.
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