Debate: How to Value an L1 Token

This episode delves into the critical debate on valuing Layer 1 (L1) tokens, contrasting cash-flow-centric models with those emphasizing monetary premium, and exploring what this means for Crypto AI investors and researchers assessing long-term viability.

The Quest for Superior L1 Valuation Metrics

• Jonah Weinstein, an investor at Skycatcher, opens by stressing the investor's need to "understand really the opportunity we're underwriting." He argues for frameworks that clarify return drivers and risks, enabling informed decisions based on a measurable thesis about a token's potential price appreciation.
• Dan Smith, Head of Data at BlockWorks, highlights the disconnect: Layer 1 (L1) smart contract platforms, which facilitate decentralized applications and form the base layer of blockchain ecosystems, command hundreds of billions in market capitalization, yet "we don't have a great answer at the moment to why that's the case or what drives those valuations." The core challenge is moving beyond disparate ideas to a unified valuation model.

Limitations of Current Crypto Metrics

• The discussion addresses why existing metrics like stock-to-flow, PQ=MV (an equation of exchange model), and TVL (Total Value Locked), which represents the total value of assets deposited in a decentralized finance protocol or blockchain, have proven insufficient for comprehensive L1 token valuation.
• Dan Smith points out that while metrics like TVL are "super useful" for gauging capital within an ecosystem, "it's not clear today how that number translates into a market cap or a fully diluted valuation." The goal is to bridge this gap, potentially using metrics like REV to forecast cash flows and build equity-style valuation models.
• Jonah Weinstein emphasizes the need for metrics "rooted in what is really driving value to these tokens," moving beyond conceptual or top-down views to measure specific on-chain events.

Defining the L1 Token: Company, Commodity, or Money?

• The host introduces a common point of confusion: whether L1 tokens should be viewed as companies, commodities, or money.
• Jonah Weinstein firmly positions L1 tokens as fitting the definition of money, specifically "commodity monies." He references John Pfeffer's 2017 paper simplifying money's functions to "store of value and payments."
• L1 tokens are the primary means of "paying for transactions."
• They are staked for yield (a native return for taking duration and liquidity risk) and used extensively in DeFi (Decentralized Finance), which encompasses financial applications built on blockchain technology, as collateral and liquidity.
• Jonah argues, "they really don't fit the traditional equity style... value accrual mechanism." Unlike equities where investors analyze their pro-rata share of cash flows, L1 staking yields are paid in the native token. Valuing this future yield in USD requires an assumption about the token's future exchange rate (forex rate).

Dan Smith's Nuance on L1 Tokens as Money

• Dan Smith concurs that L1 blockchains are not companies, being networks of diverse stakeholders (validators, token holders, infrastructure providers like Flashbots or Jito for transaction processing, and staking operators like Lido or Figment) rather than single legal entities.
• While agreeing L1 tokens fit the definition of money, Dan questions if their current usage fully justifies valuing them as money, especially when compared to a hypothetical future where "global trade is settled on chain."
• He finds the "store of value thing – I want to use this vehicle to transport wealth through time – that's the most interesting commodity-like aspect in my mind."
• Dan also touches upon payment abstraction, where users might transact in their preferred currency (e.g., USD via credit card in Europe) while the merchant receives local currency (EUR). This highlights that the user experience can obscure the underlying settlement currency.

The L1 Settlement Layer and Store of Value (SOV) Demand

• Jonah Weinstein clarifies that even with payment abstraction, the "currency of settlement... is euro" in Dan's example. For L1s, the native token is the unit of account for on-chain goods and services, primarily transactions.
• He notes that while transaction fees are deflationary due to scaling, "the supply of the token does not scale as demand for those two use cases [staking and DeFi] of the token scales." This inelastic supply for SOV use cases, contrasted with the elastic supply of blockspace, is where Jonah sees "the meat of the monetary value accruing."

Challenging Traditional Discounted Cash Flow (DCF) Models for L1 Tokens

• Jonah Weinstein outlines two primary shortcomings they encountered when applying traditional DCF (Discounted Cash Flow), a valuation method used to estimate the value of an investment based on its expected future cash flows, to L1 tokens:
• The Forex Rate Dilemma: Stakers earn yield in the L1 native token (e.g., ETH, SOL). To value this future native yield in dollar terms, "you have to make a forward assumption of what that exchange rate is going to be in the future." This inherently pulls L1 valuation towards currency valuation paradigms.
• Overlooking DeFi-Driven Demand: A simple DCF misses the substantial demand for the native L1 token within its DeFi ecosystem, where it serves as primary collateral and a key component of liquidity pairs. Jonah notes, "50 to 70% of [DeFi deposits] are all the native token."

The Core Debate: Dollar-Denominated Demand vs. Native Token Settlement

• Dan Smith posits that many users, especially new ones, express their demand to transact in dollar terms (e.g., bringing $1000 on-chain to trade). He argues this allows for forecasting transaction spend (REV) in dollars, making a DCF more viable without getting caught in the "circularity" of needing a future token price to value token-denominated cash flows.
• Jonah Weinstein counters that this is not about psychology but "ground truth." He states, "the reality is that when they transact... the unit of exchange that is happening here is in the native token." For investors holding the L1 token, "they are earning a native yield."
• He uses a "litmus test": if one entity held all L1 tokens, the network would be unusable, unlike a company. This underscores the token's essential role as a distributed medium of exchange for network services.
• Jonah emphasizes that even if projecting dollar-denominated activity, "you have to make some forex assumption" because the underlying settlement and investor earnings are in the native token. This forex bet, he argues, "is really the core bet we're making."

Introducing RSOV: Realized Store of Value

• Jonah Weinstein introduces RSOV (Realized Store of Value), a metric developed by Skycatcher.
• RSOV is calculated as: Realized Value of L1 tokens Staked + Realized Value of L1 tokens in DeFi.
• "Realized Value" is effectively a rolling cost basis, tracking the aggregate price at which tokens entered these specific use cases.
• Jonah explains, "with RSOV we're measuring these capital inflows... specifically we're honing in on these two use cases that are SOV in nature and very fundamental and like core to the network." It aims to quantify the monetary value accumulating in the L1 token due to demand for staking and DeFi participation.

Introducing REV: Realized Economic Value

• Dan Smith explains REV (Realized Economic Value), a metric he worked on.
• REV is "a standardized metric to track blockchain value accrual based on user activity." It is calculated as: Fees + Tips paid by users for blockspace.
• Fees include in-protocol charges like base fees and priority fees.
• Tips encompass out-of-protocol payments for transaction ordering or inclusion, such as those facilitated by systems like Flashbots (Ethereum) or Jito (Solana).
• Dan clarifies, "the intent of REV is not to be a valuation metric. It is literally a demand metric... a financial metric to see what users are paying for chain." While it can be used in valuation ratios (e.g., Price/REV, similar to Price/Sales), its primary purpose is to gauge demand for blockspace.

RSOV and REV: Distinct but Potentially Complementary

• Jonah Weinstein views REV as a "fine way to measure the value captured by the validators from transaction activity." However, he believes RSOV offers a broader perspective for investors by incorporating the "FX component" and DeFi-driven SOV demand.
• Interestingly, Jonah suggests RSOV can, in a way, capture REV over time: "as those fees accrue to the validators and the validators just compound... the realized value [component of RSOV related to staking] will increase over time."
• Both speakers seem to agree that the metrics are not necessarily adversarial; REV measures immediate transactional demand value, while RSOV attempts to quantify a broader, monetarily-driven store of value aspect.

The Significance of "Hotspots" and Average Transaction Fees

• Addressing concerns about transaction fees trending to zero, Dan Smith distinguishes between median and average fees. While median fees for simple transactions might approach zero due to blockchain scaling, "average fee I don't expect to do that."
• This is due to "hotspots" – instances of high demand for blockspace for specific, valuable actions like arbitrage opportunities or popular NFT mints, leading to state contention (multiple users competing for the same state change). Anatoly Yakovenko, co-founder of Solana, is referenced as saying "median fees to zero, hotspots to infinity."
• Jonah Weinstein concurs, seeing these hotspots as a "durable driver of real yield" from sequencing, which is crucial as an incentive for holding L1 tokens, especially given their inherent risks compared to assets like Bitcoin.

Monetary Premium and Capital Flows in L1 Valuation

• Dan Smith acknowledges the importance of the "monetary premium" and capital flows in driving L1 token prices, making RSOV "really interesting at trying to get at that number." However, he finds it "harder to square" this with a token's intrinsic value.
• Jonah Weinstein argues that since L1 tokens are fundamentally "money," their value is "really driven by the capital inflows and outflows," not intrinsic operational value like a company. He connects this to a broader market trend of seeking "non-government money" alternatives, with L1 tokens (offering native yield and transparent monetary policy) being part of this category alongside Bitcoin, gold, and real estate.

Interpreting RSOV and its Relation to Market Cap

• The host questions how to interpret Ethereum's RSOV trending up while its price hasn't always followed suit.
• Jonah Weinstein explains that RSOV represents the token's aggregate cost basis for staking and DeFi. The market capitalization can trade at a premium to this RSOV. This "premium... tells you in dollar terms how much... the cost basis... has to rise... that the market has currently priced in."
• A Price-to-Value ratio (Market Cap / RSOV) can be used. A lower ratio might indicate less growth premium baked in. Investors can also analyze the annualized change in RSOV to gauge if the current multiple is justified by its growth rate.
• Dan Smith raises methodological questions about RSOV, such as the impact of price volatility on inflow/outflow calculations when tokens are unstaked (e.g., unstaking ETH at a much higher price than when it was staked) and the exclusion of tokens simply being held in wallets (not staked or in DeFi). Jonah clarifies RSOV focuses on measurable, on-chain SOV activities.

The Future of L1 Valuation: Real Yield and Strategic Focus

• Responding to an audience question from Tom Dunlevy about REV's viability with ultra-low fees, Dan Smith reiterates the median vs. average fee argument and the significant, often overlooked, benefits of building on established L1s (e.g., CEX integrations, wallet support, oracle access, data indexing). These network effects create stickiness.
• Jonah Weinstein agrees on the durability of real yield from sequencing/hotspots, arguing it's essential to compensate for the risks of L1 tokens relative to Bitcoin. "The market... is pricing that risk relative to Bitcoin and relative to each other."
• Dan Smith concludes that investors should discern which L1 teams are "thinking very deeply about the fact that this [contentious state and sequencing fees] is true and their contentious state matters a lot," versus those who believe all fees will inevitably go to zero.

Concluding Perspectives on RSOV and REV

• Dan Smith reiterates his interest in RSOV for tracking capital flows but maintains his core disagreement on the primary denomination of user transaction demand (dollars vs. native L1 token units), which impacts the direct applicability of DCF models. He sees immense potential if L1s settle global trade, generating real yield from worldwide transaction demand.
• Jonah Weinstein, from an investor's standpoint, emphasizes that "it's really about are people buying and holding this token long term." Even if users think in dollars, the on-chain settlement in native tokens and native yield for investors necessitate a model like RSOV that accounts for the token's "forex rate" and the demand to hold it as a store of value.

Reflective and Strategic Conclusion

This debate underscores that L1 token valuation requires a multi-faceted approach, considering both transactional utility (REV) and monetary characteristics (RSOV). Crypto AI investors and researchers must analyze how L1s balance generating real yield via mechanisms like MEV/hotspots with fostering long-term store-of-value demand, as this interplay will likely define sustainable value.