Bankless - Why $ETH is going to $3T | Ryan Allis

Episode Date: February 2, 2022

CORRECTION: It's actually ETH to $4 Trillion 👀 Ryan Allis is the managing partner at Heart Rithm, and a serial entrepreneur with 20 years in technology, marketing, and business. Ryan write about Ethereum, Bitcoin, Polkadot, DeFi, Blockchain, Web3, and the future of money on his substack - Coinstack. Today, we're evaluating ETH according to Ryan's recent DCF (discounted cash flows) model, and getting to the bottom of why ETH could be fairly valued at $10k with a market cap of $3 Trillion. Model:  https://docs.google.com/spreadsheets/d/1_IqNzqm-_Jlk-cK4twQ-bzhJKrsOhrckdQA2isTwKRA/edit#gid=0  ------ 📣 ZERION | Trade Across 7 Networks and 500+ protocols https://bankless.cc/Zerion  ------ 🚀 SUBSCRIBE TO NEWSLETTER:          https://newsletter.banklesshq.com/  🎙️ SUBSCRIBE TO PODCAST:                 http://podcast.banklesshq.com/  ------ BANKLESS SPONSOR TOOLS:  ⚖️ ARBITRUM | SCALING ETHEREUM https://bankless.cc/Arbitrum  🍵 MATCHA | SMART ORDER ROUTING https://bankless.cc/Matcha  🚀 SLINGSHOT | LAYER 2 SOCIAL TRADING https://bankless.cc/Slingshot  🏦 GEMINI | TURN FIAT INTO CRYPTO https://bankless.cc/Gemini  🦁 BRAVE | THE BROWSER NATIVE WALLET https://bankless.cc/Brave  🦄 UNISWAP | DECENTRALIZED FUNDING https://bankless.cc/UniGrants  ------ Topics Covered: 0:00 Intro 6:00 Ryan Allis, ETH, Cash Flows 12:29 Making a DCF for ETH 16:34 Costs & Security 21:16 Generating Insane Revenue 31:42 The Outputs are Sexy 40:55 Monetary Premium 47:00 Buybacks & Distribution 52:14 Markets vs Education 57:02 Alt Layer 1's & L2 1:03:25 Memes vs Fundamentals 1:08:19 Closing & Disclaimers ------ Resources: Ryan on Twitter: https://twitter.com/ryanallis?s=20  CoinStack: https://twitter.com/coinstackcrypto?s=20  HeartRithm: https://twitter.com/HeartRithm?s=20  ----- Not financial or tax advice. This channel is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This video is not tax advice. Talk to your accountant. Do your own research. Disclosure. From time-to-time I may add links in this newsletter to products I use. I may receive commission if you make a purchase through one of these links. Additionally, the Bankless writers hold crypto assets. See our investment disclosures here: https://newsletter.banklesshq.com/p/bankless-disclosures 

Hey, Bankless Nation, excited about this State of the Nation episode. David, you ready to talk about ETH, the asset, my friend? It's my favorite asset, Ryan. I don't know if people know this, but I'm really bullish on ETH. And it's been a while since we have discussed why and what are the numbers behind the bullishness. Because that is the cool thing about ETH is there are actual numbers there. We can actually unpack and discuss some of the reasons why ETHER you can be bullish on ETHER. Yeah, so like I think this this obviously if you guys been listening to bank lists, you know that we think eth is undervalued.

But how much, how much, by how much, what is the model to prove that this is undervalued? And I don't think this is the end all be all model. It's a discounted cash flow analysis. It's fantastic for, you know, capital assets like stocks and, you know, equities and bonds and and. Dividend producing assets. But our guest today will show us why Ether, if you use a discounted cash flow model based on his blockchain fees alone, Ether should be worth $4 trillion. What?

It's not worth $4 trillion. I only put $3 trillion in the tweet. I guess I wasn't bullish enough. Yeah, it's kind of up, okay? The model was just updated as of today for these new numbers. We have Ryan Alice on the podcast who's going to walk through this discounted cash flow analysis. This is part of the reason we think ETH is undervalued. So stay tuned.

Sharpen your pencil. We're going to crunch the numbers. We're going to open up some spreadsheets. And we're going to take a look at this asset in some more detail. Before we do, David, we should talk a bit about our friends and sponsors at Xerion because they are doing some awesome things. We are huge fans of Zeran. I think last time we told you about their new NFT features.

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But let me ask you the question. We begin every state of the nation episode with, and that is this. What is the state of the nation today, sir? The state of the nation, Ryan, is aspiring. We are aspiring. We are dreaming bigger dreams. This is always something that I think people, when they try and reason about ether and reason about Ethereum, they need to dream bigger dreams.

And so, Ryan, today we are aspiring to dream bigger dreams. And we've got the receipts to back that up. And that is what we are going to unpack. to the day today, the receipts that back up the rational as to why people who are bullish ether should dream bigger dreams. We're going to get to the episode, but before we do, we want to thank the sponsors that made this episode possible. Slingshot is a decentralized trading platform that combines the performance and ease of a centralized exchange with the openness and transparency of DFI. Slingshot aggregates liquidity from all of DFI in order to find the best price

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Hey, everyone. We are back with Ryan, Alice. We are going to model the fair price of ETH today. I hope you're ready for it. Ryan is a managing partner at HeartRhythm, which is a crypto hedge fund. He's a serial entrepreneur as well. A ton of experience in the space. Also has a fantastic newsletter that I subscribe to. It's called CoinStack, where he writes about Ethereum, Bitcoin, Pocod, all of the other chains, Web3, the future of money, everything I'm sure bankless listeners are interested in. Ryan, welcome to Bankless. It's great to have you on. Thank you, Ryan. Super excited to be here on Bankless. I'm a big fan, and it's been a goal to be here, and I'm happy to be here today.

Well, you made it with this analysis, my friend. It's a fantastic analysis, and this is probably a honeypot for coming on the podcast, right? Because we are just definitely drawn towards these sorts of things. Listeners of the podcast know we think ETH is undervalued, and you are bringing some numbers to the table to prove it. So we're going to go through your discounted cash flow model here in a second. And, you know, I don't want to bury the lead here, because basically you are predicting according to the valuation of discounted cash flow that ether should be a lot more valuable than it is today.

Okay, above 10K, three to four trillion dollars is what the model says. But I want to start with this question for you, Ryan. So what do you, how do you think about ETH, like from a valuation perspective, high level? I know we're modeling it here as a discounted cash flow, but how do you describe ETH when someone asks about it. Is it like a stock? Is it like a money? Is it a commodity? Is it something else? What words do you use to describe it? Yeah, obviously, ether is all kinds of things. I like to think of ether as the token of the new digital age. It's the primary money of the internet. And I think from a valuation perspective, you can look at it as a commodity. You can look at as utility. What ultimately drives the value of

Ether is going to be demand to buy the token to actually use it on the Ethereum blockchain. And so there's a core demand that drives the price of ETH over time. And as more people want to use the Ethereum blockchain, that price of ether is going to go up. And also, we now have cash flows soon coming after the merge with the proof of stake transition to holders of ETH. And that in and of itself is going to drive institutional buyers to further purchase more ether. One question I have.

Go for a round. I was just going to ask, could you ground us, Ryan, just for a second in, you said cash flows. And what we're going to look at in just a minute or two is a discounted cash flow analysis. But people who don't have experience with this sort of thing, didn't take finance in school, aren't trying to value equities. Can you give us the TLDR on what a discounted cash flow analysis actually is and why it's important? Absolutely. So just briefly on my background, I spent 10 years building a soft.

company, a CEO called Eye Contact in North Carolina. And then I did it to two-year MBA at Harvard Business School. And when you go to Harvard Business School as an MBA student, they grill into you that the way you value any asset is the present value of future cash flows. And so you can, and anyone can, model out the future expected cash flows of Ethereum. Now, this is something that you couldn't do two years ago. And it's only since the EIP 1559 update in August when they began burning using some of the rent revenues from the transactions to burn the tokens, which you can think of sort of like a stock buyback. It's reducing the supply of ether. If there's 118 million ether today, that's going to go down if you follow Justin Drake's model over the next 10 years, probably to 100

million ether, somewhere around there. And so it's like a stock buyback where it's reducing the supply. And then the key thing is for anyone that follows bankless, you know that coming later this year, we have the merge, we have the proof of stake merge, and we will soon have the rest of those cash flows that aren't going to burn the ether, going to long-term stakers, which are long-term holders. So you can think of that as a dividend. You can think of that as a on-chain cash flow to holders, which is going to be very, very attractive. When you combine those two, that means that a 100% of the revenues that are being paid for in the auctions to use the Ethereum blockchain are going to be paid out directly or indirectly to holders. And because of that, you can build

a discounted cash flow to price ether. So we've got two mechanisms here. We've got one, a stock buyback. And then two, we have a dividend distribution. And the reason that discounted cash flow makes sense is because these mechanisms are in place when you model the price of an equity. And, Harvard and the MBAs of the world and the business undergrads have been doing this for decades already. And that's why the same tool set applies here in your mind. Is that the case? Yeah, that's exactly correct. You could look at Ether as having additional value as a monetary value or utility value. But what I'm looking at is purely based on the cash flows, the folks sitting in New York and Singapore and London that are going to be valuing Ether from a business perspective,

a year from now, two years from now, trying to come up with what is the fair value of this asset based on cash flows alone, this is the model they're going to be using to be able to value how much should ether be priced at in terms of total market cap and then in terms of per ether. So for all the listeners out there that don't have a business background or a finance background, I don't know, maybe you like perhaps me graduated with a degree in psychology and the name discounted cash flow is like, what? The reason why we have this discounted word in there is.

is because you have to give a discount for money that you don't have today, but you do have in the future. And so if we think that this company or equity or crypto asset is going to be producing money for us in the future, money for you in the future is nice, but it's not as nice as it is money today. And so that's where the word discounted comes in because we have to make some sort of assumptions

as to how to devalue money in the future versus money that we have today. I just wanted to unpack that discounted cash. flow side of things. Ryan, you want to add anything to that? Yep, that's exactly right. $100 in your pocket today is worth more than $100 in your pocket 10 years from now. So that's why we discount it to create the value of it today. And Ryan, I'm assuming that you've made discounted cash flow models for other assets before. Looking at your model for Ether, it kind of seems like you've done this a few times.

But how is Ether as an asset different? What's it like to go and do a DCF for Ether. Is it, you know, similar run of the mill like, oh, let me just plug in the numbers, or are there any curveballs for producing a model like this? What's it like to produce a DCF for Ether? Well, when you're doing a DCF for a company, all you really need are its current revenues, its current expenses, and then you take it what it's or its current net profits. And those net profits are essentially its annual cash flows. And then you provide a growth rate that you assume that those cash flows are going to grow. And usually DCFs are done over, say, a 15 or 20 year period. You're projecting the future cash flows of a business. Now, that could go up. That could go down.

But generally speaking, a growing business is going to grow at some average rate per year. The U.S. economy is growing about, you know, three to four percent a year, somewhere like that. If a fast growth company might grow at 30 or 40 percent a year. Now, what's interesting with ether is two things. Number one is that because, Ethereum is a distributed ledger technology. It's a smart contract platform. There actually aren't any costs of running the network. The costs are all paid for by the third parties that participate in providing security to the platform.

There's no centralized Ethereum company that has a staff that has, you know, people they have to pay. There's, of course, the Ethereum Foundation, but that's completely separate from the Ethereum blockchain itself. And so what's unique, this is the very first asset I've ever seen in 15 years of looking at different assets where there are no costs. So 100% of the revenue from the Ethereum blockchain is profit. 100% is cash flow. There is no overhead. There's no servers. There's no electricity.

It's paid for by the third party validators. And so that's something that's extremely unique. In an average business, maybe they'd have 10% net profits. With Ethereum, you have 100% net profits. The other thing that's extremely unique is most businesses tend to grow about 10 to 30% a year. Ethereum, if you just look at January 2022, the month that just ended, and you compare that versus its revenues a year ago in January 2021, which of course, even then we were in the middle of a bull market, we have grown revenues year over year for Ethereum by 400%, 47% exactly,

year over year. And so what's interesting about this is not only do we have 100% revenues, are cash flows, we also have a growth rate that's more than 10x an average growth company. And yet Ethereum is still trading at a price to earnings multiple that is lower than an average company. So there's a lot of opportunity for upside. Yeah. So those two points, you know, the second point that you said is the growth, right? David's getting pretty hot and steamy over there. So we better slow down and get a little bearish for a second. But, you know, the first point where you said there are no cost, Ethereum doesn't have any costs. Just want to clarify that with you.

Because I guess from the perspective of the Ethereum network, the cost, the thing it's paying for is security. And that I guess is it's from the Ethereum network. That is its expense line item. But I think you're looking at it from a staker's perspective or a validator's perspective, where all of this network security costs actually comes back in the form of a dividend, if you are a staker, right? So right now, hopefully listeners will know that Ethereum is completely proof of work. So unless you run mining nodes, you are not receiving any of that revenue. But in the future, proof of stake, hopefully June, July of this year, then if you are staking in the network, that means you own Ethan and you actually stake it, then you are a recipient

of that revenue. Is that what you mean by no cost? Because if you're a staker, you just get that revenue? That's exactly right. Now, with Bitcoin, you can't do a DCF model because on the Bitcoin network, which has revenues, they're about, you know, 95% lower than the Ethereum network revenues, but Bitcoin blockchain does have some revenues. None of those revenues go to long-term holders. They all get paid out to miners. And so because of that, you can't model the actual fundamental intrinsic value of Bitcoin. But with Ether, you now can model the fundamental intrinsic value of ether. And you're exactly right, because all of the security, starting with the proof of stake post-merge world just six months from now, it's going to be provided by a distributed

network of tens of thousands or hundreds of thousands of stakers around the world, potentially millions soon. What that means is that all of the security costs are actually being paid out to long-term holders who are staking the asset. And so because of that, it's 100% of revenues go flow directly or indirectly to long-term holders and stakers. Okay, revenue flows directly and indirectly. I want to unpack that a little bit. And this will be the last thing before we get into the model. There are direct dividends being paid to those who stake.

And those who stake, they watch the amount of ether that they hold go up, tick upward slowly over time, and that is a cash flow. But then we also have, and this is where things get a little bit muddled because bankless has used different terms to describe the buyback and burn, where we've also talked about how the burn mechanism is kind of like a dividend model, but we need to be careful there because when you hold ether, you benefit from the burn in a similar way to a dividend, but it's actually a buyback.

And so while like you receive that value, it's through the process of buying back. And so when we use the term dividend, we're talking about ether stakers receiving ether distributors, receiving ether distributions from staking their ether and validating the network. And then there's the buyback, which is for everyone else, all ether holders, that makes the ether more scarce. And so while that revenue number for Ethereum, like if Ethereum pulls in a million dollars of revenue, roughly 70% of that million dollars will get burnt, which is like a buyback.

And sometimes in the past, bankless has called that a dividend, but technically that's not right. Technically, it's just a buyback. And then the dividend aspect, if we're going with a dollar discounted cash flow model, the dividend aspect is just going to those who stake. So I just wanted to unpack that a little bit. Anything you want to add to that, Ryan? That's exactly correct. And in the spring of 2021, about nine or 10 months ago, you had Justin Drake on for some

of his, you know, incredible episodes on bank lists. And he put out some models. And from those models, I was able to build this discounted cash flow with the exact assumptions you just shared that 70% of the transaction fees are going to be burned. That's now, of course, happening. And that soon that rest of it, the other 30% is going to go back to the stakers, the long-term holders that anyone can participate in. By the way, does that ever happen in a DCF? Do companies, I know companies buy back their stock, but do they ever burn it? They ever like just take it off the market permanently and just decrease supply?

That is what happens. So when a stock buyback happens in traditional equity markets, they purchase the stock back from shareholders, and then they actually get rid of that stock from their corporate treasury, such that the denominator of the total number of shares goes down, which makes everyone's stock per share go up. So it is fairly analogous. So, okay, we talked about maybe two differences, which is the insane growth rate. and in comparing this to other discounted cash flows. One other difference maybe to illustrate is you don't have to wait for an annual report

to get these revenue numbers. And I think that's really cool. Like you don't have to trust insiders or, you know, analysts to parlay these numbers to you. They're updated in real time. And anyone can query Ethereum and forecast this and create their own counter cash flow models. And that's a first in history, especially when we're dealing with this amount of capital and this amount of money. So I think that's interesting. But let's start to dive into the model then here. And I'm showing it now, Ryan. And I want to start maybe on the

left-hand side with some of these inputs to the model. And if you're, if you guys are tracking on YouTube, you can see this on my screen. You can also click the link in the show notes to also go look at that you can see all the people that are looking at that because they've done that yeah okay cool and then for podcast listeners uh we will try to talk about these things but let's talk about the inputs to the ethereum discounted cash flow Ryan so what are the most important inputs uh that we're assuming here and where did they come from and by the way notice you just updated this today because the numbers went up I think from the last time I saw this so um ether's worth even more I'm assuming you You got that, you updated this based on January 2022 already.

So this is completely fresh. That's correct. To your last point, this morning, which is February 1st here in the United States, I literally went on a glass note and I got the January 2022 Ethereum total fees. Total fees are equivalent to the other side is revenue. People sometimes complain about fees, but you have to understand as a long-term holder, the other side of fees is, of course, revenue that is now being paid. back to holders. And so for January 2022, the total Ethereum revenue was $1.35 billion.

Now, that actually went up from $1.1 billion in December 2021. And so even though the price of ether has come down by almost 45% over the last two months, we've actually seen month over month growth in what really matters, which is the amount of revenues that then get paid back out to holders. So that's the very first input. It's the revenue from the prior month. You could also do the revenue from the last 365 days, either way. And then in the next row, we annualize that number. So we just take $1.3 billion times 12, and that gives you $16 billion. That would be what Ethereum's total revenues would be if we do exactly what we did in January 2022 times 12 for the year of 2022. Now, you could just leave it there. If you were trying to price, the value of Ethereum today on the proof of work model without the rewards going back to long-term holders, you would take the total profits, the total revenue at 16.2 billion. However, using Justin Drake's modeling, it looks like the latest data post-merge that I have, correct me if I'm wrong,

but I think we're going to see about 1.1 million ETH that are going to be created each year as rewards for stakers. And so at the current price of about 2,800 per ETH, that adds an additional $3 billion in value that is going to be paid out to the holders, the long-term holders and stakers of ether once the merge happens, hopefully around July, as you mentioned. So you add those two numbers together, $16 billion plus $3 billion, and you get the total revenue for an annualized basis for total Ethereum network of $19.2 billion. That is a huge amount of money. So that's the first input.

The first input is annualized total revenue. I'm doing it January 22 times 12, but you could also do it the last year. Just to pause there, one thing we've often said on bankless is like blockchain sell blocks. Apple sells iPhones, blockchains sell blocks. This is the product that blockchain. chain sell, in particular smart contract platforms like Ethereum. And so what you're saying is, look, last month, January 2022, Ethereum sold $1.3 billion

worth of its product that is Blockspace. And if you analyze that, that's a $16.2 billion a year revenue number for the product that is Ethereum Blockspace. That is exactly correct. So that's really all you need. You start out, the second input, of course, is your profit margin. There are no costs in distributed network. All the costs are paid for currently by the miners and later by the stakers and validators.

And so if you assume that 100% of the revenues are, in fact, cash flows, then what you do in, you can see in sell E-54, you take the total $19.2 billion in cash flow for your 2022. here and you put that in as an input into the discounted cash flow. And so that is the beginning year, 2022, the first year in the model. And then what I do is I've now forecasted the next 20 years of revenue from 2022 to 2041. And I've assumed what I believe is a modest and conservative growth rate for those cash flows. I've assumed it's starting at 40% a year, going down to 10% a year by 2041. That averages out to exactly 25% average growth over the next 20 years of the revenues from Ethereum. Now, I think it might actually be higher than 25% a year for the next 20 years. And here's why. In the last year in 2021 versus 2020, it went up 1,000%. And then in January of 2022 versus 2021, it's up

407%. And even in a market where the prices of ether are down the last two months, we've seen a month over month increase in the amount of revenue of Ethereum, the blockchain. And while some say, okay, layer two side chains might provide alternatives, as you all have talked about on bank lists, Ethereum is the Manhattan of block space. It's the block space that if your visa settling a few hundred million dollars a day, you're going to do that on the Ethereum blockchain. They don't care about the $100, $150 gas fee to do that. They're going to pay that all day long.

And so because of that, I actually think we're going to be in a world where the cost to use main net, Ethereum main net, on a per transaction basis, it's probably not going to go down. Even after sharding happens eventually in a couple of years, I think the price will stay around the same. And I think the revenues of Ethereum will continue to grow over the next 15 to 20 years, significantly more than 25% per year. So, Ron, I want to unpack. the annual proof-of-sake staking rewards.

So can you just remind me where that number comes from? Is that from blockchain fees, or is that from issuance of new ether? That's issuance of new ether. If you go down to the bottom left of the model, there's a table that shows the annual, keep going all the way to the bottom. There's a little table right there. And so last I understand it, we're going to be having post-merge about 1.1 million new supply created each year. This is then multiplied by the current price per ETH about $2,800 to get an additional $3 billion in cap USD value to stakers.

That obviously goes up as the price of ETH goes up in U.S. dollar terms. And of course, the total net supply for ether is going to be negative. And so you can't say, oh, well, they're just inflating away the value of Ethereum to give out cash flows. No, they're actually giving out reward in ether. However, the total supply is going to go down, which is going to be increasing the value of ether further. Right. So previously, when Ryan and I have talked about this on other shows, we talk about how the issuance is actually the costs. And that's where a little bit of these models kind of get finicky when we have like these more legacy type mental models for understanding things.

It's like when we mint new ether, that is a cost to the network. Or when you mint new currency, that is a cost to the network. But that's not how you've organized it here because while it's maybe a cost to the monetary asset of the network for stakers, it doesn't really matter because it actually just ends up as cash in their pocket. And so there is a little bit of like a discrepancy, I think, between like just like having a traditional DCF model and like how we apply it to crypto networks. So when we take this is coming from the perspective of people who are staking eth. While like Ethereum is issuing new ether, which is a cost of the network, it's not a cost to stakers because it's just going. right into their pockets. Is that kind of a perspective you've had? But am I correct, Ryan? You're just saying this new issuance will be offset by the burn. And so it's basically like, just considerate

revenue. Yeah, there's two things there. So this issuance will be by far more than offset by the burn, right? Because we're actually going to have probably a negative issuance here. However, if you look in column G and H and rose 11 and 12, you can see that I've actually created two different values, a little bit higher. It's either $10,615 is the DCF value per ether token. But if you have staked the token, then you benefit from that added rewards. And so the actual value to you is higher by about $2,000. And so what that's going to do is increase the incentive to stake and get a lot of people staking and providing security for the network. Amazing. Amazing. This is really, really cool. Can we are we ready to talk are you just want to talk about the inputs David I want to get to the outputs pretty soon but yes

No I yeah go for it. Ryan. I'll ask my question after the outputs can we talk about the outputs? When you when you put in all of these numbers and If you were to kind of model this with DCF as looking at like ether as if it's an equity You know trading an S&P 500 what are the outputs so what do we get? I mean it seems like the assumptions going to this model are fairly conservative. It's just basically growth assumptions of revenue. And I guess you're assuming that block space doesn't, on a theorem, doesn't collapse and doesn't go down, maybe in the face of alternative layer ones or the face of, you know, some people think layer twos will decrease the cost of block space. I don't agree with either of those assessments.

So, you know, but I think you're being very conservative with growth. We put those assumptions in. What do we get on the other side here? Well, the outputs are very attractive. The outputs are, quite sexy. And so let's get there's two ways to get the outputs. I'm going to give you the headline output. And then we'll talk about the different ways to get there. So the headline is, is that if you hold ether today, if you're on there and you're, you know, you just bought an ether for $2,700 today, great. Because I think if you hold for four or five years, there's a great chance that you may do quite well on that. I know we all believe that. But I think there's math here backing that up, not based on speculation, but based on real numbers.

The DCF value per single ether today, an unstaked ether, according to this model, is $10,615. I don't see any reason why a properly assessed and evaluated price per ether should not be $10,000 plus. The only reason it's not is because the knowledge of how to properly value Ethereum is not out into, the mainstream institutions yet. And there's also a risk discount that is being applied because proof of stake hasn't gone live yet. The month that that goes live, you get 30 to 60 days of track record with it actually being utilized and settling billions of dollars of value. The price of ether is highly likely to move quite quickly, I believe, toward what the actual value of those cash flows are. then you have $12,623, and that is the value in the model outputs for the value per staked ether.

You get the equivalent of about $2,000 in incremental value per ether just by staking it and participating in network security because you're getting daily cash flows for doing that. So where we are today at 2,800, I'm expecting about a 350% increase just based on the DCF model alone. And now keep in mind if the revenues increase faster than I project, that's only going to increase the DCF value per state ether. And so that is the headline. That is the underlying valuation here that on a fair value fundamental basis, ether should be worth between $10,000 and $13,000 today. And did we bake in a particular PE multiple in that number? And how did we come up with that number? Isn't there an assumption there at some point?

Yep, so let me walk you through this. So I think it's important for listeners to understand that price to earnings ratios are a simple way of coming up with what is a more complex DCF. And so let me just walk you through this. If you go down all the way to the bottom right, you're going to see a green cell. It's in row 73, so just a little bit up. And so if you go in 73 all the way to the right to column L, There's a green cell there, and that's L73, and that's $1.49 trillion. And what that is is the net present value of what the market cap of Ethereum should be right now, and that's assuming a 12% discount rate, which is essentially the standard discount rate that you use when you value anything. And what that means is that today, Ethereum has a market cap of 330 billion. It should be at about $1.5 trillion, according to this analysis. And there's a huge opportunity for it to increase. And so that is how you come up with the discounted cash flow per ether.

You just take $1.49 trillion, the net present value of what the expected market cap should be. And you divide that by $118 million, that total ether supply. and that gives you the $10,000 to $12,000 value per ETH. Now, there's a simple shortcut to getting there if you don't want to do all this math. For those of you that don't have MBAs or you don't want to build a new model every time you're trying to value an asset, all you do is you look at earnings and then you apply a multiple to that based on its growth rate. And so let's look at Tesla. Tesla is one of the faster growing tech companies out there.

their PE ratio as of this morning is 302. And so Tesla, Elon Musk's electric car company, is being valued at 302 times its last year earnings. It's 2021 earnings. What that means is that it would take 300 years of 2021 earnings to essentially justify the value of the stock today. Now, that's one of the higher ones in the industry. But that's not abnormal for a high growth company, to have a price to earnings ratio of 100 to 200. Now, the average company in the S&P 500 today, the average stock in the S&P 500, has a PE multiple as of this moment of exactly 37.32.

And so I've put 35 here in the model. And so if the average S&P 500 company has a price to earnings ratio of 37, what do you think Ether's PE ratio should be? The question is, is ether growing faster or slower than the average company in the S&P 500? Well, the average company in the S&P 500 is growing at about 8 to 10% a year. And ether is growing at 400% a year plus. And so you'd think the PE ratio of Ethereum should be significantly higher than 35 or 37. You'd think it'd be more like 100 to 200, which would make the price for ether about 16,000 to 33,000.

But the reality is because people don't yet know how to value Ethereum as a cash flowing asset, but they will in a year. They might start understanding it after this episode and after the merge. The current Ethereum PE ratio as of this morning is a very low 20.3, which is creating the implied valuation of $2,800 per ether. That obviously is way too low compared to. to its comparisons in the market. Yeah, and just for more anchors in the market,

Amazon has a 56 PE ratio, Facebook has 21, Google has 25, Netflix has 34. And again, comparing Ethereum to these companies is an interesting comparison just to get an anchor, but it's also we're comparing a network to a company. And networks fundamentally do and operate and grow in different ways than companies. Companies are in my mental model, they grow linearly, like one foot forward in front of the others, where networks grow at all directions at once. Because Ethereum is a permissionless network, because anybody can come and deploy any sort of defy app, any sort of NFT project, any sort of marketplace, you, Ethereum doesn't actually have to, like, grow in any one particular direction. It can grow,

it has the option of growing in all directions at once. So it's very much the difference between, like, linear growth of what I would expect a traditional company to grow like versus geometric growth, which is exponential growth, orders of magnitude growth. So when I see a PE multiple of 20, which is less than Facebook, when while, you know, Facebook is, I mean, it was once a network had network growth, but it's hit the saturation point. Like Facebook basically has like 80% of the planet on it and it's not really going to grow much beyond that. Ethereum has like 1% of the planet on it. And it is way more permissionless, way more accessible than Facebook is. And so perhaps the P.E. multiple of a comparing to a company is already selling Ethereum short of

its potential. That's right. And you look at Facebook's, you know, cash flow growth rate. You know, maybe it's growing by 20% a year. It used to be growing it a lot more than that, you know, 15 years ago, but Facebook in 2022 is only growing at 20, maybe 30% a year. You look at Amazon, Shopify, Netflix, similar, probably 30, 40% of year maximum. But you look at Ethereum, it's growing more than 10 times at 400% a year. I think it should be worth probably five to 10 times what it's worth today. What's interesting here to you is this is, we've talked about this before. People who listed in bank lists might be familiar with, you know, that ether has a triple point asset. that's sort of a thesis that Ether can be valued based on three kind of commodity asset types.

One is a commodity, or just supercategories, one is a commodity, the other is a capital asset, and the third is a store of value. What's interesting here is we're really modeling it based on a, the DCF models it based on just one of those legs of the three-leg stool, which is capital asset. Okay. So we're not talking about commodity. You might value a commodity, differently based on more supply and demand sort of metrics. And we're not talking about a store of value. Store of value is also supply and demand, but it's kind of rooted in this idea of use as money. And the more it becomes a medium of exchange, unit of account, then it increases in its moneyness and has this monetary premium, almost its meme value. What this analysis is doing

is it's just valuing ether based on capital asset, based on discounted and cash flow. So if you're to take this, right, which basically says the fair market value of ether is about 10 to 12K. And then you add monetary premium on top of that. So we're at 10 to 12K, but now we see ETH being used as the money for the NFT economy. And when people are auctioning it on Sotheby's, you see yen, euro, dollar, and ether, right? And people are starting to hoard their wealth in ether as well. Then there's a monetary principle on top of that. And this model doesn't take into account that monetary premium.

Is that the case? That's exactly right. This analysis is primarily designed for institutional investors who I expect will be coming into Ethereum very heavily in the second half of 2022 once the proof of stake merge happens because they'll be able to value the cash flows that they're being paid to hold this asset, which you can't do with Bitcoin or any other major digital asset. And so on top of the cash flow value, the DCF value, you also have the value that's supported by it actually being a utility token, if you will, where you have to have ETH to use

any of the Ethereum applications to utilize defy to purchase an NFT. And then beyond that, you have a monetary premium. And so you are right. If you're looking at the full bulk case, you have to use this as a baseline. And then on top of that, add the utility value and the monetary value. So I think we're, I mean, I'm definitely in the camp that if Ethereum's fair PE multiple should be 200 plus. So if we take that assumption in, what should the price of ether be?

Well, if the PE multiple of ether were 200, based on last month's revenues times 12, you'd be looking at a $3.8 trillion valuation. You'd be looking at a valuation that's more than 2x what the entire crypto market cap is right now. And you'd be looking at a price per ether of about $33,000. Fantastic. Fantastic. That's exactly what we're like. I just wanted to use the soundboard.

You feed you up for that, Ryan. Ryan, there's another aspect of this Ethereum that's different than a company doing a DCF4. That's the combination of the aggressive buyback from EIP-159 in combination with the distributions to ETH stakers. And so I want to get your head chewing on what happens when this buyback really compounds over time. Because I think that might really change the dynamic of the ether price in the very long term. So I want to get you to start chewing on that. But before I ask that, actually ask that question, we're going to talk about some of these fantastic sponsors

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All right, guys, we are back with Ryan Alice, who has this incredible DCF model for Ether, the asset. And a question I have, Ryan, is that we have this combination of, buybacks, pulling ether supply off of the market. Right now, because of the heavy issuance from proof of work, it's kind of a wash. But once we get to the merge, the amount of ether deflation is going to become really, really significant. And when that happens, that makes, you know, the ether supply goes down over time, of course. But then that also starts to meaningfully increase the value of the actual dividends. Because, say, for example, we're at, you know, call it 120 million ether today. And I don't know how long, but maybe five, 10, 15 years, maybe we start to get below

a hundred million supply of units of ether, maybe even lower than that. And that starts to compound the value of the dividends for stakers. Is that included in this model where over time the reduction in supply increases the actual strength of the dividend? Or how do you account for that? And is that something that we have seen before in other DECD? Or is that something new to Ethereum? Well, that's something that's quite new to Ethereum. You know, as you've mentioned right now, we have a slightly positive net issuance for Ethereum, although a couple of weeks ago it was negative for the whole week for the first time.

Post-merge, there's going to be a lot less rewards going out. And so there's going to be less issuance instead of having, I think, 4 million ether per year created for miners. We're going to have 1.1 million for stakers. And what that means is that the net issuance of ether is going to be negative. If you look at ultrasound.money, the website right now, just based on the last 30 days, if you click that supply, if you simulate the merge, click that checkbox on, and then click supply growth until you get to 30 days.

If you just look at the last 30 days alone, we're looking at a projected reduction in ether supply by a net of 3.6% per year, which means, you know, we're going to be getting, going from 118 million. It's probably going to max out at 119 million or so. And then it's going to trend downward toward 100 million over the next decade, which is exciting. And what that means is instead of making the denominator 118 million, you know, 10 years from now, we can just sort of make an edit to the model, and we can make the model 100 million. And so suddenly now that's the new supply of ether. And that's going to make the value per state ether, you know, 15,000 instead of 12,000. And not only that, there's a, there's a dynamic in the market where as you're

burning it, it essentially increases the price as it goes. And so you're going to have institutions coming in to get these cash flows. It's important to note that the $3 billion, and annual staking rewards is priced in USDA, right, because I'm doing a discounted cash flow model in USDA. But if the price of ether goes up, let's say the price of ether then becomes 15,000. Our dreams are realized it's two years from now. All right, now we're going to be having $16 billion in annual staking rewards in

USDA basis. And that's going to make the gap and the delta even higher, where the value per stake is, you know, $10,000 above the DCF value per ETH. So I think there's a huge opportunity here. Wait, so I think the ether supply accidentally reverted back to $118 million. What happens if we, boom, what happens if we lock in a $100 million ether supply in the model? Yeah, so if we lock it in in $100 million here, you know, this is the outputs. And then do we need to also change the current value per ETH?

back to 2,700. Yeah, so you know, you're really going for the bull case here. Oh, yeah. Oh, yes, I am. You know, if that gets to, let me hide the middle column here. I mean, you're looking at a 25,000 value per state Eth, just taking the price that you could buy it on the market and then adding the $10,000 an additional value of the value of those staking cash flows,

that gets you to $25,000 per Eth, potentially within two or three years of now. And then what happens? if we do a PE multiple of 200. Just max out all the stats. Yeah, if you do a PE multiple of 200 at that point, and this is the highest my model has gone so far. It breaks the model after this, okay? It's all we can do.

You get to $56,000 of value per ETH. I guess that wouldn't be fair, though, because we shouldn't be pricing in 200 PE multiple of growth after we've already burned so much. So I guess that would be a little bit ridiculous. however, I'm a fan regardless. This is just silly, right? Isn't it silly?

This whole thing is kind of silly. I want to summarize this and then maybe talk about why it's silly. So this discount and cash flow model in your mind, Ryan, is kind of the basement floor value of what ether should be. And we're talking 10 to 12K is the basement floor, is the base case. Right now as we're recording this, the price of ether is 2,700. Okay?

So it's undervalued at even the base case levels of what this asset should be valued at. So, like, I guess, why? Why do you think, why don't, why don't people understand this? Why isn't the market front running this a little bit? I mean, as we just said, when we're coming into the model, the data is here for everybody. We don't have to wait for the CEO of Ethereum to issue an annual report for us and tell us what the numbers are and what the growth projections are. Anyone can query the chain and see what they are.

So why isn't the market factoring this in right now? And why does this look so silly? As Bitcoin dominance declines, Bitcoin dominance was 73% a year ago. Now it's under 40%. And that's been declining quite rapidly. And so as Bitcoin becomes less important in the overall market, assets like Ethereum will be able to be valued based on their actual value as opposed to a proportion of the largest one in the space.

I think that's one reason. And then I think the second big reason is that people are applying a, there's a knowledge gap, and then there's a risk gap. And the knowledge gap is that there's only about 20,000 people in the world now that understand what we understand about how to properly model the cash flows of Ethereum. And, you know, that was probably 5,000 yesterday before this episode. And so this is important alpha. important information. And I would say that once we actually see a successful merge and the

actual cash flows are being paid out daily to stakers, that we're going to see an onrush of institutions coming in. They can't yet invest until it's happened. But once it happens, institutional investors are going to be really wanting those cash flows. And that's going to drive the price of ETHU, I believe, in the second half of this year. I hope listeners just heard there that you are front-running the institutions if you're buying ETH and you know this information. And I think what you're saying, Ryan, too, is basically like after the merge, after this happens, the education, like, so David and I, probably yourself and others, have been pounding our fists on the table, talking about the different ways ether as an asset should be valued.

But after it actually starts happening and the cash flow start rolling in, our education work is kind of over. because the market will just figure this out at that point in time. Like big banks, other industry analysts, everyone will start reporting on this, and it will be self-evident that, of course, this is the way you value an asset like ether. And we won't have to do this intense education as we have previously. That's exactly right. We've got probably another four to six months here to accumulate. I'm getting as much as I can really up until a 5K price point.

accumulate as much as I can. There are going to be cycles. It is going to be volatile. It's going to go up and down in the short term. But in the long term, I'm a huge believer in ether. And I'm a huge believer that if you look ahead in 10 years, we're going to be looking at values that are more than 10x where we're at today. And so I'm accumulating.

And I think it's even once the merge happens, it's still going to take another 12 months after the merge for the knowledge to spread around the world and for risk committees to evaluate it and approve, you know, multi-billion-dollar investments. Risk committees, God, something I'd never ever have to want to be a part of. I do not want to be in a risk committee meeting. I'm inviting you to our new D-Fi Risk Committee

a meeting, David. Ryan, I want to ask this question, too. So I read Coinstack. I'm a big fan of your newsletter, by the way, and hopefully folks have an opportunity to subscribe at the end of this. And I know you're bullish Eith. I also know that you're bullish other alternative layer ones.

And I wanted to ask about that and talk about that for a minute. So, because I don't understand it fully, right? It's like I understand the narrative trade around alternative layer ones. But I'm curious if you believe discounted cash flow is a primary way for layer ones to be valued, as the way it's valued with ether as an asset. Have you done a discounted cash flow for these other alternative layer ones? And what does that yield?

Because when I run those numbers back of the napkin, I get, I get red signals flashing that these things are overvalued relative to the cash flows and the block space that they're selling. What's your take on this? Do you apply discounted cash flow to other alternative layer ones? And if not, why are you still bullish these alternative layer ones? Yeah, it's a great question. So I have not yet built a DCF for any other digital assets besides Ethereum, besides Ether. The reason why I'm bullish on other L-1s and other smart contract platforms is simply from a technology

standpoint, I'm looking at the defy market share. And I'm sourcing this data from Defy Lama. And when I look at the total value locked in defy apps across all the different smart contract platforms, Ethereum has a 60% market share as of today. Terra, finance, smart chain, Phantom, Avalanche, and Solana round out the top six. And I wouldn't be surprised if Pocodot starts taking some share after it launches over the next few months. And so those are the ones that I'm particularly interested in. I'm less interested in Binance Smart Chain and Solana.

But when you're looking at Terra, Phantom, and Avalanche, I do see some promise there from at least a technological standpoint. They have, of course, made tradeoffs in the trilemma. and they are often, as you know, trading off decentralization in order to get faster speed and more transactions per second. Many of these are already on proof of stake. And so I think it would be an interesting project to take their current fees. You can see the competitive L1 revenues on cryptofees.infoam. However, because they've made such a tradeoff with decentralization, ironically, in order to get their fees to be so low, their revenues are, significantly lower.

Avalanche, well, let's say Binance smart chain is number two by fees. And yesterday it was $1.5 million versus $33 million for ETH. And so you're looking at, you know, less than 8% of Ethereum and avalanche is number two at $425,000 a day over the last seven days. So I do think Ethereum is going to be king for a very long time. And from a technological perspective, I'm looking at the market share. So is the bet basically right now that these alternative layer ones, you're betting on different metrics at this point in time. You're kind of for these alternative layer ones, you're betting on total locked value growth.

And you're kind of extrapolating that and you're kind of saying, well, if total locked value is growing and these alternative layer ones are able to cross the chasm and start charging for their block space in the way that Ethereum is charging for its block space, then you can start to rationalize the, you know, tens of billions of dollars that these alternative ones are, uh, are valued at today. If you just apply a, like a discounted cash flow model in the way that you're applying to ETH, my guess is like the PE has got to be in the like, you know,

2000, three thousand, you know, maybe for some of these, the 30,000 mark. It's like broken. It breaks the model in the opposite direction. So I think you're kind of what I see a lot of investors doing is you're kind of,

classing these things as different. It's almost like Ethereum is sort of value and growth type of play where these other assets are just like pre-revenue, just venture bets, speculation or early stage venture bets at unicorn valuations. Is that how you rationalize this? Because this is sort of what I think people are doing. I think that's right. Ethereum is the only digital asset where you can model out its cash flows. It's only a smart contract platform where you can really model out its cash flows and realize that it's deeply undervalued. All the other smart contract platforms have a very healthy valuation, often in the tens of billions of dollars. And some are more than a hundred, you know, there's some that are 40 or 50 billion dollars now.

And I think that is more based on hope and speculation than actual hard cash flow numbers. I think, Ryan, there's going to be a world where all of the layer twos that come online that aren't, that don't have to pay for security and therefore don't have to have issuance and therefore have much more reasonable like metrics that don't break the charts. I think there's a world where, especially when this multi-L2 ecosystem gets built out and the tokens actually start to come and these layer twos also start to generate revenue in the same way that Ethereum L1 has. that there could be discounted cash flows for all the layer twos. And so I think maybe there's a world where we repurpose your model for ETH and start doing all of these same things with the layer two tokens when the layer two tokens come out. I don't really have a question, but I'm wondering if that is something that is also in your brain. It is.

You know, when you look at Arbitrum, they have $1.9 billion in total value locked in DFI right now. You look at optimism. They have 300 plus million in total value locked on defy. And so if and as they come out with tokens, I think it'll be possible to value them as well. Ultimately, though, I think your theory about Ethereum being the Manhattan block space of the world is going to prove true. And even though there are cheaper alternatives, there aren't necessarily better alternatives when you're settling very large amounts of money. And that will always lead ETH to be the best. Let me ask you a deeper, more fundamental critique of this style of valuation, and that is a critique by like the three hours capitals of the world, the sous of the world, and that's this. DCF doesn't even apply to crypto. This market trades on memes and narratives, and that's it. And DCF, like valuations, we're borrowing this from capital F assets. We're borrowing this from equities. that's a narrative in and of itself.

And the crypto narratives and how it's valued might be completely different than the DCF models that we've used in the past. How do you respond to that? Thank you for the DCF model, but that just doesn't apply to crypto. Well, in a pre-2020 world, going back 14 years now, it is hard to create a fundamental analysis of what is the actual value of these digital. assets. Today, though, we have real cash flows. And the moment that you have money, actual cash flows, going into the wallets of these holders, which is going to be happening in six months from now or less, then people that control the hundreds of trillions of dollars of global wealth, there's about $500 trillion of global wealth today, are going to look at that. And they're going to look at how

much they're earning from traditional fixed income, which is about two to three percent per year. And they're going to say, wow, if I can hold a U.S. Treasury and get half a percent a year or hold a corporate bond and get two and a half percent a year, or I could simply stake ETH and get six, eight, ten, twelve percent a year, depending on how many transaction fees are going through, there's going to be a lot of people saying, wow, I would rather stake ETH and I would rather get those cash flows. And so I do believe that as staking becomes normal and as staking rewards from revenues become more and more normal, we are going to see traditional metrics begin to develop to combine with new metrics of valuing digital assets. Ryan, if this model goes wrong, how would it go wrong?

What assumptions are a bit more brittle versus the other? I've assumed a 25% annual growth rate. I think the biggest risk in the model is that the overall cash flows and revenues of ETH don't grow. And, you know, that would not be the end of the world because that means lower transaction fees for people. But from a, and that could then create more usage, which would create more utility, which can drive value for the asset in other ways. But from a cash flow perspective, the way this model goes wrong, the risks in it are if we have, let's say L2s take over 95% of the market. Let's say alternative smart contract platforms take over the majority of the market and that the main net is doing less and less fees, then that will impact the cash flow. So that's where the model could be a little over optimistic. And that's why I've tried to make these assumptions quite conservative to account for that.

What do you think of this? That's like when you zoom out, Ryan, have you ever seen anything like this? So like, coming on the bankless podcast, we've made this claim, you know, often. But you run ahead. You run a head fund. And you're making the claim that this is an obviously undervalued asset, right? That this is maybe like the market doesn't provide these sorts of opportunities where something is so fundamentally obviously undervalued. Like 5 to 10x undervalued is sort of magnitude we're talking about.

Just on like basic fundamentals alone. Have you seen anything like this in your time investing? Or is this sort of a I don't want. So we start to say like a once in a lifetime opportunity. We start to sound like we're some kind of an infomercial, but I just feel like the answers are so obvious. I'm wondering if you've seen this in any time throughout your career of investing, something that's been this obvious. You know, I haven't. I built this model almost a year ago. It was late March, early April of 2021. And it was just after Justin Drake's materials came out on bank lists. And, you know, that price of Heath was, you know, $1,300 or something right around then.

and I was looking at it saying, wow, I can buy ETH for 1,300 and I can hold it all the way up to 10,000 plus. There's a great opportunity. And so, you know, that's what I've done. You're right. I do run a crypto hedge fund, heart rhythm. We generate market neutral yield by investing and providing liquidity to defy. So that's how we do what we do. So we're huge users of the ecosystem.

And I think there's a huge investment opportunity here. And once we derrisk it, once you make big control, shaving live and merge, I think that's going to actually start playing out in the price performance. That's it, guys. Ryan, Alice here, giving us the discounted cash flow. It's a fantastic lens on ether, the asset that you probably won't find in many other places as people are looking at the day trading of ether, not looking as much at the fundamentals. Ryan, thank you for making this case for us on why ether is so undervalued. We appreciate it. Where can folks sign up for your fantastic newsletter, by the way? Could you?

you hit us with a URL. Yeah, if you would like to subscribe to our free newsletter, Coinstack, just go to coinstack.com. Fantastic. And I recommend bankless listeners do that. Of course, guys, we talked about some financial topics. We talked about some price targets, but none of this was financial advice. All right, eth is risky. Bitcoin is risky. All of Defi is, you could definitely lose what you put in, but we are headed west. This is the frontier. It's not for everyone, but we're glad you're with us on the bankless journey. Thanks a lot.