Looking for Relative Value in the Crypto Wreckage

With crypto markets in freefall, Bitcoin and Ethereum are dramatically outperforming all other layer 1 protocols and assorted applications. The MVIS CryptoCompare Smart Contract Leaders Index is down 48% month-to-date vs. Bitcoin (-26%) and Ethereum (-27%).

Amidst the wreckage, it is helpful to establish floor valuations for the layer 1 protocols, which we believe will survive and take share through the downturn. One way to do that is by analyzing the price of blockspace on a given chain vs. the economic output of that blockspace.

Here, the ratio of Avalanche to Ethereum gas prices on blockspace cost equivalent terms is calculated. Clearly, the blockspace price of Ethereum, on a unit for unit basis, is substantially higher than Avalanche. However, as Avalanche usage has taken off, the ratio rose to reflect demand for Avalanche’s blockspace. The gas price ratio is informative, because it gives us an understanding of the relative value of each chain by looking directly at ledger real estate price. Curiously, while Ethereum has more daily transactions than Avalanche, the total output of gas by Ethereum is less per day than Avalanche’s. Therefore, the average Avalanche transaction uses more gas than the average transaction on Ethereum. Because gas is a measure of computational effort, this implies that the average complexity of transactions on Avalanche is either of a higher order than Ethereum’s or that Avalanche’s version of the Ethereum Virtual Machine¹ (EVM) is not as efficient. We lean towards the latter.

Avalanche/Ethereum Gas Price and Market Cap Ratios

Source: Dune Analytics, Avascan, Etherscan, as of 11/5/22. Past performance is no guarantee of future results.

The gas price ratio appears to act as a floor price for relative value between the two chains, because both use an EVM and there exist numerous bridges between the ecosystems. If Ethereum becomes too expensive to use, users with higher gas needs will move to Avalanche. This has clearly been the case with the enormous popularity of the Avalanche bridge – which peaked at $7.2B in assets on December 1, 2021 before falling to around $3.6B on 11/5/2022.²With that dynamic in mind, we apply the relative valuation of the Avalanche blockspace to find considerable support at about 0.003 – which is about 40%-50% lower than where we stood as of 11/5/2022. Indeed, if we examine the ETH/AVAX market cap ratio during the epoch when we last approached the 0.003 level of block space relative valuation, the AVAX/ETH market capitalization ratio also reached levels 40% below 11/5/2022. As a result, we should expect the relative market cap floor to approach that threshold if the blockspace ratio continues to decline.

Avalanche and Ethereum: Market Cap/Sales 30-Day Average Reverse Extrapolated

Sources: Dune Analytics, Avascan, Etherscan, as of 11/5/22. Past performance is no guarantee of future results.

Stepping back to look at output value, we examine Avalanche “price-to-sales” based upon daily market capitalization and rolling 30 days of transaction fees annualized. Using this approach, Avalanche’s relative valuation has declined precipitously as its P/S multiple has compressed. In 2021 and early 2022, this compression appears attributable to the rapid growth of Avalanche’s on-chain fee revenues. By April however, amidst general de-rating of the space, Avalanche and Ethereum price/sales have moved downwards in lockstep. This convergence corresponds to our previous work showing correlation increasing across crypto amid the broader risk-off in financial markets.

Returning to Avalanche fundamentals, Avalanche revenue from transaction fees appears to have room to decline further with the announcement of Crabada moving to its own subnet. Crabada is an on-chain strategy battle game that accounts for nearly 50% of Avalanche’s transaction fees for the month of April and around 30% of the fees generated for the month of March. Losing this source of revenue may slow fee growth trends for Avalanche, a possible negative prospect for relative valuation. This is because the deployment of Crabada’s subnet confirms that future scaling will come by means of subnets. Unless something changes in the economic model of subnets, subnet scaling implies fee revenue will accrue to the sub network constituents rather than to AVAX token holders. Because subnets will off-board a large portion of potential gains in fee revenue, it is possible that Avalanche has found a P/S ceiling, rather than a floor, as its chain-fee growth expectations slow. As a result, a basement multiple valuation may approach the sub 20 P/S mark that Ethereum experienced in January 2022 and early in the fall of 2021.

As we managed a portfolio of layer 1 tokens during this market rout, we sold some AVAX to buy more ETH as prices declined, preserving capital in search of a sustainable bottom. As the above analysis shows, however, there is a price at which we would change our minds. We just aren’t there yet.