The Macro View: Valuation Perspectives From a TradFi Veteran | Brian Russ - BMO Financial Group

out there have a have a good feel like they have a really strong sense for what an investment Bank actually does like maybe with the show of hands like I really understand what investment banking is okay just a few just a few hands okay that's a good that's a helpful starting point um so investment Banks do a lot of things uh and frankly it's not as complicated as it seems and so I wanted to kind of simplify some of that down for everybody today um and I think a good analogy for this is um a real estate broker actually who you might hire to sell your house investment bankers one of the main things they do actually is sell companies uh and so while investment bankers might be brokering the sale of a company an easy kind of less abstract way to think about this is for anyone who's ever bought or sold your house you might have hired a real estate broker to uh handle that sale and if you and if you did that you know one of the first questions you'd probably ask of that broker is well what the hell is my house actually Worth right that's what you'd be curious about so if you owned a company and you were going to take it to market for sale uh and you hired a banker to do that the first question you might ask them is well what is my company actually worth and so your real estate agent they might do something like look at well what did your neighbor's house sell for or what did you know the last 10 houses in your neighborhood what did they sell for take the average on a price per square foot basis and then they would apply that to the number of square feet in home and they would come up with a valuation your house is worth this so to make banking less abstract that's a big part of what I Bankers do and so I have built a model um that's kind of rooted in traditional quantitative analysis around this uh and the idea is to help everybody understand how would you value a company how would you value a blockchain how would you value a token uh and instead of walking through the model because that would be pretty abstract uh instead I took that model and I valued the ethereum blockchain so what we're going to do is we're going to walk through EV valuation of ethereum today and hopefully you can use it in some other pockets of your life if there's one thing that you take away from what I have to share today um I would ask that it is just this that when you're valuing something if you're valuing your project if you're valuing a company that the valuation is rooted in quantitative analysis you know I I meet with a lot of Founders who are raising money for their projects and it's kind of finger to the wind sort of valuation or what they're trying to accomplish is to maximize the amount of dollars that they can raise and minimize the amount of tokens or the amount of equity that they have to give up to do that that is not the right way to do that that may seem like the right way in the very short term but in the long term what you really want to create is a win-win partnership between a founder and an investor so that it's successful for both parties for the long term because the real benefits of that type of a partnership will come in the end okay before we dive into the model who am I uh my name is Brian Russ I've got 20 years of experience in Investment Banking corporate banking hedge fund management um and I run a family office today I run the state of Colorado for bimo financial group we are 1.3 trillion in assets we're the eighth largest bank in North America here in Colorado I manage 2 billion of capital and we have 800 employees mostly we are involved with helping large companies and their Capital needs the other hat I wear is as CIO of my family office 1971 Capital we are investors in disruptive technology and have been investors in the blockchain space since 2013 okay let's jump into the model um the model is actually four different models um so we're going to use four different approaches to valuation here and then at the end we're going to take a weighted average so I I won't talk about the models here I'll talk about them as we get into each of the four one quick note before we dive in um the valuation process whether it's for company or a blockchain it is the reality of this is that it is as much art as it is science and it matters immensely what types of assumptions we make the assumptions will drive the valuation so we want to First be accurate with our assumptions second we want to be conservative with our assumptions and then third we want to make sure that we State what our assumptions are along the way because ultimately they drive the valuation so please keep that in mind okay let's start with model number one there are four so model number one is discounted cash flow um if you've ever taken a finance class this is like Finance 101 this model essentially says that your company or your blockchain is worth the summation of all the profits that it will generate forever in perpetuity so your blockchain is worth the amount of profits it will generate for you this year plus the amount of profits it will generate for you next year and the year after and the year after that forever and so what we do is we have to build a model to project forward what those profits are and then we use a discount rate to bring those profits back to 2023 or 2024 chain dollars so that we can say what is the project or what is the company worth today so let's take a look at this model um so first we've got to come up with a proxy for what are cash flows and how quickly are they growing so first I attempt to answer how quickly might cash flows or profits grow on the ethereum blockchain and so for that we're going to look at wallet growth if you go on ether scan you can see that Wallets on the ethereum blockchain have been growing at about 36% annually for The Last 5 Years so we used a slightly more conservative metric of 33% so we assume that ethereum wallets total wallets using ethereum grow at about 33% per year for 10 years if we take that math forward that means that we'll have 4.5 billion users by 2033 so that's about half the world's population that's a good back check to make sure that our assumption around growth is reasonable and while I would say half the world's population is a lofty assumption I think everybody sitting here is here because they think that type of growth and adoption is possible for this industry okay let's take that growth rate that 33% and let's apply it to ethereum's cash flows first we have to say well what are ethereum's cash flows what what type of profit does the ethereum blockchain generate um in order to do that I actually ended up using the same profit methodology that's used on ultrasound money so if anyone's been there great website great resource go check it out um and in order to do this we essentially look at a proxy for ethereum revenues which we use as uh burn as the proxy so burn other revenues essentially on the ethereum blockchain and then issuance we would call the expense so the issuance is kind of the inflation it's what you have to pay the stakers um and so if we take the revenue the burn minus the issuance the expense Revenue minus expenses equals profit okay and so um if we do that we get a profit figure of $1.8 billion that the ethereum blockchain generated in 2023 and so we're going to take that 1.8 billion we're going to grow at 30 3% per year for 10 years uh and that's what's represented by the black bars after year 10 we're going to use a slightly more modest growth rate of 5% and then we're going to take all the value of all those cash flows and we're going to discount them back to today and to Discount back we use something called the risk-free rate or the FED funds rate which is 5% so we're bring all those cash flows back to 2023 or 2024 and here's what the model tells us if we do this exercise the ethereum blockchain the represented by that pink bar is valued at $458 billion the actual valuation is about 400 billion today so this model suggests there's a 15% premium that in other words that ethereum is undervalued at today's prices by about 15% that's interesting let's jump to the next model OKAY second model is precedent transactions I've got a picture up here of a residential neighborhood let's go back to our you're selling your house example and you ask your broker what's my house worth well they're going to look at what your neighbor's house sold for uh we already talked about that right so that's essentially what we do here we want to look at other technology companies what they've sold for and use that as a proxy to Value ethereum so because ethereum's early stage we can't really look to other blockchains so instead um we're going to look to other early stage tech companies that became the dominant player in a network that they created I thought this was a good comp set so here you can see we're looking at Amazon dominant in e-commerce Google dominant for search meta dominant for for uh social network Etc we had Netflix Tesla Uber and we're going to look at something called the PE Ratio many people might be familiar with that price to earnings ratio just the the ratio of the price of a company's stock divided by the earnings that it generates in a 12-month period uh and so in order to do this for those companies we've got to rewind the clock and go back to when they were earlier stage so that it's more apples to apples with ethereum but we we don't want to go all the way back to the point where before they were profitable right because then we wouldn't have the E we wouldn't have the earnings for that ratio and we wouldn't be able to calculate it so what I did was I went to the first profitable year for each one of those companies and I looked at their PE ratio for the next five years took the average and that's what's charted in the black bars the average PE ratio for the first 5 years of profitability for those projects or those companies excuse me and then if we take the average that's that pink Line 178 and so what we want to do is take that average PE ratio of 178 and apply it to the ethereum profits of again we talked about 1.

8 billion so 1.8 billion * 178 PE ratio gives us the value of the pink bar there which is to suggest that the ethereum blockchain is worth $321 billion so this model actually suggests that ethereum is overvalued today by about 20% interesting let's look at the next model OKAY the next model is something called Market comparables uh investment bankers call this comps or comp sets um here we're going to instead of looking at Google and Amazon and Netflix we're going to actually look at other l1s that directly compete with ethereum and we're going to see how are they valued and then compare that to ethereum's valuation so let's dive in in order to do this I wanted to come up with a standardization standardization metric that lets us look kind of apples to apples across different l1s so here um I've pulled the top including ethereum top six but excluding ethereum top five l1s by market cap and the black bars are showing market cap divided by total value locked this is a ratio MC to TV L that's becoming more and more widely used in our industry now what's interesting here is that these get kind of all across the board you know something like Tron is at 1.4 whereas cardano is at 55 um so instead of taking the average what I did was I took the total so we took the sum of the market caps for the top in this case six projects will include ethereum and we divided it by the total value locked on those six projects and came up with a total MC to tvl of eight that's that little pink bar on the left hand side now we have to take that and apply it to the ethereum blockchain to do that we'll take eight and multiply it by ethereum's tvl which is about 47 billion and when we do that we get the big pink bar on the right hand side which suggests that the ethereum blockchain is valued at about $376 billion based on MC to tvl so that's actually pretty close that would suggest that the blockchain is about 6% over valued arring error okay let's jump into the fourth and final model metaps law many of you may be familiar with meta's law John metf was an early internet Pioneer uh and he essentially came up with a theory that uh Network valuation uh is actually it because of how it scales uh the growth and the valuation is exponential it should not be valued on a linear basis it needs to be valued on an exponential basis uh and so the simple example for for this is the telephone so if you think about a telephone network if you add one more user to a telephone Network um you don't get a value accretion of one you get a value accretion of greater than one because that now new phone can connect with every other phone on that Network so it's not scaling linearly in terms of valuation it's scaling exponentially and medf came up with a formula for this um that formula is V which is value equals N2 so it's pretty simple n equals the number of nodes on a network uh and then you just simply Square them to determine the valuation so it's a very simple model um here I went on ether scan again and uh made an assumption around monthly active ethereum users here that's about 15 million and then we just simply take the square of that if we Square 15 million we get that pink bar uh 225 billion valuation for the ethereum blockchain so this one actually suggests that ethereum is is is quite overvalued by about 44% um it's the most kind of out of line with the other models interesting okay let's jump into the valuation let's put it all together so here we've got our four different models with four different valuation metrics and what we did is we applied a simple weighted average so we take 25% of each of the four models we sum that and we come up with a model weighted average valuation for the ethereum blockchain at $345 billion this is about 14% below ethereum's market cap today you know what's interesting is that my data probably lags about a week and I think eth is up about 15% over the last week so let's just say the ultimate conclusion is that the ethereum blockchain based on this model is fairly valued plus or minus 14 15% um okay so that's not the most exciting conclusion but it's important and this exercise is important and that's where I want to kind of conclude so first of all key takeaways we touched on a few but I want to re reiterate them um when you're making a valuation model the model itself and your assumptions they should be accurate first they should be conservative second this is important um also we want to make sure that the model is always rooted in this type of quantitative analysis um again that's going to create those win-win type of outcomes for Founders and in vors where your Partnerships can be successful over the Long Haul and then if you guys are just investors out there and you're thinking how does this apply to me if you built this type of model it might actually help you identify some Arbitrage opportunities so let's say we had done the model and we all felt reasonably comfortable that the the ethereum blockchain was worth 800 billion instead of 400 well then we could invest with the expectation that we might double our money in short order so it can be helpful for Arbitrage as well okay um this I think is probably the most important conclusion if you're an investor um again it might seem like well we went through this whole exercise and at the end we just determined that the market value was what the model said isn't that kind of disappointing um in my mind it's not because what that tells us is that through this rigorous quantitative approach we're able to determine that the valuation of the ethereum blockchain is actually Fair we think it's fairly valued and the reason that's important especially as invest is because it gives us the conviction that we're investing in something at fair value and with that conviction we can hold on to it for the long haul for 3 years 5 years 10 years imagine if you had done this exercise and determined that ethereum had this upside potential uh back in 2016 or 2017 and you were going to hold it for 10 years you'd been sitting in very good shape right now so I think that is why the this exercise is important you can develop a conv ition rooted in quantitative analysis uh around why you're investing in an asset and how long you want to hold on to it and then lastly um I mentioned a 17x return what's that well let's look at some simple compounding so um we talked about ethereum wallets and therefore profits growing at 33% per year based on the historical Trend uh if that Trend continues for 10 years $1,000 invested today would be worth over $177,000 by 2033 so this is why the model is helpful in these types of projections it's helpful for the conviction that's necessary to hold on to something for 10 years um and I think that's kind of the ultimate conclusion and what I got what I wanted you guys to take away from today so I am down to uh the end of my time but I really appreciate everyone coming here today uh if you want to get in touch with me I'd love to get in touch QR code takes you to my website um if you're a founder and your raising Capital feel free to reach out if you're a a founder and you want some help valuing your blockchain uh please feel free to reach out to me there as well or if you're an investor and you just want to network uh and connect and share ideas I'd love to do that as well uh my email address is up there and my Twitter DMS are open so thank you all so much and hope you enjoy the rest of the [Applause] conference thank you Brian