Breaking Down Fully Diluted Valuations
Fully DIluted Valuations

Breaking Down Fully Diluted Valuations

Fully Diluted Valuations

I want to start off by acknowledging that many of you might already have a solid grasp of the concept I’m about to discuss. Yet, I’m aware there are also quite a few who might not be as familiar. As someone who identifies as a degen, but more importantly, as an onboarder, I feel it’s crucial to shed light on this topic. It’s a key element in the investment arena, one that I frequently talk about and will continue to emphasize. For the seasoned degens, I’m confident you’ll still find something of value in this discussion. And for those newer to the scene, pay close attention – this is crucial knowledge.

Now, let’s dive into the term “Fully Diluted Valuation” or FDV, a term you’ve probably encountered frequently since stepping into the world of cryptocurrency. While it’s prevalent in the crypto space, FDV isn’t exclusive to it; it’s a common term in broader finance and investment circles as well.

So, what exactly is FDV? In general finance, FDV represents the total value of a company, assuming that all forms of securities such as options, warrants, and convertible securities are converted into common shares. In the crypto context, the concept is somewhat simplified since we deal primarily with tokens. Here, FDV calculates the maximum potential market value of a crypto protocol, considering the total possible tokens that could exist or be in circulation.

In simpler terms, a crypto protocol’s FDV can be calculated as the Maximum Token Supply multiplied by the Current Price per Token.

Take Bitcoin (BTC) as an example. As of this writing, the price of BTC stands at $41,000. With a maximum token supply of 21 million, the FDV of BTC would be $861 billion (calculated as $41,000 multiplied by 21 million).

What is the difference between FDV and Market Capitalization (Market Cap)?

Market Cap is a metric reflecting the current market value of a cryptocurrency project, calculated solely on the basis of tokens that are presently circulating in the market. This approach doesn’t account for potential future token emissions, which could dilute the value. Consequently, Market Cap might not always provide a complete picture of a company’s market value.

In contrast, FDV offers a more comprehensive and forward-looking valuation. It includes all issued tokens, including those not yet in circulation, thereby factoring in the potential impact of token inflation. This aspect of FDV makes it a more accurate tool for assessing a protocol’s future growth potential.

Furthermore, when comparing different projects, Market Cap can sometimes be misleading, especially if there’s a significant variance in the circulating supply between the assets. FDV addresses this issue by providing a more balanced and equitable basis for comparison, taking into account the total token supply of each project.

The Nuances Of Fully Diluted Valuations

When discussing Fully diluted valuations, it’s crucial to recognize that it operates under the assumption that all tokens within a protocol will eventually be released into the market. However, this assumption doesn’t always align with reality. There are instances where a portion of a token supply is intentionally destroyed or ‘burned,’ which can happen through various strategies like buy-back and burn initiatives. A case in point is Rollbit. Rollbit has a strategy of repurchasing their tokens from the market and burning them. Originally, Rollbit had a maximum supply of 5 billion tokens, but they have already burned nearly 2 billion of these. Therefore, when calculating Rollbit’s FDV, the figure should be based on the remaining 3 billion tokens, not the initial 5 billion.

Another critical aspect to consider is the ratio of circulating tokens to the maximum token supply. If only a small fraction of the total tokens are currently in circulation, the FDV might exaggerate the protocol’s actual market value. This discrepancy is why new tokens often experience rapid price increases, leading their FDVs to appear disproportionately high compared to more established protocols. For example, consider Jito ($JTO), which at its peak reached an FDV of $4.4 billion. This was more than double the FDV of Lido ($LDO), despite Lido being a larger and more established protocol. The key to Jito’s high FDV was the limited circulation of its tokens, with only 11.5% available, in contrast to Lido’s 89%.

It’s evident, then, that market dynamics such as supply and demand play a significant role in shaping token prices. This means that relying solely on FDV for investment or trading decisions can be misleading. For instance, if you had evaluated Jito purely on its initial FDV of $2 billion, you might have considered it overpriced compared to Lido, potentially missing out on a substantial 100% gain. This example underscores the importance of considering multiple factors, including market cap and circulating supply, alongside FDV for a more nuanced and accurate assessment of a token’s value.

Fully Diluted Valuations And Fundamentals

As you might have gathered from my discussions, I place a lot of emphasis on evaluating protocols using metrics in relation to their Fully Diluted Valuation (FDV). I find this approach highly effective for comparing protocols within the same category on an equal footing. By examining crucial metrics like transaction volume and user base in the context of a protocol’s FDV, it allows for a fair comparison, akin to comparing apples with apples. Consider, for instance, the comparison between Synthetix and MUX, both decentralized exchanges specializing in perpetual contracts. On the surface, Synthetix appears to have a higher transaction volume than MUX. However, it’s also important to note that Synthetix’s FDV is considerably higher than that of MUX.

When you assess the transaction volume in relation to each protocol’s FDV, the picture changes. MUX emerges as the more attractive option, offering impressive volume when considering its relatively lower FDV. This can be clearly seen in the Google Sheet presented in degen-dive #9.

In this context, protocols with lower ratios are more favorable. This implies that their key metrics are robust, yet their Fully diluted valuations has not fully caught up to reflect this strength. It’s an indicator that the protocol could be undervalued, presenting potential investment opportunities. Such a nuanced approach underscores the importance of not just looking at raw numbers, but also understanding their significance in relation to a protocol’s overall market valuation.

Bear Market Vs Bull Market Impact

Market attitudes toward FDVs can vary greatly between bear and bull markets. In bear markets, where the general mood is negative and token prices are often disappointing, investors tend to be more cautious and critical regarding what is deemed overvalued or undervalued. The focus during these periods is more on the fundamentals and true valuations of tokens. Contrastingly, in bull markets, the atmosphere is optimistic, with token prices seemingly on a constant upward trajectory. This optimism can sometimes lead to a lack of discernment, as evident in meme coins reaching FDVs worth billions.

As we navigate towards another bull market, my suggestion is to shift focus from the absolute size of FDVs to a more relative evaluation. How should this be done? There are three key methods for assessing Fully diluted valuations:

  1. Comparative Analysis with Market Leaders: Compare the FDV of a protocol with the FDV of the leading protocol in its category (like DeFi, gaming, NFTs, etc.). This comparison sets a benchmark or a potential growth target.
  2. Evaluating Metrics in Relation to FDV: As discussed earlier, look at important metrics such as user base and transaction volume in relation to the FDV. This helps in assessing whether a protocol is fundamentally sound and possibly undervalued.
  3. Historical FDV Trends: Analyze past bull markets and their FDVs to understand the potential upper limits for current FDVs. Tools like CoinMarketCap’s historical data can be invaluable for this purpose.

It’s crucial to remember that in the crypto world, especially during bull markets, token prices can be significantly influenced by social media buzz and public attention. In many cases, the extent of discussion and hype around a crypto protocol (‘Crypto X’) can be as impactful as traditional fundamentals. This phenomenon has been observed repeatedly, where protocols with strong metrics and fundamentals can underperform compared to those with more hype but less substance, primarily due to the amount of attention they receive on platforms like X.

Fully diluted valuations serve as a crucial component in our investment and trading strategies, offering a valuable method for assessing and comparing different protocols. Yet, it’s essential to remember that a token’s price is influenced by a multitude of factors, including market attention, supply and demand dynamics, and overall market sentiment. Therefore, the main takeaway is to adopt a holistic approach in your analysis, taking into account all relevant data and factors, rather than relying exclusively on FDVs.

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