A valuation analysis of Kyber Network Crystal (KNC)
Kyber Network was one of the most anticipated ICOs in September. Kyber is creating a decentralized exchange that will allow for instantaneous on-chain transaction with guaranteed liquidity (i.e., you don’t have to worry about having a counter party to match your order.) It is also the last project in which Vitalik has agreed to be an advisor publicly. The project has amassed a large number of followings with its Slack group being largest in the world with 30k+ members.
Since KNC became transferable on September 24th, its price has seen a sharp rise and is now being traded around 3x — 5x its ICO price (0.00167 ETH / 1 KNC at ICO) you might wonder…Is KNC already overvalued? or is it still cheap based on its fundamental?
In this article, we try to answer that question by analyzing potential monetary gain a KNC token holder will receive and arrive at estimated market cap for KNC. We have also created an interactive tool where you can modify assumptions and arrive at your own conclusion of KNC’s price.
Disclaimer: this article constitutes our opinions and is for information purposes only. It is not intended to be an investment advice. Seek a duly licensed professional for investment advice.
First step in valuing KNC is to understand its utilities. For this, we take a look at an excerpt, taken from Kyber’s white paper:
Before operating, KyberNetwork reserves need to pre-purchase and store KNC tokens. In every trade, a small fraction (exact numbers are TBD) of the trade volume will be paid by the reserve to KyberNetwork platform in KNC.This small fee represents the reserve’s payment in return for the right to be able to operate and earn profits from trading activities in KyberNetwork. The collected KNC tokens from the fees, after paying for the operation expenses and to the supporting partners, will be burned, i.e. taken out of circulation. The burning of tokens could potentially increase the appreciation of the remaining KNC tokens as the total supply in circulation reduces. In order to determine the network fees, the conversion rate between KNC and ETH will be updated frequently to the Kyber contract by KNC operators, based on the trading rates on various exchanges.
- KNC is required as a fee for reserve manager to use Kyber platform
- Proceeds from fee minus operating expense will be used to buy back KNC from open market (basically a share buyback scheme)
A quick note regarding share buyback scheme. Share buyback is similar to dividend in a sense that both are method of distributing profit back to the token/share holders. Both methods has its pros and cons. Several advantages share buyback has over dividend payments are:
- Easier execution: buying tokens back in open market is much easier than having to send dividend to each individual wallets which could incur large transaction fee
- No wasted value: if a private key to a wallet is lost with some tokens stuck in it, dividend payment going into it is technically also lost forever
However, share buyback also has a disadvantage. Because buyback happens in open market, If it occurs when price of asset is overvalued, share holders would have benefited more from just receiving dividend and they can choose to put that money in other investment.
For equity asset, one way to estimate the value of a company is to use Discounted Free Cash Flow (DCF) method. However, KNC token holders is not really the share owner of Kyber. They have no claim on company’s free cash flow or assets — only on the remaining portion of platform fee after operating expense. Using thing method would also require us make other assumptions such as discount rate, terminal growth rate, which are difficult to do accurately.
Alternatively, I would like to think of KNC in “steady-state” operation as a business that provides a stream of regular payment — something like a bond or high-dividend paying stock. We can then try to estimate the value of KNC based on 1) the size of the payment 2) price multiple (or dividend yield) investors are willing to accept.
With this knowledge, we can now devise a formula to try to estimate the value of KNC.
KNC market cap = Price Multiple * Annual Buy Back Amount
We will look at each of the component.
i) Price multiple: In equity market, multiples such as PE (price earning multiples) or Price to EBITDA multiple are used for comparative valuation analysis. An example would be if an analyst try to estimate the value of a private company, she would first calculate EBITDA multiples of comparable publicly traded companies. She would then apply those multiples to the company in question to arrive at a range of valuation. We will do something similar for Kyber.
For the purpose of this analysis, we consider kyber’s buyback as a form of dividend and we believe that in the long-term (crypto currency widely adopted, trading volume is stable), a price multiple range ~20 is reasonable. (equivalent to 1/20 = 5% dividend yield; typical range for large blue-chip stocks with characteristic of steady, reliable stream of income) In the shorter term, people might be willing to pay a higher multiple with expectation of future growth.
ii) Annual buyback amount: to estimate the annual buyback amount, we need to breakdown our formula further
Annual buyback amount = (Crypto Market Trade Volume * Kyber Market Share * % Fee) – operating expense
iii) Crypto Market Trade Volume: In the short-term, Kyber will only support ERC20 tokens trades. While in the medium-term (2019), they will start supporting cross-chain trading. To estimate the addressable market size for Kyber, we look at all the crypto-crypto trade pairs value. (Kyber won’t be able to support crypto-fiat trading pairs) Based on CoinMarketcap data, current daily trading value of crypto-crypto trade pairs is ~USD 850Mn.
Since cross-chain feature will only be available in 2019, we will try to estimate the trading value for that year. To do this, we look at historical trading value growth rate over the past few years:
The trading value has risen substantially so far in 2017 (10x) going from around USD 100Mn to USD 1Bn. Between Q1 2015 to Q2 2017, trading value CAGR is ~400%. Can the trading activity continue to grow at this pace? It depends on many factors and any action from government could affect the market in a big way. However, trading activity in crypto asset is still minuscule compared to other asset classes. For example, NYSE daily trading value is in the range of USD 200Bn. So compared to NYSE, bitcoin trading activity is only representing about 0.5%.
We believe as a base case, trading activity will continue to grow, and will be 5x — 10x current level in the next couple of years (120% — 220% CAGR.) This means the crypto-crypto daily trading value will be in the range of ~USD 4Bn — 8Bn. We will pick the middle number (USD 6Bn) for our analysis, which means crypto-crypto annual trading value will be ~USD 2Trillion in 2019 when Kyber releases its cross-chain product.
iv) Kyber market share: A quick data pull from coin market cap (minus crypto-fiat trading) shows the relative market share of the largest exchanges as followed:
We believe that if executed successfully, Kyber can be in the top ten list of exchanges and can have about 5% market share. We particularly like the idea of becoming a payment API for generic token. As more tokens are generated, having an instant exchange service integration would be beneficial to merchants who are only looking to receive certain currencies (e.g., ETH) This payment service can give Kyber significant volume upside beyond just regular exchanging.
iv) Kyber platform fee: centralized exchanges charge ~0.25% of transaction value; we believe in the long-term, this fee will go down as more competition arises and better decentralized exchanges start to roll out. While Kyber does not specify how much they are going to charge yet, we believe 0.1% range should be competitive and is reasonable. In fact, it is the value Kyber use in an example in its whitepaper — so we will go with this value in our assumption.
v) Operating expense: Kyber will pay for its operating expense using proceeds from platform fees. Remaining amount will be used to purchase back KNC tokens from open market. Operating expense is difficult to estimate. Typical tech companies can have OpEx range between 20% — 40% depending on the stage of the companies, nature of businesses, and how efficient they are run. For Kyber we believe this should range in between 20% — 30% of revenue. Once the technology is developed, running a DEX is pretty straight forward and quite cost-effective. Most of the operating cost will likely be in personnel and marketing bucket (e.g., sign up merchants onto the platform, etc.) and as Kyber scales OpEx should goes up at a slower pace, so we believe 25% is a reasonable number.
To summarize the ingredients for our calculation:
- Price Multiple: 20
- Crypto-Crypto annual trade volume: USD 2 Trillion
- Kyber Market share: 5%
- Kyber platform fee: 0.1%
- Operating expense: 25% of revenue
Plug it in to our formula, we arrive at the valuation for Kyber (market cap) of USD 1,600 Mn
So while KNC price has already risen since ICOs, there still appears to be potential upside to the current price level (~USD 250Mn market cap as of 27 September 2017.)
However, there are still many execution risks involved in realizing this valuation — e.g., good UX/UI and customer experience, reserve managers provide competitive rates vs. other exchanges, ability to implement cross-chain exchange protocol, speed to market versus competitors. We should have a better idea of how well the solution is once main net launch happens in Q1 of 2018.
This valuation derives from a number of assumption outlined above, but we realize that you may not agree with all of our assumptions, so we have created an interactive tool in Tableau (here) where you can play around with your own assumptions and arrive at your own conclusion. All the assumptions are listed on the right hand side panel. Feel free to comment with your thoughts and feedback — we would love to hear your opinions.