Why Network Size isn't a fundamental in cryptocurrency valuation. Yet

cryptocurrency network valuation

A rising network activity may not be an improvement in a cryptocurrency’s fundamentals, according to a research paper released by Goldman Sachs.

The paper questioned the relationship between a cryptocurrency valuation and its network size. Cryptos are a new asset class and analysts have few, if no, established practices for determining valuation or understanding how cryptocurrency prices form.

Network size is a fundamental often used to valuate social media firms’ equity: can it be a valid approach to determine the value of a cryptocurrency, too? According to Goldman Sachs, no. Actually: not yet.

The valuation of a network is usually based on Metcalfe’s Law: the value of a network increases with the square of the number of users or nodes. GS analysts considered five different proxies based on the number of network addresses (“users” or nodes”) for eight different cryptoassets: Bitcoin, Bitcoin Cash, Dash, Ethereum, Ethereum Classic, Litecoin, Ripple/XRP, Zcash.

In most cases, cryptocurrencies valuations are positively correlated with network size: they grew more than one-for-one with the numbers of users, but by less than predicted by Metcalfe’s Law.

Which cryptos grew more?

Data shows that in the last few years Ethereum experienced the highest valuation/users growth, followed by Ripple and Bitcoin. But it was Bitcoin that scored a +520% free float market capitalization in the same period.

How so? GS analysts say that appreciation in excess of network growth could be the result of many other factors, from macroeconomics to expectations for potential growth of the network in the future.

Rising prices may then be the result of more speculative trading activity, generating address (“users”) growth. This is why rising network activity cannot be considered among the fundamentals of a cryptocurrency: mere speculative trading does not create a higher sustainable economic value.

Cryptocurrency networks need non-speculative, real-world use cases to fully enjoy the network effect.