Originally published on June 28, 2018
The current rage in crypto seems to be the Binance Coin. Its resilience and massive outperformance (it more than doubled vs BTC YTD) in the face of a heavy bear market are remarkable. After all, an increase of 120x in less than a year is not something we see every day, even in crypto. I find the current price stretched and pricing in quite an upside already.
A few valuation attempts are already circulating the net, like this one for example, which paint quite the rosy picture. I find it to be deeply flawed. Among the logical mistakes in it is valuing the exchange itself and then deriving a market cap for the tokens. Another analysis was done by Foreground capital, where they value BNB by first valuing Binance the exchange using EBITDA * a P/E multiple and then dividing by the circulating BNB supply to get to a token value. There are too many flaws in these approaches to address here so I’m not going to do that.
Disclaimer: I don’t own BNB and this is not investment advice in any shape or form.
Binance is something of a financial miracle in the way it is run leading to its meteoric rise. This is only possible in crypto and is truly fascinating. Kudos to CZ and the team for making this work even if luck occasionally played a role as CZ has mentioned in interviews. Respect.
The BNB coin is a great instrument. It allowed early users to fund the development of Binance in exchange for offering them a clear utility later — to save money on fees. This is one of those rare cases of coin utility, which has both proven to work out well and can be quantified. It has built-in network effects because the more people trade on Binance, the higher the coin burns and the more referral fees are paid out. Also it would allow Binance to potentially reduce fees further after the BNB discounts disappear and competitive pressure increases. There is no question in my mind that BNB is a very useful coin and is serving its purpose.
I would approach the valuation of BNB from two incentive sides: 1/ as a trader, who is using BNB to pay fees and 2/ as a speculator who is betting that the price should increase due to the increase in exchange volumes and token burns.
A few assumptions and caveats:
- All fees on the platform are paid in BNB. I know this has not been the case so far, but let’s assume people do it for the sake of maximum benefit
- 1% discount rate. This sounds very low, but the idea is that saved USD not spent on fees are kept in the bank
- 50% trading volume growth per year. Frankly, this could be lower or much higher — crypto is not a place where forecasting works very well at this point. So you can make your own assumptions, this is meant to be one case
- Fee structure and discounts on Binance stays the same, they don’t change due to competitive pressure. This seems plausible, but given the speed of crypto and the adaptive nature of CZ and co, who knows. They will do what is best for the users after all
- Everywhere I am talking about the values in USD. Given that Binance is crypto only, I assume everything is denominated in USD for the sake of simplicity
- 8,000,000 customers
Using these assumptions, here is what we do:
1/ Users of BNB’s utility to reduce fees
For any user who buys BNB to pay lower fees the value comes from the savings. The saved USD can be kept in the bank (and earn small interest). Let’s run a simple calculation.
We can estimate the present value of all savings until discounts disappear in year 5. The total PV is USD1.5bn. This can mean anywhere between $7.7–$15 per BNB depending on the supply assumptions. Please note that this calculation captures the value from day 1. If you were an ICO participant and have used BNB to pay fees — this is the calculation. If you are considering whether to buy now and use BNB, you essentially need to exclude year 1 (it ends in July 2018) and your savings value would be $5–$9.5. Incentive wise, if a user buys BNB shortly before they trade and then uses it, they don’t really care what the price of BNB is because the fees they pay are based on what they trade (e.g. BTC or ETH) and not on the price of BNB per se. Let’s assume that traders want the utility of BNB and don’t want to carry its price risk. If prices go up, the user has more money to spend on fees, if prices go down — less, so the incentive to keep a large balance for a pure trader is not clear, it is a gamble.
The PV is the maximum amount of savings that is possible given these volume forecasts and the maximum value that all users derive from the utility that BNB provides.
The total value of BNB should not exceed the amount of savings because otherwise it would mean that users pay more for fees than they are saving. To illustrate, let’s assume I am the only trader on the exchange. I want to make full use of the discount and will achieve the above volumes myself. I know how much USD in fees I will need to spend. I also know how much I will save and how many coins are circulating. How much should I pay for all BNBs? If I pay more than the $1.5bn USD present value of savings, I am essentially losing money by paying a higher fee than without the discount, which does not make much sense.
The value depends on the circulating supply, future burning of coins and whether the 80m Founder tokens will be released when they get unlocked. You can see three different values based on assumptions about the supply: 1/ using the current supply, 2/ using the minimum (100m), meaning that everything else has been burned and 3/ all Founder tokens are released into circulation by Year 5.
Comparing to today’s price of $14 (27 June 2018), it seems the market is pricing in quite a good development already: only 100m coins in circulation, 6x in trading volume by year 5 and that the exchange traders make full use of the discounts. Obviously if you pick different assumptions, you will get a different value, but this shows you roughly what is in the price today. Important to remember: you get this value only if you make use of the trading discounts.
Speculators in BNB
We are witnessing the interesting development that the early token investors in BNB are holding the token instead of using it because its price increased so much (120x in less than a year). Given the price action, this is absolutely logical and the value increase is much larger than the value from saving fees. These early holders are now selling to the active users who buy to make use of the lower fees.
If you are not using BNB to pay fees or you have much more BNB than you need, then the question becomes: why hold? The simple answer would be: to capture any further price increase due to fundamental increase in demand. Sounds logical considering the price action so far. However, one has to ask himself whether the price action and current price are reasonable at all.
On one hand, the BNB discount is going down every year, which reduces the amount of BNB needed. This is offset by an increase in volume. On the other hand— the quarterly token burns by Binance are reducing supply, which should in theory boost the token value. The incentive for everyone is that trading volumes go up — this leads to more demand for BNB and more dollars for token burns. Also, the first batch of Founder tokes is unlocked and in future this gives CZ and the team a good lever (80m tokens) to apply in order to navigate the price. Currently, it seems that the founders have not introduced their first 16m into the circulating supply, which means that the original Angels have circulated basically all of their 20m tokens (again, quite logical given the price development).
If one is not a user, there is no benefit to owning BNB apart from speculation that the price will go up with increased demand from the actual users and reduction of supply due to burning. In other words, piggybacking on traders. Let’s examine this:
The way to look at this is fairly simple, we take the total amount of USD going after BNB for fees and divide it by the circulating supply. Obviously, the higher the volumes and the lower the supply, the higher the resulting BNB price in USD terms. Using the numbers above, we have $556m in fee demand (based on a rough estimation of Binance’s total traded volume from August 2017- July 2018) going after 114m tokens, resulting in $4.88 equilibrium price. Obviously this is much lower than the current price and it is easy to jump to a conclusion that if you only increased volumes 3x, you get to the current price. By the way, increasing volumes 3x should be quite easy — they were 3x back in Jan 2018 so going back to these levels is very plausible.
There is a small issue with this approach however, and it is the almighty velocity. Many project owners and their investors would like to reduce velocity in order for token prices to increase with increased network usage. Often, this is a natural result of the token economy and product design. Here, however, the goal of circulating BNBs is to float as quickly and freely as possible to satisfy trading. Generally, that means that if users purchased BNB for trading, then used it to pay fees, chances are, they would not hold the coins for very long. Why would they keep large amounts of BNB locked and expose themselves to the probability of price declines and a resulting need to add more money?
The equilibrium price assumes that all the coins are used only once per year. We need to adjust it by dividing it by the number of times the tokens are circulating per year. We don’t know the actual usage velocity at Binance (obviously, people who hold the coins for speculation are reducing velocity artificially). Generally, trading velocity should be quite high. Look at the illustrative velocity table below and pick your “poison”.
If we take an average holding period of 7 days, it means that ALL coins in circulation are traded every week and we need to divide the $4.88 by 52x (365 days / 7 days). The value suddenly drops to $9 cents. To satisfy the current BNB price, Binance would need to process $70trn (130x) in volume per year — TODAY. One metric to observe is that during this past year, the average amount of BNB traded per week was ca. 2mn coins, which is only about 1.7% of circulating supply. That is to show that with its current trading volumes, traders don’t need that many BNB tokens to facilitate fee payments, hence the price per token does not need to be high.
The reality is that not many traders use the BNB token for fee discounts. They hoard the coin in anticipation of its price rising and so far this has worked out pretty well. The result is that the velocity of BNB currently is not high at all, probably even below 1 (all tokens don’t even do one turn per year), which, when applied to the numbers above, can rationalize the current price. The important thing to remember here is that the relationship is inverse: the more volume is traded on Binance and the more BNBs are needed for fees, the higher the velocity and, hence, the lower the fundamental value.
In any case, the value of savings (from usage) is much clearer and higher than the hoarding value.
Lastly, it makes sense to think about the incentives that the Founders of Binance have. They own 80m BNB, which unlock evenly every year for 5 years. They don’t use the saving utility of the coin, but benefit from it dramatically as it works as a marketing tool. Their levers to manage the price of BNB are threefold: 1/ decide when to release their tokens into circulation, 2/ find new uses for the coin (such as the DEX) which increase usage and demand and 3/ manage the net profit of the exchange which affects the amount of token burning. When the price increases, they benefit directly together with their users as long as they keep their coins. They also benefit indirectly as they get to keep happy users.
Whatever happens to BNBs price, the team at Binance needs to think about these dynamics when talking about the value of the coin. The savings value is easy to see and rationalize, but the fundamental one is tricky. Obviously, their aim is to keep all stakeholders happy and lay the ground for their future products. So far, they have proven that they can execute flawlessly so keep up the good work.