VeChain (VEN) is a supply chain focuses cryptocurrency based in China.
Whether or not you believe in the quantitative valuation model, the analysis below is meant to provide an excellent summary of VeChain, from their strengths to weaknesses, and what makes the technology unique in the cryptocurrency world.
You may also be interested in our other post, How to Buy VeChain (VEN).
What is the Quantitative Valuation Model and Analysis
“Quantitative,” is often considered to be an opaque mathematical black art, only practiced by Ivory Tower academics and supercomputers. Nothing could be further from the truth. Quantitative, or systematic, processes are merely tools that value investors can use to minimize their “survival” instincts when investing. Quantitative tools serve two purposes:
- Protect us from our own behavioral errors.
- Exploit the behavioral errors of others.
These tools do not need to be complex, but they do need to be systematic. The research overwhelming demonstrates that simple, systematic processes outperform human “experts.” The inability of human beings to robustly outperform simple systematic processes also holds true for investing, just as it holds true for most other fields.
Much of the analysis conducted by value investors—reading financial statements, interpreting past trends, and assessing relative valuations—can be done faster, more effectively, and across a wider swath of securities via an automated process. Gut-instinct value investors argue that experience adds value in the stock-selection process, but the evidence doesn’t support this interpretation.
When value investors respond to non-quantitative signals (e.g., the latest headlines on MSNBC, their expert friend’s opinion at the cocktail party, etc.), they unconsciously introduce cognitive biases into their investment process. These biases lead to predictable underperformance. Quantitative Model Analysis is best suited for value investors who can acknowledge their own fallibility. The approach is not perfect, and should always be questioned; however, the approach seeks to deliver the following: a systematic, evidence-based, value-focused investment strategy that is built to beat behavioral bias.
- Value investing works over the long haul because the strategy is highly volatile
- There is a mispricing component of the value premium that is caused by an overreaction to negative fundamentals.
Technical Overview of VeChain
VeChain is a blockchain platform that focuses on the supply chain process, specifically the process of “asset digitization” through the combination of RFID/NFC tags and the immutability of a distributed blockchain. VeChain will use Ethereum as its core layer, and will be split into two tiers of different currencies:
- VEN/VET: function of the VEN/VET is to serve as the intermedium of value and secure the network by being staked in nodes. VEN holders are rewarded with another asset called THOR POWER (THOR)
- THOR Power represents the underlying cost of using the VeChain Blockchain and will be consumed (proportionally burnt) after certain blockchain operations are performed, such as transferring VET and executing smart contracts.
You can think of this an analogous to NEO and GAS, where the holding of one asset rewards with a type of “dividend” with another asset, and that secondary asset being what powers the network.
The equations and functions of this can be found here.
Market Analysis: What transactional problem or inefficiency does VeChain attempt to solve?
One of the major problems in global supply chain is the large amount of counterfeit items being passed around. Right now we have a very archaic system to deal with this, where for example luxury goods will have a paper “certificate of authenticity” that is really easy to copy and fake.
VeChain plans to create a secure network where assets could be authenticated at the creation source and then tracked from party to party. Each item would have its own unique ID created with the SHA256 hash algorithm on the blockchain, and hence once entered in the platform could have its information accessed by anyone within the supply chain process. In addition the platform plans to provide the full spectrum of standard supply chain management tools through its smart contract platform and APIs.
The initial targeted industries will be those who suffer from the issue of asset validation and authentication, a problem all too familiar to Chinese supply chain companies. For example, think about a luxury handbag. A tiny RFID chip could be implanted in the packaging, or even within the bag itself, which would ensure ownership and authenticity.
VeChain Development Team
VeChain has a technical development team of over 40 people, with nearly 150 in total. Key members on the team include:
- Sunny Lu – Founder. Graduated from Shanghai Jiao Tong University, majored in Electronics and Communication Engineering. He has been served as IT Executive in Fortune 500 companies over 13 years, former CIO of Louis Vutton China.
- Jay Zhang – Finance Director. Jay has worked for PwC and Deloitte as a senior manager for over 14 years.
- Jianliang Gu – Technical Director. Jianliang was graduated from Shanghai University with master degree majored in Cybernetics. He was working in TCL communication technology as Technical Director.
- Richard Fu – PR & Marketing Director. Ever 20 years’ working experience in multinational enterprises such as Shangri-la Group and LVHM specializing in sales and marketing
- Jerome Grilleres – Business Development. holds an MBA from London Business School and a MSc in Computer Science. He is from Barclays France and has 8 years experience in Business Strategy and Development in retail banking and 6 years in developing Real Time trading application in Investment Banks.
VeChain is primarily based in China and leases an additional office in Europe.
Partnerships and Products To Date
VeChain currently has several parts of a working product, from Android and iOS apps in the store to the initial platform code. Currently the development team is working on a 3rd generation sensor for RFID tagging.
Partnerships are perhaps VeChain’s greatest initial strength. While certain partnerships like PriceWaterhouseCooper are oversold (at the time its largely an investment and advisory partnership), other partnerships within the Chinese industrial sphere are impressive:
- Mlily, the largest memory foam mattress and smart bedding product research, development and manufacturer in China. Mlily will be utilizing VeChain Thor for Proof of Origin, Proof of Authenticity and Supply chain management. It is estimated that this project will add at least 20 million RFID chips every year for the next five years (blockchain data entry points) on chain.
- Auto manufacturer Renault, an initial partnership to ensure that their manufacturing process is traceable across the supply chain.
- VeChain officially established a cooperative relationship by signing a strategic agreement with Jiangsu Printed Electronics in November 2017. Both parties agreed that we would mutually explore and cooperate towards solutions within blockchain-centric IoT equipment.
- Recommended by and initiated by a government member for Hubei province, VeChain partnered up with Hubei Sanxin Cultural Media Ltd to develop a series of solutions using VeChain blockchain technologies for the proof of origin, the supply chain management and the accounting of digital publications and ebooks. The first phase of this partnership will last for 2 years, to be extended at a later date. Importantly, if this pilot goes as planned the government of Hubei will recommend VeChain Thor Digital publication tracking solutions to The State Administration of Press, Publication, Radio, Film and Television of the People’s Republic of China.
Where does VeChain Fall Short?
- Several other strong competitors within this same field, primarily Walton and WABI. VeChain will have to differentiate itself from them with a superior product or lower fees if it aims to secure the Chinese contracts.
- Getting the ROI on THOR that will surpass your initial VET investment will likely require a multi-year hold. Small stake holders get substantially less THOR per VEN held, which will make non-node positions likely highly liquid and traded. This in turn reduces the value proposition for small holders.
- It’s a Chinese organization, meaning it has all the potential traps and risks of them. Most of the first hand information is in Chinese first. Even reading their English version of the Development Plan will raise a few red flags since its filled with really poor grammar and comes off really unprofessional in the English language.
- There is risk that the powernode users could come to dominate the network.
The Quantitative Valuation Model for VeChain
Equation of Exchange Model
VeChain tokens derive their value from generating THOR Power (THOR), which will be used to pay transaction costs within the network and blockchain. So if we can find estimate the transaction fees and THOR float generated and burned per year we could derive a price for THOR. This would be the expected future value of THOR, which can be discounted back to 2018 and then we can value different tiers of VEN stakes (nodes, masternodes, under 10K tokens) based on this information to arrive at a rational basis range for the price.
This model is inspired by Nodar Janashia’s model for valuing the Raiden Network, which itself is inspired by Chris Brurniske’s blogpost on creating a Cryptoasset Valuation. It uses the same underlying equation, the Fisher’s Equation of Exchange (Quantity Theory of Money):
https://en.wikipedia.org/wiki/Equation_of_exchange
The equation MV= PQ can be thought of in terms of cryptocurrency, where
- M is the monetary base (market cap) of the cryptocurrency
- V is the velocity of the currency
- P is the price of the digital medium underlying the currency transaction
- Q is the quantity of the digital medium underlying the currency transaction
In order to value a cryptocurrency, we need to figure out the equation M = PQ/V for each year in future, divide it by the expected outstanding float and then discount the entire equation to derive the present value of this future utility. In my model I project the expected utility out 30 years until the year 2048, discounting back to 2018 and adding on a perpetuity for all years past 2048.
The term PQ is essentially the value of the cash flow that the “economy” of the cryptocurrency generates, for example for a cryptocurrency that focuses on being a token for online gaming (like FUN), the total value of the economy would be the gaming site revenue that is undertaken with the coin. For VEN, this term would be the value of the fees that are being paid in THOR power by companies and individuals for using the VeChain network. Once you divide that by velocity, you can discount it back to the present day. The final complexity is that VEN tokens generate a fixed amount of THOR per year depending on how much of a stake you hold, with nodes and masternodes generating more than individual VEN tokens. In addition the valuation is also dependent on how long the average person aims to hold the VEN token. If you hold a single token for just 1 year, you only get 0.15 THOR and however if you hold it for 6 then you are close to 1. The final sensitivity analysis is what will present the valuation depending on what the holder expect in terms of hold period in years and also how many VEN they have (node, masternode, under 10K).
The first section (Float Outstanding Schedule) aims to figure out how many THOR Power tokens will be available for burn each year. This depends on the outstanding float of VEN tokens. So far 12.6% of VEN has been burned, which leaves us with 867K VEN outstanding. I applied a 4% annual burn rate to this number, then figure out the number of THOR based on this number. The THOR reward per VEN can be figured out by applying the formula set out by VeChain Foundation:
| Stake Type | VEN Held | THOR per year | THOR/VEN per year |
|---|---|---|---|
| Thrudheim Masternode | 250,000 | 65,700 | 0.2628 |
| Mjolnir Masternode | 150,000 | 39,420 | 0.2628 |
| Thunder Node | 50,000 | 11,771 | 0.2354 |
| Strength Node | 10,000 | 2,080 | 0.208 |
| Non-Node | <10,000 | 0.15 |
For the model I break down users into the non-node bonded users (under 10K) and node bonded users (>10K). For the node bonded users, I will use an average of the masternode and node returns, which comes out to 0.2423 THOR/VEN each year. I assume a 50/50 split between these two groups.
For the transactional market, I’m assuming two different total relevant market inputs. One is the total market for counterfeit and fake goods economy, which according to the Organization for Economic Cooperation and Development accounts for $461 billion. The second is the market for supply chain management software and various dApps, ICOs, extension…etc. The supply chain management market is around 17 billion according to Supply Chain Quarterly magazine, and another $120 billion will be the initial market for the other industries, growing to past $592 billion by 2038. The totality of these market segments is compounded by 5% every year, and growing to 2.58 trillion by 2048. I assume an S-Adoption curve that reaches 10% adoption in 2048 and starts in 2019, accelerating in 2022. The average fee is set at 3.5%, which I think is reasonable.
Now the velocity of THOR is set at 1.0, because I don’t expect it to be used as a currency for anything other than powering the VeChain network. The discount rate I used is 24%, or 3X the long term expected return on large cap equity (around 8%), to account for the risky nature of crypto.
In Summary
After deriving the NPV of THOR, we can give a valuation for VEN across a matrix of VEN stakes and average hold periods based on the assumptions within the image:
| Stake Type (Node Tiers) | THOR/YEAR | 1 Year | 2 Years | 3 Years | 4 Years | 5 Years | 6 Years | 7 Years | 8 Years |
|---|---|---|---|---|---|---|---|---|---|
| Thrudheim Masternode | 0.263 | $6.36 | $12.72 | $19.08 | $25.44 | $31.80 | $38.16 | $44.52 | $50.88 |
| Mjolnir Masternode | 0.263 | $6.36 | $12.72 | $19.08 | $25.44 | $31.80 | $38.16 | $44.52 | $50.88 |
| Thunder Node | 0.235 | $5.68 | $11.37 | $17.05 | $22.73 | $28.41 | $34.10 | $39.78 | $45.46 |
| Strength Node | 0.208 | $5.03 | $10.06 | $15.03 | $20.12 | $25.15 | $30.18 | $35.21 | $40.24 |
| Non-Node | 0.15 | $3.63 | $7.25 | $10.88 | $14.51 | $18.14 | $21.76 | $25.39 | $29.02 |
Ultimately the valuation depends on what stake you hold in terms of node status and how long the average hold period is expected to be. Assuming a fundamental-based approach to investing, I think a 4 year average stake position period is reasonable which gives us between $14.51-$25.44 valuation. Longer periods and larger stakes take us up to $50.88 if you could secure a Thurdheim Masternode stake, a 10x premium over current prices.
Creating a model for VEN really does make you think of these tokens as less of currencies and more as cryptoassets. People like to say that VEN pays a dividend in THOR, but I find it more helpful to think VEN as a financial derivative, its almost like a collaterized derivative contract. It also highlights how much of a disparity there is between the expected value for a non-node holder and the node holders. I expect this desire for node holders to move up to the next tier will put upward pressure. I should note that there is an additional complexity in that the top two node types (Thudheim and Mjolnir) get an additional 30% of THOR Power in the network, something I ignored in the model for simplicity.
In my view VEN and the general supply chain cryptos are some of the most promising, because they address real problems rather than imagined ones like so many crypto currencies. They also apply the properties of the blockchain to these problems in a way that makes sense rather than trying to fit something into the blockchain because its the trendy thing to do. Tracking identification numbers for unique items and luxury goods specifically is something that is well fitted for the blockchain. You can’t fake them like you can fake a paper Certificate of Authenticity.
Are these reasonable expectations? In the model by the year 2027 THOR Power is accounting for over $1.1 billion in transaction fees and by 2048 its up to $9 billion. Is a $9 billion annual fee economy in the long term something within the realm of reason? I think with so much revenue being lost to counterfeiting there will be a strong drive by companies to capture this back, and they will be willing to pay for a solution similar to VEN. If VEN can capture even 10% of that lost revenue, the holders are in for a great time over the long term. What about more optimistic adoption curves? Well if we ratchet up expectations we get the following 4 year average hold valuations:
- 15% adoption: $20-$35 per VEN
- 20% adoption: $27-$48 per VEN
- 25% adoption: $34-$60 per VEN
- 30% adoption: $40-$71 per VEN
I think this provides an interesting way of valuing one of the most promising projects in crypto with a sceptic eye while fully recognizing the potential. That’s what great about modelling, they allow you to keep your expectations within the realms of reality while also checking that VEN isn’t overvalued, because most other coins in crypto definitely are.
Final Rating: UNDERVALUED
Disclaimer: The author (/u/arsonbunny) currently holds 560 VEN bought at $1.20. The author will continue to hold and add on the dips.