I can’t tell you the number of times I’ve been asked whether cryptocurrency is a ponzi scheme and how its value is decided. To most people, crypto’s valuation seems pretty arbitrary. But if you really start to dive into the details you’ll realize it’s actually pretty straight forward and not very different from a traditional stock’s valuation.
Cryptocurrency’s monetary value comes from the use of its blockchain. When any blockchain is used there are transactions that need to be validated. Validators of transactions are rewarded for participating in reaching consensus to approve or deny transactions. The more transactions completed using the blockchain the more value is created.
There are two main ways blockchains validate consensus:
1) Proof-of-Work (Bitcoin, Ethereum, Monero) Proof-of-work (PoW) requires miners to compete to solve complex mathematical problems. The first miner to solve the problem gets to add a block of transactions and earn rewards. This results in mining devices around the world computing the same problems and using substantial energy.
2) Proof-of-Stake (Ethereum 2.0, Algorand, Cardano): With proof-of-stake (PoS), cryptocurrency owners validate block transactions. Validators, also known as "stakers," are responsible for processing transactions, storing data and adding blocks to the chain. Validators receive interest on their staked coins as a reward for their active participation in the network.
Rewards are essentially dividends issued to holders or miners for participating in the network. In the case of Ethereum, its Intrinsic Value comes from its cash flows. While Bitcoin is seen by some as a speculative asset that has no cash flows to holders and little to no utility for building applications. Ethereum is programmable money with smart contracts and provides cash flows to its long-term holders indirectly via token supply reductions (burning tokens after they are used) and directly via staking rewards. These cash flows can be applied to the valuation of the token through Discounted Cash Flow Analysis.
Discounted cash flow (DCF) is a valuation method used to estimate the value of an investment based on its expected future cash flows. DCF analysis attempts to figure out the value of an investment today, based on projections of how much money it will generate in the future. This applies to the decisions of investors in companies or securities, such as acquiring a company or buying a stock, and for business owners and managers looking to make capital budgeting or operating expenditures decisions. (Investopedia)
If you want even more information check out this video that explains Ethereum’s Discounted Cash Flow Analysis by Ryan Allis of CoinStack (skip to 6:53 to avoid commercials).