The Intrinsic Value of Crypto Network Tokens

Even informed commentators often argue that crypto network tokens (bitcoin, Ethereum ether, etc.) have no "real" value or utility. The "coins" only have value because a group of people accept them as a medium of exchange or, more importantly, they have the speculative value of a du-jour Ponzi asset.

As I have argued in a previous post, a crypto network is technical infrastructure; a network of compute and storage devices. Crypto network token confer the right to consume compute and storage resources on that network.

Consider following questions:

What would you be willing to pay to store 1 GB of data for an indefinite period of time on a very secure decentralized and distributed compute network that is always available and can be accessed from any internet-connected device? If the answer is "more than 0 dollars" then crypto network tokens such as ether have positive intrinsic value.

What does it cost to store that amount of data and run applications for a "very long" period on a platform such as Microsoft Azure or Amazon AWS each instance replicated "many" times and how much do you value decentralization and quantifiable security?

The intrinsic value of the network token is correlated to the security of the network, e.g. hash rate, and the level of distribution, e.g. number of nodes. If there are multiple comparable networks, for example multiple alternative Ethereum networks, then the token for the network with the highest level of difficulty and the largest number of nodes should command the highest price if the networks are otherwise comparable, e.g. in terms of transaction throughput and confirmation speed.

The fact that an unlimited number of Ethereum networks can be created does not diminish the value of the existing networks and their respective tokens unless resources are reallocated.

There should be a (set of) equilibrium price(s) where users' willingness to pay for compute and storage at the given level of security and distribution equals the cost of maintaining the network (aka "mining" costs") plus some margin. The relationship between price, mining hash power, and network difficulty should ensure that the token price closely reflects mining cost, i.e. network tokens should have an administrative price.

However, if networks tokens are used as a means of payment to settle transaction or as a store of value and speculative investment then the token price could be decoupled from its intrinsic value.

I will explore this question more deeply in a future post. For now let's have a look at the relationship between intrinsic value of ether and the strength of the Ethereum network.

For simplicity, we will express intrinsic value of the Ethereum network token as the number of bytes that can be stored on the network for one ether and we will use hash power as a proxy for network strength.

The Fall of Intrinsic Value and the Rise of Extrinsic Value

There is a clear inverse relationship between the data storage value of one ether and network hash power. The correlation over the observed time frame was -0.7.

The amount of storage one ether buys on the network has decreased because the gas price has increased. One possible interpretation is that miners need to be compensated for providing more hash power with a higher gas price all other things being equal.

However, miners compensation also depends on the token price at which ether can be converted to fiat currency, assuming that miners pay their expenses in fiat currency. Interestingly, the network token price has also increased significantly over the observed period.

The chart shows that in relative terms, ether storage value has fallen at a higher rate than the network hash rate has increased while the network token price has inflated substantially. This means that the intrinsic value of ether as defined in this post has fallen while extrinsic value has risen.