A sane model for pricing Augur REP tokens
Introduction
Recently, Augur REP tokens have been trading over the counter on Gatecoin for as much as 0.02 BTC, or about $8 at the current bitcoin prices. At CoinFund, we hold a stake of REP which we purchased as Day 1 participants in the Augur crowdsale and so we are interested in pricing REP tokens as accurately as possible before they become liquid.
Let’s take a look at a model for pricing REP tokens and compare with the current state of the pre-launch markets.
Note that models are only attempts at approximating reality and in cryptoasset markets where speculation abounds, no one can truly predict the outcome. But models can also give a mathematical clarity to real world processes which can provide a useful framework for thinking about investments. In general, our analysis here stands as an example blockchain investment vehicles can be a vastly superior to private equity, as their products are open and measurable and succumb to traditional price modeling.
As real metrics from the Augur platform begin to emerge over the next months, this model will allow us to begin zeroing in on REP pricing firmly grounded in reality.
Dollar turnover on the Augur platform
In the Augur crowdsale, 11,000,000 REP tokens were distributed to participants. The holder of 1 REP token is entitled to 1 vote in resolving a decentralized prediction market on Augur, as well as half of the trading fees generated by that market. Therefore, one can model the returns of a REP holder by considering a metric called dollar turnover — the number of dollars transacted on the Augur platform through the mechanism that generates fees for users (and returns for investors).
For instance, if the turnover of Augur is $1 billion in one year, and we assume the average Augur market fee to be 1%, then REP holders will collectively receive a dividend of $1 billion × 0.01 × .5 = $5 million. The holder of 1 REP would accordingly receive $5 million ÷ 11,000,000 = $0.45. Thus, if I give you a REP token today then a year from now you can expect to get paid $0.45 under these assumptions.
How much money should you pay me for the privilege of getting $0.45 in one year?
The present value of a REP token
Of course, getting money in a year is less valuable than getting money today: you could put $0.435 worth of bitcoin into, for instance, Magnr’s savings account at their 2.35% APY and come out with $0.45 just the same. So the present value of our REP token should be discounted by the risk-free interest rate and it should be $0.435.
Now, the Augur dividends will in all likelihood not end in a year. The present value of a REP token has to take into account the turnover of the following year and the year after that. In other words, we can model REP ownership as a security which pays some dividend every year, on and on, into the future. Such a security is called a perpetuity.
Hence, the price of a REP token, P, can be thought of as the present value of a perpetuity security which pays a dividend D. Such a present value is calculated as follows, where r is the risk-free rate:
As the dividend payment D is the same every year, this model corresponds to the simplest case where we assume no growth in the Augur platform. Yet, it’s easy to see that if D was some monotonically increasing function representing growth, this would raise the price P. The perpetuity model thus provides a lower bound on REP price, assuming Augur can maintain some minimum level of turnover each year.
We can then ask: does $8 imply a reasonable lower bound for average turnover of Augur each year in the future?
Working backwards from the current price
If you have fixed r, and you know P, then you can calculate the implied dividend payment D. And if you know D, then you can calculate an implied turnover for the Augur platform.
If an Augur REP token is today worth 0.02 BTC, or about $8, and we assume r = 0.0235 as before, then the implied yearly dividend payment is D = 8 × 0.0235 = $0.0188. This in turn implies a total of yearly platform fees of $2,068,000; and if this is half of 1% of all turnover on Augur, then Augur must have transacted a whopping $413,600,000 each year — roughly half of the current market capitalization of Ethereum.
We can run a similar analysis for several price levels, starting with $0.47, which was approximately the crowdsale price.
Is $413.6 million a reasonable turnover for Augur?
A turnover sanity check
Given our model assumptions, the following graph shows a tradeoff between the number of users and their monthly expenditure, on average, into Augur prediction markets in order to justify a REP price of $8.
For instance, 1M active users must each spend $17.68 per month (or, $212.16 per year) on Augur in perpetuity; in this case REP buyers obtaining REP under $8 are getting a deal.
Is it sane to expect a 1M user base in Augur any time soon?
Benchmarking user base against the growth of other startups
Let’s approach the problem from the standpoint of user acquisition. As a starting point, we can measure the user acquisition rate of various successful startups. The results vary. On the high end, it can take a growing and market-compatible startup 2.5 years to acquire a million users; other startups go viral and see overnight success.
The following table shows the number of months it took thirteen successful companies to reach the 1M benchmark in their products:
This is, of course, selection bias. We are not taking into consideration the 95% of early stage startups which fail before ever achieving this kind of user benchmark. Nevertheless, the chart above goes to show that even for well-funded companies with experienced management teams, a 1M benchmark is a non-trivial achievement which takes time.
Modeling Augur user growth and 10-year returns
Let us shift our perspective and try to understand what kind of growth in Augur user base would be required to explain $8 REP tokens. For this purpose, we’ll model the user base of Augur on a yearly basis for 10 years and then calculate the present value of the implied 10-year returns for REP holders — we call this the implied 10-year price of REP.
Today, the @AugurProject Twitter account has ~4K followers, the /r/augur subreddit has ~1.3K subscribers. Many readers of /r/ethereum — which recently has over 10K subscribers — are also following the project. Optimistically assuming that Augur that project followers will convert to users and tell 5 of their friends, we can estimate the number of first-year users at around 50–100K.
Using a linear growth model, the following table shows the Augur user base as it grows from 75K users in the first year. The model shows that for these users to justify a 0.02 BTC price point for REP, the average yearly turnover must exceed $2.1B — a third of bitcoin’s current market capitalization — over the next ten years. And this in turns implies a $215.50 monthly expenditure for each Augur user, which seems high.
Alternatively, we can ask: how many first-year users would be required to support this price under a conservative estimate of monthly expenditure of, say, $10 per user?
The answer is: Augur would need to attract 1.62M users in the first year — a growth to 1M users in 7.4 months — putting it into the same high-growth category of startup such as a Dropbox, a Spotify, or an Instagram. Again, this seems entirely optimistic.
10-year returns under an exponential growth model
For many successful products, users are acquired from multiplicative network effects, and thus an exponential model of growth might be a more accurate description of reality. An exponential model also helps to bring sanity to the average monthly expenditure parameters.
The following table shows the Augur user base as it grows from 75K users in the first year with an average yearly growth rate of 50%. The output of this analysis is the monthly expenditure per user, which comes down to a much more reasonable $54 per month.
Under these assumptions, the user base over time grows conservatively compared to our last linear model. Augur doesn’t reach a million users until just about Year 7, while still justifying current pricing.
Play with CoinFund’s Augur REP turnover model
Want to try modeling REP price with parameters of your choosing? Make a copy of our Augur Turnover Model on Google Spreadsheets and share the results with us @coinfund_io.
Summary and conclusions
- Augur REP token price can be theoretically modeled as a perpetuity present value, or the present value of 10-year returns based on a model of Augur growth. We can use a real APY from a real product as proxy for the risk-free rate in our modeling.
- If we assume a linear growth in user base (like Facebook), we can’t quite make our model work with reasonable outputs: if we assume conservative growth in user base, Augur users have to pay thousands of dollars to Augur per year. On the other hand, assuming a conservative expenditure sends the required user growth into unlikely 99th percentile territory.
- If we assume an exponential growth in user base, our model shows an aggressive growth which is not unreasonable for a successful product and a much improved monthly expenditure. Still, the required turnover is measured in billions, which implies that in some sense Augur itself would have to grow larger than the current size of its parent platform, Ethereum.
- Based on these findings, we lean toward the conclusion that Augur REP is probably overvalued at the moment. A lower price would allow us to bring both linear and exponential model outputs into a more realistic realm. At the same time, we wish the Augur team success in bringing many users to their advanced prediction market platform, and we’ll be adjusting the model parameters as real metrics become available.
