Augur Valuation and Thoughts
Revisiting Multicoin’s Valuation Model
Not to be construed as investment advice.
This short piece will rely on the premise that the reader has a basic understanding of Augur and its token. The valuation model through which we will view REP is a DCF with both a Gordon growth and exit multiple method (P/E) for its terminal value.
Let’s collect a few pieces of information. Augur’s token, REP, has a total supply of 11mn tokens.
REP derives its value from the reporting fees it collects on settled prediction markets. The basic formula for calculating the return on REP is (outstanding interest * reporting fee) / tokens reporting.
For the denominator, the tokens reporting should trend over time to 100%. If we forecast that Augur should exhibit the qualities of a mature product with billions flowing through in outstanding interest, then all tokens should be reporting on the premise of an efficient market. Holding the token without receiving the cash flows from reporting would be a marker of immaturity.
As for the reporting fee, it is suspected to be 1% over time, in actuality the reporting fee dynamically changes as a function of the max of either (0.01%, the min of (1. reporting fee * (target market cap / current market cap) 2. 333/1000 or 33.3%)). While we can delve into this more deeply, for the purpose of this analysis, 1% will be used.
The primary variable then is to forecast outstanding interest. Multicoin takes a top-down approach (how big is the market) while Coinfund’s Jake Brukhman takes more of a bottoms-up approach (user growth model) to identify the number of users and average spend that would justify the current price.
It is important to explore the assumptions made in Multicoin’s model.
Top Down Model:
The issues explored within this publication include the size of the market and the multiple used. The reader should still dig deeper into how much of the market Augur will capture and what discount rate should be used, but this will not be dealt with here.
For the total addressable market, Multicoin references four bullets to allude to market size. The first bullet speculates that the global sports gambling market may be in the low single digit trillions. The referenced article is from Daily Mail and sourced from a UN conference. The article itself mentions that of the speculated $3trn market, the majority (90%) is generated by illegal gambling. You might counter by observing that some laws in certain regions are strict and you just want to bet on the next Premier League game, however, it is rather likely this demographic is small. The article further describes how the illegal gambling is primarily fueled by high stakes bets in China ($1bn on a single football match) as well as organized crime groups operating in match-fixing. The morality part of whether this product should be built when it can facilitate these other areas of gambling is questionable, but in a similar manner in which money laundering within bitcoin is negligible, it is unlikely you will find Chinese whales or organized crime groups on Augur any time soon. One final note on this bullet: it is unclear how much of the global sports gambling market is done in-person vs online.
The second bullet regarding online gambling is the number that Multicoin is currently working with. Before this point is addressed, the third and fourth bullet should be tackled. With regards to the size of the political market, InTrade processed $230mn over the course of the 2012 US presidential election and Markets, a similar startup, processed about $1.2bn a year. The number is insignificant in the context of a trillion-dollar market. Again, we would also question the implications of a prediction market within politics and what influence or manipulation may arise if the addressable market within politics would grow.
Moving to the fourth bullet, we dismiss financial products as a viable market within Augur. Yes/No markets are equivalent to binary options; these products tend to have more risk than their value for return and the market is very small. Even with scalar and categorical options, when compared with traditional markets, financial derivatives are sophisticated products and a decentralized counterpart in our view provides no value-add when it erodes the capabilities of the original system. Competitors like Robinhood already offer zero-fee options trading in a legal capacity so why should the average user opt for a system operating outside the bounds of the laws in a highly regulated market? Would you risk the wrath of the IRS when Robinhood lets you upload your taxes in seconds? When Ninjatrader lets you build strategies and analytical tools without the fear of being shut down? Sure, you can go build in Malta and avoid persecution for some time, but why make this more complex? It is understandable to want to avoid the tail event of counter-party risk, but it hardly seems justifiable.
Circling back to the second bullet, the online gambling market as mentioned by Multicoin and forecasted by Juniper Research should be about $1trn by 2021. Note that this data has been revised as of February of this year to push back the date to 2022. Also note that a non negligible portion (just under 50%) of this online gambling is within casino-like games, which Augur cannot capture.
Let’s move forward with re-estimating the actual market for Augur to $500bn (portion excluding casino-like games 50% of $1trn). Our working assumptions include the 2022 addressable market for online gambling + current market for political predictions and excludes illegal gambling (whales + crime groups) and financial derivatives. To be conservative, the model will increase the captured market from 2.5% to 5% in line with Multicoin’s numbers in the original analysis.
The next issue concerns the multiple. Let’s dive into the +200x multiple used by Multicoin from Damodaran and download the excel file. For one, using a multiple that incorporates every OTC security in the world is likely to skew results. Dozens of these securities will trade below pennies and have negative or close to zero in earnings. OTC multiples would also not be applicable to the target comparable that Augur likely has in mind. It would be a mistake to forecast the value of a company based on the multiples of a pool of troubled companies. Secondly, the multiple includes values from regions all over the world and they can be influenced by growth rates and risk premiums within individual countries. Because Augur is global, its P/E multiple should increase on the assumption that its decentralized nature will make it less susceptible to the risks of individual regions. The multiple should further increase if one assumes that the majority of online global gambling will most likely initially come from developed markets and over time from emerging markets. Finally, average P/E’s for the internet/software sector are closer to 25x (based on S&P 500 internet/software companies). It is difficult to reference these multiples without the user having special access to data such as Factset or Bloomberg, but hedge funds with substantial capital should have access to these data providers. Please feel free to suggest multiples outside this range and why, however, a 200+ multiple seems unlikely. In the case of a company trading with a multiple in the hundreds, an investor is better suited to using EV/Revenue or EV/EBITDA.
A separate point to challenge is Multicoin’s pros for Augur, specifically within capital/liquidity and its decentralized nature related to security and resistance to regulation. Multicoin presents an argument for growing the TAM via the creation of new markets such as predicting the probability of a hurricane striking a certain area. Having the ability to execute a trade or create a market doesn’t necessarily mean you should. Will there really be any liquidity in this market? How many people are capable of trading this market? To consider variables such as location, age of property, type of property, etc., insurance companies previously defined flood insurance as an “uninsurable risk”. The government has largely subsidized flood insurance albeit at a current deficit, but it is only recently that private companies have developed catastrophe models equipped to serve the market as new big data has become available. Simply because a global pool of knowledge is accessible through Augur does not make it so that this global pool is qualified to engage in niche markets. One other example is in financial derivatives. The average individual will likely not make markets for derivatives nor will the average individual trade in such markets. Unlike working for a centralized entity, how do experts, markets makers for derivatives in this example, or actuarial teams in the previous example, make money with Augur? Who will pay their salary? Will their objectives within Augur be to create the largest spreads possible to earn a profit for themselves? Regulated entities are not too keen on their employees working on outside interests without approval. This issue will spread across many markets Augur may attempt to create and capture. If you are able to create a prediction market for financial derivatives with a centralized entity and knowledgeable employees outside the bounds of law, the entity provides a marginal benefit for a problem that largely does not exist with substantial added risks. If you are able to create a prediction market with a centralized entity and knowledgeable employees within the bounds of law, congratulations you have reinvented the wheel.
On the point related to superior security, it is unlikely that users will be driven onto the application for this feature. For now, it is a cherry on top for the majority because counter-party risks are black swan events and the majority of users operate with a framework of “That won’t happen to me”. Finally, the last point on resistance to regulation is questionable. We defer to the opinion of knowledgeable lawyers, but we wonder whether the US or other developed markets would attempt to discourage using Augur, especially if it works outside the realm of their control and engages in illicit activities. Will someone out there be made an example? Traced and fined? Jailed? If the average user hears this, will they likely continue to engage in using the application when alternatives exist without the possibility of persecution?
The final point to mention is that Multicoin seems to be calculating a terminal value without regard to cash flows prior to it. The cash flows may be negligible, but they should still be a factor of the model. Building out the model allows a user to understand what is required to get to the target valuation over time. How fast should growth be the first, second, third, and fourth year? How is it progressing?
Model below includes implied Augur value; feel free to make changes within the model.
~5% of addressable market captured, 600% growth per yr required
3% perpetual growth rate (IMF global growth rate is 3.9%)
~1.5mn staked last 30 days multiplied by 6 to include last 5 months of yr
40% discount rate provided by Multicoin
Mid-year discounting applied, “Sale/exit” occurs at end of 2022
Bottoms Up Model:
Augur currently averages about 100 daily users, although the current trend is bearish. If each daily user has been unique over the 30-day period from which Augur launched, then the average user is spending at least $450 (assuming 3,000 unique users and 1.37m at stake, average spend is more given that some markets have settled). It is difficult to extrapolate anything from 30 days of data, especially attempting to forecast several years out with a current downtrend.
Our current model will assume slow adoption as UX needs improvement and Augur will need to provide a significant, not marginal, improvement to existing centralized platforms. The difference in Augur as compared to Facebook or Snapchat, etc is how easily it can be shared. Any current users of Augur would have to go through several layers of explanations before another colleague or friend would understand what to do. This can be solved of course, but impacts the timeline of user growth until complete.
No commentary included with user growth model. The model does not reflect current reality with regards to users and spend for simplicity. Feel free to make changes as desired. Terminal value is added from DCF sheet for simplicity. Current model assumes a monthly 20% growth rate in order to capture $25bn per Multicoin.
Risks continue within the crypto space, including scaling solutions, volatility, govt. regulation, etc. Traditional risks are also still inherent such as competition and user adoption. The discount rate is fair given the additional premiums for unchartered territory, but a successful project should ideally see a reward commensurate with the risk.
A note on Multicoin’s newest piece and the rise of AugurCo’s. Bitmex’s Arthur Hayes previously mentioned in a podcast that he intends to create swaps in Q3 of this year so an individual can exchange BTC for a product that tracks the returns of a traditional financial product: Imagine buying Facebook stock without owning the underlying equity using BTC and capturing the return or loss. This will be important over time as the industry watches how regulators respond against Bitmex. It will give interested parties clues on how censorship resistant AugurCo’s must become if they engage in activities involving financial products and politics within a centralized entity outside regulated markets. Otherwise, operating in a centralized environment seems far less revolutionary and more of a push on current competitors to trend them down to lower fees.
Two other risks include 1. Forked protocols and newREP tokens as a negative for REP 2. The introduction of legalized sports betting. Tushar conducted a poll through Twitter with about 350 responses. Most of these responses voted that legalization would benefit Augur. It is difficult to understand just how much of a benefit legalized sports betting would be for Augur. While legalization grows the addressable market, there are very real and immediate negative impacts around increased competition and liquidity. With all this information, the point is simply one: Exercise caution and be aware of the risks. Nothing great was ever built without substantial risk, but successful projects are tail events.
Not to be construed as investment advice.
Thank you for reading. Where is the publication incorrect or what can be improved? Feel free to email any questions to firstname.lastname@example.org.