*Migrated from Medium* Original Date - 10/18/20

Going off of the theme of decentralization, presented two blog posts ago, I have decided to create a short post concerning the valuation of Uniswap, a decentralized crypto exchange (DEX) that resides on the Ethereum blockchain. Personally, I have been interacting with Uniswap for about a year and consider it to be the best decentralized exchange out there in terms of UI and UX. Moreover, I even find it better than a centralized exchange. The trust issues with KYC have begun to really seep deeper within me the more I navigate the crypto world. Do we really need to give all this information to conduct a token swap? Uniswap, among other protocols, has answered “no”!

Uniswap, founded and brainstormed by Hayden Adams, went the traditional VC route before becoming decentralized. It received funding from major firms such as Andreessen Horowitz and upcoming firms such as Variant. Then, in September, Uniswap decentralized, providing ownership of the exchange to the public, most of which went to its users (talk about community ownership…). If one was a Uniswap user prior to September 2020, one received 400 UNI (worth around $1,200 at the time). Overtime, preprogrammed inflation will hand out more UNI tokens to both investors as well as the treasury, creating the supply curve below:

Holders of UNI act as part of the governance mechanism, that is they get to vote on proposals relating to the platform and direct its course. More importantly, and something overlooked by the mainstream media coverage, is the protocol fee switch, which, if turned on by governance holders, would allow for a 0.05% fee charged per trade. Upon learning this back in September, my eyes lightened up as I saw a viable channel to monetization. In order to really understand the potential of this, I sought to build a BoE valuation model (couldn’t go more complex as this is still such a young and new opportunity). My model sought to value UNI through two different ways: one was on a P/E basis per every year forecasted, and the other, which is the one I focus on more, was a basic DCF based on fee earnings. One thing to note is that I did assume the 0.05% fee switch to be turned on next year (this can be debated).

First Basic Model:

Second Basic Model:

Reflecting on this valuation, there are pros and cons that need to be discussed.

Pros

• Trading volume is too conservative. Attending a talk given by Scott Kupor (a16z) the other day, the biggest lesson the firm had from the last decade was how they consistently underestimated TAM. I think this is the case for Uniswap, and if we really are to move to a crypto-centered world, massive volume growth should be seen in 2023 and beyond. Now, there are some big assumptions here, namely that we do move to this crypto world and that Uniswap is chosen as a DEX of choice. While the former is always up for debate, I am quite bullish on the latter. There are three reasons that support my stance. 1) The UI/UX is phenomenal and should drive an advantage. 2) Uniswap targets the tail-end of tradable assets. The tech isn’t the best suited for trading large amounts of money into the largest tokens, however, it is great for the what would be the OTC equivalents in stock markets. Pink sheet stock exchanges are valuable, and I see Uniswap as fitting that mold. 3) Uniswap has a bustling community around it and is backed by some very strong investors, leading to the building of a solid network foundation

• Took into account dilution through a SBC expense-like manner

• P/E is inline, if not lower, than competitors. A 30x is a very fair multiple, especially given that it will still be in growth phase by 2025. Moreover, if one looks at these graphics from Messari, one can better understand how Uniswap warrants being traded above competitors:

Cons

• In come my traditional finance tendencies: way too much value is coming from TV (however, this can be justified given the youth and future prospects of the company)

• WACC, even at 30%, might be a bit too low. There is a lot of potential volatility and risks here. We should, therefore, measure it against a higher hurdle rate

In conclusion, I am happy to reflect on my first attempt to understand the value of UNI. Clearly, the drivers are volume and the fee switch. Volume will be propelled by both crypto and the exchange’s future adoption. The fee switch is more binary and up to the governance body. As a believer and investor in this token, I really feel that this has the potential to be a phenomenal business, while I also understand the immense amount of risk at bay here. If it just manages to scrape the surface of OTC markets today, well, then we are really in for a phenomenal ride.

Disclosure:* This blog series is strictly personal/ educational and is not investment advice nor a solicitation to buy or sell any assets. It does not represent any views from where the author is working — all views, opinions, and arguments are the author’s. Please always do your own research.*