Bored Apes a Better Investment than Cryptopunks?

A simple financial analysis of blue-chip NFTs

Yes, Bored Apes are a better investment than Cryptopunks.

Yes, that’s meant to be clickbait. It’s also true.

Investing means that you have an expectation of future returns relative to the price of an asset, not just the hope that an asset grows in price. There’s nothing wrong with betting on price increases, it’s just different than investing. Per Buffett, investing requires a focus on what an asset will generate. Speculation focuses on the price action of the asset. There’s a lot of speculation in the NFT space, but not a lot of investing.

Using an investor’s lens to determine the value of an NFT is a contrarian strategy in a market gripped by speculation.

Determining Fair Value

NFTs that offer future distributions, whether fungible crypto tokens or new NFTs, aren’t much different from stocks that pay dividends. For decades, investors have used the dividend discount model (DDM) to assess fair value of a stock based on dividend payments. The formula takes an estimated dividend and divides it by an investor’s discount rate (target return) minus the expected perpetual growth rate of the dividend. The quotient represents fair value of the stock.

Fair value = Dividend / (discount rate – perpetual dividend growth rate)

For an NFT, the dividend is the investor’s estimated market value of any fungible crypto or NFT assets that are airdropped or reserved to purchase (less minting and gas costs) for the core asset holder on an annual basis. The growth rate is how much the investor expects the value of the annual dividend to grow into perpetuity.

No investment formula can definitively tell you what makes a good investment. If we knew for certain what some future dividend stream would be, the price of the asset would be very stable, only moving to account for discount rate changes. Markets are unpredictable, and formulas require imperfect information.

The DDM has two major weaknesses: It’s hard to predict dividends, and it’s hard to predict the growth of dividends. These weaknesses are doubly true for an emerging, volatile asset class like NFTs. Despite these weaknesses, formulas are useful in comparing the prospects of two assets like Bored Apes and Cryptopunks.  

BAYC vs Cryptopunks: The Analysis

A simple DDM tells us that Bored Apes are valued more favorably than Cryptopunks based on current market prices and recent distribution history.  

Distributions

Both BAYC and Larva Labs (Cryptopunks) distributed NFTs to core token holders this year. BAYC airdropped Kennel Club (BAKC) and Mutant Serum (MAYC) tokens to holders. Larva Labs reserved Meebits for Cryptopunk holders to mint for free less gas. These distributions form the basis for determining the value of each project’s dividends.

BAYC’s distributions are worth about 7 ETH year to date. BAKC’s current floor price is 3.23 ETH. The current Mutant floor is 3.76 ETH, and the Serum floor is 3.7 ETH. Each of those have several recent sales near or above those floors, so they are reliable minimum prices for each asset.

Note: Many in the NFT space incorrectly use floor price as a determination of minimum value of an asset. Floor is only the minimum value of an asset if there is liquidity at the floor. Many projects have floor prices where there is no market. It doesn’t matter if a project has a 10 ETH floor if no one is buying there. 10 ETH is just the lowest ask, not the lowest clearing price. As an investor, the only thing that matters is what assets are actually selling for, not the lowest current offer in a marketplace.

Larva Labs has distributed dividends to token holders worth about 4.7 ETH, which is the current floor of Meebits. Several Meebits have sold near that floor, confirming the floor.

For modeling purposes, it seems fair to assume dividends near this year’s distributions worth 7 and 4.7 ETH respectively. I assume a 6 ETH dividend for the BAYC model, a slightly more conservative view relative to current distributions. I assume a 5 ETH dividend for Cryptopunks to give the team some additional credit given the king status of Punks in the NFT space. Some may object to the assumption that BAYC will generate more dividends than Punks, but recent history tells us the BAYC team may be more aggressive than Larva Labs in their distributions.

Discount Rate

The discount rate of the DDM reflects what you believe is fair compensation relative to the risks you’re taking in the investment. Setting a discount rate should factor in both macro and micro elements of the investment, as well as your personal tolerance for the asset in question. My rate may be different than your rate even if the asset is the same.

From a macro perspective, NFTs are still a speculative space. That warrants a higher base discount rate than something established like large cap public equities for which I believe investors generally use 8-12% in the current environment. NFTs also warrant a higher base rate than later stage venture capital, which I would say start in the 20-25% range in this market.

From a micro perspective, BAYC and Cryptopunks are the best blue-chip assets in the space. They’re fairly liquid. Their discount rate shouldn’t be as high as the hurdle for some new, unknown, illiquid project. Both should also get credit in their discount rate for having great teams with strong track records and extremely active communities that support the asset. In my opinion, the odds of either project becoming irrelevant is lower than an early stage startup failing.  

I’ll use a 35% discount rate for both. Some may think that’s far too low, others too high. As long as the discount rate reflects your hurdle, it doesn’t matter what anyone else thinks about it.

Dividend Growth

How much will the value of distributions grow for each project in the future? Blue-chip tech companies regularly grow revenue and earnings in the 15-20% range, although I’m not sure that’s the right comparison. What the perpetual dividend growth estimate really represents here is a belief that both projects will continue to grow in cultural relevance over time, increasing the value of distributions they offer. I think something around 10% is fair.

Again, some may think that’s far too low, others too high. As long as the growth rate estimate reflects your beliefs, it doesn’t matter what anyone thinks about that either.

DDM

Putting these assumptions into the DDM tells us both projects are overvalued from an investment perspective, but Bored Apes are far less overvalued than Punks.

What the analysis really says is that assuming the same hurdle for BAYC and Cryptopunks and distributions of 6 ETH and 5 ETH respectively given recent history, a Bored Ape should actually be worth more than a Cryptopunk from an investment standpoint. The fair value of BAYC is 27.3 ETH vs Cryptopunks at 22.7 ETH. If Larva Labs were more aggressive with distributions to Punks holders, this could change.

We can also invert the focus of our analysis from what estimated distributions imply about fair value to what distributions would have to be to justify the current price. At a 37 ETH floor, BAYC would need to distribute 9.25 ETH in annual value growing at 10% per year to justify the price. Cryptopunks at an 80 ETH floor would need to distribute 20 ETH in annual value growing at 10% per year to justify the price.

If an investor thinks either scenario is likely, or that either asset can reliably deliver distributions above those hurdles, then the assets should be a bargain to him.

If you want to play with your own DDM analysis, copy the tool from my Google Sheet here.

Where Could the Analysis Be Wrong?

Everywhere.

Investing in NFTs is a new world. Estimates and assumptions are fraught with potential error in such an environment, particularly as it relates to the macro environment around NFTs, the cultural relevance of each project, and the potential for future distributions.

NFT Macro

No one should be surprised that BAYC and Cryptopunks appear overvalued based on an objective investment analysis. The NFT markets have been hot, maybe a bubble, and asset prices generally look expensive based on rational analysis in those situations. Even if we’re in a local maximum, I expect NFTs to continue to grow in importance over the next decade plus, so investors with a long-term mindset and the ability to weather volatility will probably do well with blue-chip assets.

Cultural Relevance

NFTs are tradeable cultural relevance, and any investment analysis assumes some level of continued relevance for the underlying asset. It’s possible neither project is relevant at all in the next 5-10 years, although that would be a surprise at this point. For that to happen, NFTs as a category would have to fail to maintain relevance.

Cultural relevance is hard to recover. If either project falters in its relevance, it may not be able to regain it and suffer permanent investment impairment.  

Future Distributions

Future distributions depend on two things: the team’s commitment to the project and the market’s desire for derivatives.

Team commitment is the easier of the two to assess. Team is always a critical part of any equity or equity-like investment. The team’s track record of delivery and engagement with the community are the best signals. The teams at both BAYC (Yuga Labs) and Larva Labs seem committed to their products and communities.

The market’s demand for derivative projects is tougher to predict. As long as something is culturally relevant, there should be demand for derivative assets even if those assets never compete with the value of the core asset. BAYC’s strategy to expand its existing community vs Larva Labs’ strategy to build adjacent communities shows two different types of bets. I’ll write more about these strategies in a future post.

To contextualize market demand, we can consider the economic realities of our assumptions. A 5-6 ETH annual dividend to 10,000 token holders is approximately $200-240 million in distributions at a $4k ETH price. That’s about the revenue of Allbirds in 2020 ($219 million, up 13% y/y). Can BAYC and Larva Labs generate digital projects as popular as a mid-sized footwear company?

That would have seemed crazy a couple of years ago but far less crazy in a digital first world.

Relevant Observations

Doing this simple NFT valuation exercise with a few insights about investing in the space:  

There is powerful circularity in NFT core asset/distribution value. Just as stocks need to justify higher valuations with bigger earnings over time, NFTs that trade at higher values need to generate bigger distributions over time for investors. Unlike equities, NFT dividends tend to increase in value as the underlying asset increases in value. When Apple issues cash dividends, the value of Apple stock doesn’t change the absolute value of those dividends, only the level of yield that the dividend represents (dividend/stock price). When BAYC goes up in value because of growing cultural relevance, the values of BAKC and Mutant Apes also increase.

It’s hard to separate the importance of cultural relevance from the value of the distributions in modeling out financial returns for an NFT. Arguably cultural relevance is the true floor for these types of investments. Distributions from a project with no cultural relevance will be worth nothing because there will be no market for them.

Floors are for investors. Rares are for collectors and cultural relevance speculators. So far, distributions for most projects have been equal across core asset holders. It doesn’t matter if someone holds the least rare or most rare token, they get a random distribution. Therefore, it doesn’t make sense for NFT investors to own rare assets unless those rare assets come with special distributions. Investors are better off buying floor assets that come with the same expected distributions as rare assets.

Rare assets can offer incredible exits (see Punk Aliens), but they depend more purely on cultural relevance and less on the expected distributions from the project. It would be fun to see some projects experiment with offering rare distributions to rare asset holders, creating a high-value compounding asset that could attract collectors and investors alike.

Floors set value but hide dynamic upside. Any investment analysis on an NFT should be based on floor prices of both the core asset and the distributions; however, this prudent approach ignores the lottery-like element that comes from NFT distributions. While a core asset holder should expect to get a floor distribution, he has the potential to receive a rare one. Instead of getting a floor 3.7 ETH M1 Mutant Serum, an Ape holder could have received a 350 ETH ($1.2 million) Mega Mutant Serum during the Chemistry airdrop.

Sensible NFT investment portfolios should be positioned for survival over the long term with the potential for dynamic upside from any given distribution. The longer you survive, the more chances you have of getting a valuable rare distribution.

Be First

I would love to own both BAYC and Cryptopunks as a collector and even a speculator, but neither seem to be no-brainers as pure investments given my assumptions about the world. Maybe an NFT winter gives us more attractive valuations on core assets that make them strong investments, but winter would also decrease the value of distributions. In that scenario, a long-term investor in either project should expect a higher perpetual growth rate of dividends to account for a near-term decline, although it’s hard to see the future when the world is falling apart. Everything is a moving target.

There’s a movie called Margin Call that’s a cult hit amongst finance nerds. It’s about a bank stuck in the middle of the financial crisis. Jeremy Irons plays the head of the bank. At one point during the nadir of the crisis, he tells his team “There are three ways to make a living in this business: be first; be smarter; or cheat. Now, I don't cheat. And although I like to think we have some pretty smart people in this building, it sure is a hell of a lot easier to just be first.”

There are certainly people who cheat in the NFT space. That comes with any financial boom. There are also a hell of a lot of smart people in the space. That also comes with financial booms.

It always pays to be smart, but it’s better to be first. Being first as an investor means minimal competition for the assets you want to own. Even though BAYC and Punks may look somewhat expensive as pure investments, there are several other projects that look more attractive on a fundamental basis. I’ll investigate those more in future posts.