On November 8th 2021, Ethereum Name Service (ENS) has airdropped 25 million tokens out of a total of 100 million tokens to the early supporters of the Ethereum domain name. The price of $ENS has since skyrocketed from the initial $43 to $83 in less than 72 hours. At the time of writing, $ENS is priced at $60, with a market cap of $1 billion. Is $ENS overpriced? What is the fair valuation of the token?
Unlike a lot of the other tokens in the market, ENS has a fixed income flow from the annual registration fees paid by the domain name holders, which makes it similar to a traditional financial investment and easier to evaluate. With some reasonable assumptions, I will show you how to evaluate the price of $ENS using the Discounted Cash Flow (DCF) model.
As the domain name of web3, ENS is often compared with the similar internet domain giant — GoDaddy, which has a market capital of $11.8 billion and priced at $71 at the time of writing. At the current market cap of $1 billion and circulating supply of $17.5 million ENS tokens, if ENS reached a similar level of $11.8 billion market capital as GoDaddy, the price of ENS token will reach $674! Of course this is only a wild guess and I personally don’t think it’s a fair comparison because the two companies have very different businesses. So let’s not use a comparison but rather do some maths and use a model to see what the value of $ENS could be.
DCF model
The DCF model is the simplest model one can use to evaluate an investment. It makes use of the future cash flows from the company or investment to estimate the value of a stock, investment or any securities. As long as the future cash flows are accurate, the DCF model can give a pretty good estimation. The formula for fair value measured by DCF is:
As you can see, the only two inputs needed for the model are the future cash flows and the discount rate. The discount rate is normally the opportunity cost of investing in this company rather than elsewhere. So I’ll use the average annual return of S&P 500. For the expected future cash flows from ENS, assumptions will need to be made based on the current observed data:
- 432,000 names registered as of November 11th 2021; 302,044 are listed on Opensea https://opensea.io/collection/ens
- Annual registration fees are: $640/year for 3-letter names; $160 for 4-letter names; $5 for 5-letter or more than 5-letter names based on fees from https://app.ens.domains/
- The distribution of 3, 4, 5 and more than 5 letter names are — 2%, 4% and 94%, which is based on the distribution of all listed ENS names on Opensea right now.
- The assumed average annual cash flow generated per name is $24 — calculated from the weighted average of the registration fees and distribution of 3-letter, 4-letter and 5 or more letter.
- It is assumed ENS will continue to operate and generate such cash flows in the next 20 years.
- The discount rate 11.6% is the average annual return of S&P 500 index, represented by the SPY ETF since its inception (see Yahoo.finance).
$ENS expected price
Based on the above inputs and assumptions, the expected price for $ENS will be $181. If the assumptions of annual fee, discount rate and horizon of the expected cash flows change, the estimated fair price will also change accordingly. The table below shows how different assumptions of inputs can affect the expected price of $ENS. You can use a simple calculator here to play around different scenarios and see how the price of $ENS changes.
Limitations
As shown above in the different scenarios, the DCF model heavily depends on the assumptions of the inputs. The expected price can change dramatically based on different assumptions of cash flows, discount rates and time horizons. Also, this model doesn’t take into account of any growth in the cash flows or the number of new ENS names registered. It is only a simple model that gives you an idea of where the fair price should be based on the current expectation of future cash flows.
Disclosure: The author holds $ENS at the time of writing and is a beneficiary of the airdrop.
