A couple weeks ago, I shared a post outlining the properties that I find interesting about the Maker protocol. Today, I want to dig into Maker's metrics and share the way I think about valuing the business. If you don't understand what the Maker protocol does, I highly suggest reading my last post before this one.
At first it may seem odd to compare a crypto protocol to a business, but when we strip away the crypto buzzwords and look at the protocol mechanics for what they are, Maker shares a lot of similarities with traditional businesses.
Maker is a 6 year old startup that has recently found product-market fit. Their annual revenue run-rate has grown almost 200x from $850K/year to $194M/year in the last 12 months.
To generate this revenue, they have disrupted roughly 0.1% of the $7T global lending market. Despite their fast revenue growth this year, questions remain around how sustainable the growth is and how large of an opportunity decentralized lending will be.
Maker has had the fortune of substantial industry-wide tailwinds this year, and as an early leader in decentralized lending, they captured a large share of that growth. However, Maker has faced sharp revenue declines in the past as market conditions caused them to lower fees, and they may experience similar revenue declines in the future.
Right now, Maker has $130M of accounts receivable for the outstanding borrowed assets of over 23,000 customers. One advantage of building a business using smart contracts is that all of Maker's over-collateralized lending can be liquidated before the risk of insolvency presents itself.
Maker has a few dozen contributors, and expects to pay roughly $8M USD for their salaries this year.
These salaries make up almost all of Maker's expenses, but there is uncertainty around how fast these expenses will change over time. As the Maker protocol grows, it may need to hire more contributors to manage the business.
Some Maker contributors will also receive equity compensation in the form of MKR tokens. At current MKR prices, Maker expects to pay out a maximum of $70M of tokens over the next 4 years.
At a current revenue run rate of $194M, and with expenses of $8M, Maker is on pace to earn a yearly profit of $186M. Once again, since revenues have grown incredibly fast in the last year, profits are difficult to predict and could be significantly higher or lower than $186M.
Maker currently holds $386M in their treasury. Maker may return these funds to MKR token holders in the form of token burns (similar to stock share buybacks), they may use them for compensating contributors, or they may choose some other use for the funds. To date, nothing has been decided, but it is a helpful insurance fund in case Maker ever needs money to fund a future initiative.
Recently, Maker began buying back and burning their MKR tokens on the open market.
Right now, Maker is burning 25% of their daily profits (equivalent to a $125,000 stock buyback every day), though MKR token holders may choose to adjust the buyback percentage in the future.
Assuming Maker's profits, token price, and token buyback plan remain the same, Maker is expected to buy back 1% of all outstanding tokens in the next 12 months. Holding all else equal, if Maker used 100% of their profits to buy back tokens, they could burn 4% of outstanding tokens in the next 12 months.
Many of the largest crypto protocols today rely on Maker's DAI issuance as a decentralized, stable currency pegged to the US dollar. In some sense, Maker is the foundation upon which much of the DeFi industry is built. Since Maker has proven their technology is resilient, it has become the preferred tool for DeFi users to get leverage on their positions, or move their money into a stable, decentralized asset.
Despite Maker's market leader status, borrowing on the Maker protocol can be done for some of the lowest prices in the industry. Using ETH to borrow DAI on Maker is currently less expensive than borrowing stablecoins on Compound, AAVE, and BlockFi. Maker likely has pricing power to raise their fees without losing customers.
MKR token holders have complete control of Maker's operations, and stand to be diluted if the business is forced to raise additional capital. Since these token holders also collectively manage the business, they are incentivized to think about long-term value creation, and to avoid taking unnecessary short-term risks.
In contrast, many of the financial institutions Maker is disrupting have a management team incentivized to prioritize short-term performance, and a large base of equity holders that have no say in the day-to-day operations of the business.
Valuing Maker's Business
Since Maker is such a fast-growing business, it is hard to be certain what cash flows it might generate in the future.
This is a good argument for why Maker shouldn't be valued as a public company, and instead should be compared against fast-growing private startups.
However, the problem is that most startups aren't profitable, and so their valuations are based on multiples of revenue, users, or some other imprecise proxy for estimating what their profits "could be" in the future.
In other words, investors would value startups based on profits if those startups actually had profits. Maker is already profitable, and so I am choosing to value it in the same way one might value a public company.
That being said, Maker's earnings are still volatile, so I am discounting them by 20% for a margin of safety in all my calculations below.
Note: I have shared my thinking on how I am estimating Maker's valuation below. I am purposely being conservative given Maker's fast growth and lack of operating history. Feel free to substitute your own numbers below if you think mine are too generous or harsh. None of this is financial advice.
Maker's annual profit run rate is $186M right now, but it was just $850K/year 12 months ago. There are almost no businesses to benchmark against that have seen 200x profit growth at the scale of earning $100M+ per year.
Applying a 20% discount to Maker's $186M annual profit run-rate puts Maker's annual profit at $149M per year.
The S&P 500 has an average P/E ratio of 43.4 right now, and although S&P 500 companies aren't growing nearly as fast as Maker, let's ignore that for a second and use the S&P 500 average P/E ratio as a base case.
$149 million of profits x 43.4 = a $6.5 billion valuation
Discounted Cash Flow
A $6.5 billion valuation assumes Maker's profits will drop by 20%, and then grow at the same rate as the average S&P 500 company every year into the future. But what happens if Maker grows faster than the average S&P 500 company?
After all, Maker has only disrupted 0.1% of its total addressable market, and just found product-market fit in the last 12 months.
Using the same 20% discounted profits above, let's model Maker's discounted cash flows assuming 30% profit growth for the next 5 years, and 20% profit growth for the next 5 years at a 2% discount rate.
Using this model, annual profits are expected to surpass $500M within 5 years, and $1B within 9 years.
When these profits are discounted back to the present at a rate of 2% per year, the sum is $5.9 billion of cash flows.
But what about all the cash generated after 10 years? To be conservative, let's assume profits after 10 years only grow as fast as the 2% per year discount rate for 10 more years, and then drop off to $0 after that.
Under this model, Maker's discounted future cash flows are valued at $17.1 billion.
Neither model above is perfect, and critics might instinctively say two things about them:
- The first model assumes Maker will generate $0 of profit after 10 years, and that seems overly pessimistic.
- The second model assumes Maker's limited operating history provides enough information to accurately project profits over the next 20 years, and that seems overly optimistic.
For a napkin math compromise, let's take the average of the two results above.
$5.9 billion of discounted cash flows + $17.1 billion of discounted cash flows / 2 = a $11.5 billion valuation.
So How Much Is Maker Worth?
The two valuation methods above give Maker a valuation of between $6.5 billion and $11.5 billion.
While both are just rough estimates, and nothing in this article is investment advice, I think I have been conservative in my estimate of Maker's valuation.
The Maker system is tightly integrated with many of today's leading crypto protocols, Maker has some of the lowest borrowing fees in the industry, and in all my calculations above I have discounted Maker's current profit run rate by 20% in case it turns out to be unsustainable.
In addition, I have used traditional equity valuation methods that are typically used to value mature, slow-growing companies. I have also completely discarded the possibility that Maker's profits continue their exponential climb moving forward.
With all that said, the market currently has a different view on Maker's valuation. MKR is trading for $4,600 as I write this, and with only 994,672 tokens outstanding, that puts Maker's valuation at $4.57 billion.
To paraphrase Paul Tudor Jones, something appears wrong here and my guess is it is the price of MKR.