What does it mean when someone says something is worth a specific amount of money? How do we assign value to an asset?
There isn’t really one formula or calculation, but there are different approaches that can help determine the value of an asset.
That process is called valuation, and it’s based on either:
- Future investment returns (absolute valuation); or
- Comparison with similar assets (relative valuation); or
- Estimates of the immediate liquidation proceeds.
In other words, value is defined as what someone is willing to pay for something – but that may not be the same amount as somebody else.
Assets in the real world
Consider artwork, fine wine or vintage cars. The prices for these kinds of assets vary hugely, depending on the item and the tastes of prospective buyers. Art, wine and car aficionados value these kinds of assets greatly, but not always to the same degree.
Their value comes in part from what they are worth to a specific person; it’s not an
inherent property of every object. It depends, to a degree, on who is doing the looking.
As Peter Ackroyd writes in his book, Chatterton, “the value is always in the eye of the beholder. What is worthless to one person may be very important to someone else.”
Digital assets are said to derive value from their utility, scarcity and perceived value. Utility comes from being usable within the blockchain ecosystem. Scarcity means there’s a finite supply, which is true for many cryptocurrencies. Perceived value comes from any store of value they have over fiat (or traditional) currencies.
With these types of assets, there are no financial statements to review or earnings calls to listen in on. Nor are there any cash flows. They are essentially worth whatever market participants deem them to be worth.
Ultimately, people investing in cryptocurrencies are doing so based on the value they ascribe to that specific digital asset.
Irrational exuberance describes a heightened state of investor enthusiasm that drives asset prices higher than those assets’ fundamentals seem to warrant. It can also be applied beyond the equity markets.
That would explain why someone would pay so much for something — like the $69 million dollar auction price for Beeple’s “Everydays: The First 5000 Days” NFT. Or former Tyco CEO, Dennis Kozlowski’s $6,000 shower curtain. For whatever reason, that’s what that NFT and shower curtain were worth to the people who bought them.
What’s commonly referred to as “the marketplace,” is actually a collection of potential purchasers. And each has a different set of desires, spending habits, needs, and resources – as evidenced by the transactions that seem reasonable to some and unfathomable to others.
Value vs price
Some investors will learn the hard way that no matter what they think something is worth, or what its market price is, when it comes time to sell, it’s only worth what a buyer is willing to pay them for it at that time.
Value doesn’t necessarily equal price.