What to do when everyone stops believing
A few thoughts:
""Discount rate" is a financial term for the rate that investors expect to receive from an investment, or the company’s cost to borrow money."
Borrow costs would be pre-tax and after-tax cost of debt. This gets factored into WACC if you're discounting at the enterprise level. If you're discounting equity, you're going to use CoE. Of course, you can use a hurdle rate as your discount rate, which would be the required return.
"Discount rates and Belief Rates are inversely related: higher interest rates, lower belief in the future. As far as I know, there’s no formula that ties the two, but you can feel it in the sentiment shift ever since the Fed started raising rates."
'Belief Rate' can be factored in to the discount rate as a synthetic additive to the CoE beyond beta. Higher uncertainty (lower belief) can simply be expressed as a higher discount rate.
"ETH, and crypto more broadly, is even more sensitive to discount rates than the Nasdaq because its future value is so far out and speculative. "
Anything with a higher discount rate is going to be more greatly affected the further you discount. However, I'd very much argue ETH and crypto broadly are more sensitive almost entirely because of how speculative they are. When assessing, say, an equity that is 100% US-based, in USD, there is no country equity risk premium (CERP) or additional default spread (DS) to weigh into the CoE. When calculating the discount rate for say, a junior minor that primarily operates in certain African countries that are experiencing political unrest and unstable currencies, you'd certainly factor those considerations. Crypto is no different.
A very interesting article Packy. I suggest Belief = Trust (definitionally trust is a 'firm belief in the reliability, truth, or ability of someone or something') so if it's possible to measure the latter at micro and macro levels that would be a valuable input to the DCF model
Nice breakdown on the levers for discount Ted cash flow analysis. Here’s why DCF models are whack and nonsensical https://www.mostlymetrics.com/p/the-death-of-the-dcf-model
If you don't see the sucker, you're the sucker. Will be posting on an unreported angle of the FTX saga tomorrow.
great piece. specifically enjoyed and appreciated the breakdown of what a discount rate is. you made it very palatable and intuitive.
now i understand that belief rate is a product of vibe & conviction, as a whole it becomes a larger belief system that is a great input to DCF, discount rates are subject to a central authority (Fed, mostly) whereas belief rate is an individualistic at its core, though once more people resonate with that idea, the underlying concept / business / tech becomes more valued.
micro believes are so interesting to study (ETH, Meta, snap, etc) but rest assured, this is the best phase to build something lasting, relevant.
let's get to work
Did you mention the other belief? That the US dollar will have purchasing power in line with discounted inflation?
The role of Western finance, the US dollar in world trade including oil and the overall financial and economic power the West - over the world in general is also at least somewhat belief based.
A sea change in this belief is going to add external negative impact to Western balance sheets just as the previous Washington consensus status quo lent external positive impacts.
How much? We will find out. But a significant reduction in say, the $15T+ Eurodollar market would be an indicator.