ChainLink Investment Thesis
VALUATION REPORT
Highlights
Best and worst attributes
• The protocol has an expected revenue GAGR of 67%.
• The total transactional market value is expected to grow at a CAGR of 20%, given that the total addressable market is around 80B currently, with a potential to grow at a 5% for the next 10 years.
• The dilution rate is 4% of total supply, mainly due to the company vesting schedule. There is around 300M tokens to be released from 2023 to 2030.
• The current velocity is around 1.9 and it has been stable over the year.
• Chainlink has the highest market cap for oracles solutions, way above his competitors.
• Average daily transaction volume was around 50M last month, keeping around the same during the entire year.
• Decreased gas costs from architectural upgrades have increased profitability, which may lay the foundations for operational expansions and network scale.
• The Chainlink-SWIFT partnership, although in proof of concept, could provide a stronger tailwind for the network than current and inorganic scaling programs.
• Possible federal regulation around cryptocurrency poses risks to assets like LINK-USD
Description
ChainLink is a decentralized oracle network connecting smart contracts to the off-chain data feeds, APIs, and payment systems required for real world application. It aims to provide fast, reliable, and confidentiality-preserving universal connectivity and off-chain computation for smart contracts.
The company was founded in 2017. In the years since, Chainlink has become the leading provider of decentralized oraclenetworks (DONs). An oracle — also known as a node — is a third-party-owned computer that acts as a bridge between a smartcontract and real world data. Chainlink consists of multiple networks of these oracles, which comprise more than 900 Chainlink DONs. The job of these DONs is to procure real world data on behalf of a smart contract, verify that the data is accurate, and deliver the data to the smart contract.
The Chainlink ecosystem operates on financial incentives. The smart contract is paying a DON for off-chain data. The off-chain data providers are paid to provide the data, which the DON reviews for accuracy before sending it to the smart contract customer. The point of the DONs is to provide a decentralized form of consensus that ensures that the data being retrieved off-chain is true. This guarantee of truthfulness is the value that Chainlink provides to smart contracts customers. Additionally, Chainlink has developed solutions that may add value to its network, including VRF, Keepers, Proof of Reserves, and Cross-Chain Interoperability Protocol (CCIP).
Chainlink is more than a Proof of Stake blockchain, and each node is more than a piece of hardware running code in thebackground. Chainlink nodes are real-life businesses with a few main roles. They keep the network running by verifying data submitted by real-life data providers; they pay their bills to such data providers and also manage their treasury to be sufficiently capitalised for gas (in USD) and data expenses mostly through hedging LINK price action.
Chainlink does the bulk of the business development work of handling and building relationships with real-life data providers, promoting node services to clients, and finding application developers who may want off-chain data. All of this requires operating and capital expenditure, including gas costs which get subsidised to guarantee a higher level of profitability as part of the plan to help scale. Going forward, the network’s aim is to have less ‘hand- holding’.
Recent developments
Cross-Chain Interoperability Protocol (CCIP): Chainlink has announced that its Cross-Chain Interoperability Protocol (CCIP) is now generally available to all developers. This protocol enables secure and reliable cross-chain interactions, making it easier for developers to build applications that can operate across multiple blockchains.
Partnerships and Collaborations: Chainlink has entered into several significant partnerships recently:
· DTCC: The Depository Trust and Clearing Corporation is leveraging Chainlink’s CCIP to deliver mutual fund data on-chain as part of its Smart NAV pilot.
· Rapid Addition: Chainlink has partnered with Rapid Addition to develop a FIX-native blockchain adapter aimed at enhancing institutional digital asset trading.
· Telefonica: A collaboration with Spanish telecom giant Telefonica to utilize web3 technology for fraud prevention in SIM cards.
New Products and Features:
· Transporter App: Chainlink has launched Transporter, a hyper-secure bridging application powered by CCIP for moving crypto assets across different blockchains.
· Chainlink Functions: This serverless developer platform is now live, enabling the connection of Web3 smart contracts with any Web2 API in minutes.
Architecture
ChainLink primary function is to bridge on-chain and off-chain environments. Initially built on Ethereum, the protocol aims to support all leading smart contract networks for both off- chain and cross-chain interactions. It has been designed with modularityin mind, ensuring every component is upgradable. The workflow involves an on-chain request by a user, which is then logged as anevent for the oracles. ChainLink core picks up the event, routes it to an adapter that interacts with an external API, processes the response, and reports the data back on-chain.
Long-Term Technical Strategy: The strategy includes three main directions: Oracle confidentiality, infrastructure changes,and off-chain computation. ChainLink proposes the use of trusted hardware as a better approach to securing the network.
Decentralized Oracle Networks (DONs): DONs are networks maintained by a committee of Chainlink nodes. They support any range of oracle functions chosen for deployment by the committee. DONs act as an abstraction layer, offeringinterfaces for smart contracts to extensive off-chain resources and decentralized off-chain computing resources.
Key Areas of Focus:
• Hybrid Smart Contracts: A framework for augmenting existing smart contract capabilities by securely composingon-chain and off-chain computing resources.
• Abstracting Away Complexity: Presenting developers and users with simple functionality, eliminating the need forfamiliarity with complex underlying protocols.
• Scaling: Ensuring that oracle services achieve the required latencies and throughputs.
Chainlink Services:
• Chainlink services, such as data feeds and VRFs, are enabling smart contract applications ranging from DeFi to NFTs to decentralized insurance.
• The deployment of DONs will enhance the provision of data feeds in Chainlink networks, including scaling across multiple blockchains.
Hybrid Contracts:
• Hybrid contracts combine MAINCHAIN logic with a DON.
• DONs are designed to make the use of decentralized systems easy by abstracting away the complex machinery behind their services.
Economic Security:
• As more users join the system and increase potential future earnings from running Chainlink nodes, the marginal cost ofeconomic security drops, incentivizing additional users to use the network.
Team
Chainlink is not owned by a single entity or person. Instead, Chainlink is based on an open-source protocol supported by its developer, the company SmartContract Chainlink Ltd. The company was co-founded by tech entrepreneurs Sergey Nazarov and Steve Ellis.
Chainlink’s decentralized nature ensures that there is no centralized control over the network, with numerous node operators and community members contributing to its growth and development.
Sergey Nazarov (CEO) and Steve Ellis (COO) are tenured leaders with significant expertise in their roles, respect from thecommunity, and years of experience in smart contracts. They have secured first mover advantage in the decentralized oracle network as well as critical acquisitions such as Town Crier and smartcontract.com.
The Engineering and Operations team has a proven track record in software and blockchain tech with support from theindustry’s leading technical advisors in Ari Juels (co- director of IC3), Evan Cheng (co-creator of LLVM for Apple, Google, Intel, etc.), Hudson Jameson (Community Manager at the Ethereum Foundation), and Andrew Miller (leading researcher and advisor at Zcash and Tezos). Non-technical advisors include Tom Grosner (Founder of DocuSign), Jake Brukhman (CTO at Triton Research), and Brian Lio (CEO of Smith & Crown).
Business Development efforts led by Dan Kochis have debatably secured more significant partnerships than any project inthe space, with Marketing/Community Management achieving similar success among token investors. The Chainlink community (aka LINK Marines) is widely recognized as one of the most loyal and engaged constituencies in crypto.
Revenue
The company primarily generates revenue through the fees collected from users of the network, which include blockchain projects, developers, and organizations who rely on Chainlink’s services for data retrieval and exchange. These fees are paid in theplatform’s native cryptocurrency, LINK, and are determined by the free market demand of their data services.
Additionally, Chainlink may also provide its expertise and consultancy services to businesses seeking to integrate blockchaintechnology into their operations, thus further contributing to the company’s revenue stream.
Data providers can also monetize their data for the smart contract economy by selling it to the Chainlink Network or running a Chainlink Node to sell their data and API services.
Chainlink abstracts away the complexities around running nodes and handling cryptocurrency payments, allowing data providers to focus solely on providing quality data.
Chainlink products could become commoditized as node-operating businesses compete for jobs, driving down price and profitability and creating a ceiling for the scale and adoption of the network. However, competition between nodes could incentivizebusinesses to improve their cost structures, security measures, and overall services to remain relevant. The addition of unsubsidized revenue from external applications, albeit early, could also be a powerful force to sustain the Chainlink network. A proposal from GMX, one of the highest growth and profitable DeFi exchanges, stated an allocation of 1.2% of total protocol fees generated towards the node operators providing decentralized, aggregated, reliable, and secure information from a low-latency Oracle solution, as well as future development and technical support utilized and needed by GMX. The Chainlink Network could generate an incremental ~$621k in unsubsidized revenue based on GMX’s $51.80mm protocol fees over the past 3 months,approximately 6% of total revenue year-to-date for Chainlink. If other financial applications pursue a similar route, this would be a boon for the Chainlink network.
Total Addressable Market: Considering the international payment network SWIFT, which has been in discovery to integrate Chainlink in its financial messaging system for bond payments since 2017, as a proxy for one of its addressable markets. In Feb 2020, SWIFT recorded an average of 36.7M FIN messages per day — assuming just 10% of this message volume is related to Chainlink’s initial scope of bond payments, the SWIFT partnership alone would represent over 3M transactions per day. In comparison, the entire Ethereum network averaged roughly 750K transactions per day over the last year with an average market cap of $20B (about 20x the current market cap of Chainlink).
Tokenomics
Chainlink’s native token (LINK) is used to compensate the data providers and payment networks servicing the network. LINK is awarded to nodes with accurate responses and taken away from those with inaccurate/incomplete data. This systemestablishes a reputation score for oracles and allows high value smart contracts to require larger amounts of LINK as collateral from node operators to better ensure data accuracy. This makes LINK an asset with scarcity, utility and passive incomeopportunities whose value is directly related to usage of the network.
LINK Token Usage:
• The ChainLink network uses the LINK token to compensate ChainLink Node operators for various services like data retrieval, data formatting, off-chain computation, and uptime guarantees.
• Smart contracts on platforms like Ethereum need to pay ChainLink Node Operators in LINK tokens. The price is set by the node operator based on demand and supply.
The economic cornerstone of Chainlink is its token, LINK. Data is procured by smart contract developers through the purchase of LINK. And oracles and data providers are compensated in LINK. For an oracle to participate in the Chainlink network, it must buy LINK and stake that LINK to the Chainlink network. Staking on Chainlink, however, looks different from staking on typical blockchains, where staking aims to prevent attacks on consensus. On Chainlink, staking is done to ensure the timely delivery of accurate data by DONs to smart contracts. By staking LINK, an oracle is putting its own capital at risk in orderto build trust and become an active participant in the Chainlink network. Misbehavior by an oracle could result in LINK slashing (i.e. financial penalties for bad behavior).
Per the Chainlink fact sheet, 30% of the LINK tokens — or 300 million LINK — would be retained by Chainlink for purposes of internal development. This is essential because Chainlink does not generate revenue. Chainlink does not collect fees from its network — Chainlink’s funding comes from selling its own LINK tokens.
• Circulating supply is at 540M, with a dilution rate of arounf 4% of total supply of 1B
• There is around 300M allocated to the company to finance operations, which is not available and subject to vesting,350M allocated to operators and the rest was issued in the ICO.
• The company does not have treasury management in place.
• Staking reward is around 4.75%, with a staking ratio of 4% of circulating supply.
Industry
Much of the $100 billion DeFi industry was built on the pricing and market data feeds procured by Chainlink. To this point, oracle networks like Chainlink have largely been used to support DeFi. Nazarov (CEO) has said that Chainlink has at least 60%market share in verticals like DeFi and gaming.
Global industries are expected to use financial contracts to enter the smart contract ecosystem in the future. Hundreds of trillions of dollars in assets could end up connecting with the blockchain to use smart contracts — assets like gold, real estate, stocks, derivatives, ad networks, and supply chains. The use of oracles connecting off-chain data to smart contracts could explodeif this materializes, which could lead to an ever-growing valuation for Chainlink if it remains a major player in this space.
Partnerships: Chainlink continues to announce partnerships with some of the biggest names in Crypto, Legal, Insurance, Internet, Software, Retail, and other industries, including: Google Cloud, Oracle, Open Law, Credits, Binance, ZeppelinOS, DappsInc., Matic Network, Web3 Foundation (Polkadot), Synthetix, and dozens more.
The Cross-Chain Interoperability Protocol (CCIP) has the vision to move towards a cross-chain world where a single application can be deployed across many chains for better efficiency, liquidity, and interoperability. The yearly average growthrate of transactions and revenue (LINK) is considerably higher across non-Ethereum and non-Layer 2 chains. This results from starting from a much lower base and filling holes in the rest of the ecosystem.
However, the dominance of Ethereum and its Layer 2s in financial use cases and the security vulnerabilities of cross-chain bridgesmay hinder CCIP’s adoption. While the multi-chain route may be slightly less ambitious and risky, it’s the safer, more trodden path.
The biggest fundamental shift to Chainlink is its Staking upgrade. Currently, most of Chainlink’s node-operating businesses work under a trusted model where well-known companies don’t want to lose their reputation when defrauding the network by submitting false or poor data. Under Economics 2.0 and the new Staking regime launched on Ethereum on December6th, 2022, the trusted model is turned upside down by allowing the community to put their LINK to work by helping to secure specific node networks such as an ETH/USD price feed on Ethereum. Ultimately staking is not just an additional crypto-economic layer through monetary incentives of rewards and slashing but also a means to further decentralise and create a more trust-minimized environment to create a completely trustless ecosystem. Not only is the network decentralising at the node level but also at the data provider level by spreading out the number of companies that submit this data to the node networks.
Competitors
Chainlink operates within the decentralized oracle services industry and faces competition from several companies in the Blockchain space. Key competitors include Band Protocol, Tellor, API3, Augur, Witnet, Provable (previously known as Oraclize), Kylin Network, and even Google Cloud (offering through BigQuery). These competitors offer decentralized oracle solutions tobring reliable and tamper-proof data into Blockchain platforms, enhancing the capabilities of smart contracts and creating a more extensive network of secure data transfer. With innovation and growth in the cryptocurrency and Blockchain sectors, Chainlink and its competitors constantly strive to refine and expand their offerings to remain competitive in the evolving landscape.
In 2021, total value of smart contracts secured by Chainlink peaked at $75 billion.
Competitor Band Protocol boasts of having secured nearly $17 billion in 2021. The Chainlink website defines “total value secured”as: “Total U.S. Dollar value of crypto assets deposited into markets secured by Chainlink oracles.”
Competitor API3 has argued that including decentralized oracles into the off-chain data collection process increases risks to data integrity. Instead, API3 has come up with an alternative solution that connects data providers directly to the blockchain with an oracle API wrapper that essentially makes it simple for any off-chain data provider to connect to the blockchain and provide data to smart contract clients directly.
The founder of Band Protocol has stated that he views Band Protocol as one of the fastest oracle networks available dueto it being built on the Cosmos blockchain, which does not have the same congestion issues of Ethereum. Band Protocol touts its average transaction processing time at ~6 seconds.
SWOT analysis
Strengths: The company’s primary strength is its cutting-edge technology and a leadership position in the decentralizedoracle space, providing secure, tamper-proof inputs and outputs for smart contracts on any blockchain. It has a competent andexperienced management team and a growing partnership network with leading blockchain projects, driving wider adoption of its services. Additionally, Chainlink’s open-source nature ensures continuous development and transparency to its community, attracting new talent to the ecosystem.
Weaknesses: As a relatively new and niche player in the market, Chainlink faces certain risks, including the lack of understanding and acceptance of its technology by traditional businesses. This may hinder its growth prospects, especially as it expands into new markets.
Furthermore, the competitive landscape may lead to other oracle solutions emerging more prominently, posing a threat to Chainlink’s position in the market.
Opportunities: Chainlink stands to benefit from the rapid growth of the blockchain industry, driven primarily by the increasing interest in decentralized finance (DeFi) and non- fungible tokens (NFTs). These sectors present numerous opportunitiesfor the company’s oracle services to be implemented in innovative new projects. The company can also leverage its existing partnerships for marketing cross-platform benefits and further expanding its partner network, enhancing the overall adoption and use of its services.
Threats: The industry’s rapidly evolving nature may present several challenges for Chainlink, including the emergence of new competitors and rival technologies that could potentially diminish their market share or render the platform obsolete. Additionally, the uncertain regulatory landscape around digital assets and blockchain technology may pose risks to the company, as different governments could implement stringent regulations that might negatively impact Chainlink’s operations in certain regions.
Chainlink’s network effects have accelerated, consolidating it as the leading and dominant player in this Oracle sector. Securing and delivering the total value and data on-chain and between chains is significantly higher than all its competitors.Diversification and increased revenues, transactions, and products show this in action. One of the most underrated and positive signs is the emergence of external sources of unsubsidised revenue. There is also early evidence to show the network’s largest costs (gas) are also decreasing, putting a floor on declining gross profitability in a bearmarket and providing a leg up for token holders in a bull market.
Currently, there is a bear market running, with Link at 80% below its all time high, a stable and strong price of the token is key to sustain the economics of the protocol, since the company does not generate revenue.
Also, the cryptocurrency market has had a strong correlation with the stock market and is sensitive to changes in interest rates. With rates above 4.5%, the current environment is not ideal for economic growth in general and much less for the cryptocurrency market.
Risks
There could be a scenario where Chainlink operations would need more cash than LINK redemptions would enable. The price of LINK is the key to know if redemptions are enough. If the price continues to grow, then this will not be an issue. However, given the current state of the market the price could remain at a low valuation for a while, putting pressure to issue more tokens than the initial 1B.
Lack of clarity regarding the type of asset tokens represent, will bring regulatory pressure, and pose a very high risk for the industry in general.
Market saturation may limit the platform’s future growth prospects, potential dilution of LINK’s circulating supply is uncertain, and imbalances pertaining to dapp demand, node operator fees and operating costs contribute to selling pressure.
Chainlink does not generate revenue, meaning that the team would need to issue new tokens or face a problem to continue the development.
Valuation
Profitability has steadily declined since Q1 2021 but has remained relatively flat throughout 2023 when denominated indollars, as this is most likely a function of price. Looking more closely, revenues (denominated in LINK) and transactions are flat year-over-year, whilst most of the pain in dollar-denominated revenues and gross profits has stemmed from the decline in the price of LINK.
Gas costs are the highest costs for node-operating businesses, but there is evidence to show during an increase in the number of transactions and flat revenues that costs are decreasing. Annualising this year’s figures could lead to an average reduction of 40% across eight chains. This reduction can be attributed to Chainlink’s Off-Chain Reporting (OCR), which acts similarly to a Rollup, where nodes aggregate their observations off-chain into a single report and then submit the transaction on-chain. This reduces network congestion and cost and increases the speed at which these chunks of data can be delivered on-chain.
A combination of two overarching reasons — little block space left and lower gross profit margins compared to otherchains — could put a theoretical cap on Ethereum revenues as the adoption of transactions and network effects occur elsewhere. Including Ethereum within total year-over-year growth rates dampens the picture. In reality, excluding Ethereum in total revenueprojections, we may see a 117%, 97%, and 48% increase in revenues for this year, 2024, and 2025, respectively. Most of this is driven by Polygon and Binance Smart Chain.
Whilst Polygon’s network utilization is also maxed out like Ethereum’s, the difference is that Polygon continues to make efficiency improvements internally, allowing the number of node jobs, transactions, and revenues to increase. Also, Polygon’slower-than-average gas cost per transaction is 99.7% cheaper than Ethereum, making it very attractive to set up shop.
Binance Smart Chain will continue to drive adoption and profitability for the network due to its DeFi liquidity, on-ramp advantages, speed, and cost advantages.
Improved efficiencies of Chainlink architecture and operations of these node-running businesses could put a floor on declining profitability in the bear market. Going forward, Chainlink and chain updates and operational improvements for node-operating businesses will likely provide a leg up for profitability. Innovations such as Off-Chain Reporting could make it much more attractive to join the network and financially easier to expand operations across chains and with real-life data sources.
Type of token: Link is classified as a utility token, so valuation will be based on the quantity theory of money, although discounted fees flow will be taken into account.
Assumptions:
• Velocity:1.9
• Discount Rate: 32%
• TAM: 80B with a 5% growth rate
• Revenue CAGR of 67%
• Market Value CAGR of 20%
• Dilution Rate of 4%
• Long term growth rate (g): 8%
Price target: $38 per token
• Best case: $45 per token
• Worst case: $29 per token
Main Ratios
• TVL: 120M
• Staking ratio: 4%
• NTV: 56x
• P/F: 140x
• P/TVL: 28x
• Fees (revenue) Yield: 0.72%
• Liquidity Ratio (M): 4.48%
Summary
Chainlink is a dominant market participant in an industry with very large addressable markets of tokenisation, bringing real-world assets on-chain, gaming and privacy. While most products and scaling programs will not move the needle regarding profitability in the short- medium term as most are highly speculative, Price Data Feeds have managed to kick-start adoption andgenerate industry-leading network effects. External, unsubsidised revenues and the CCIP-SWIFT partnership could provide the two largest opportunities for scale and profitability going forward.
Overall, Chainlink has performed well under the hood of a bear market, with a nominal increase in transactions and only a slight decrease in revenues (LINK) year-over-year, although on an annualised basis, the network could end the year almost 40% higher. There is also significant diversification of activity on different chains, making the network more sustainable and bullet-proof to changes and flows of ecosystem value. Arguably the most promising insight, spear-headed by architectural improvements, is the decrease in gas costs, nodes’ largest expense, and increasing profitability. This has provided stability in a down-market and will lay the foundations for expansion in an up-market.