Discover the essentials of cryptocurrency fundamental analysis with our easy-to-understand guide, designed to enhance your investment decisions in the digital asset realm.
Venturing into the world of cryptocurrency can be both thrilling and intimidating, especially when it comes to grasping the complexities of this rapidly evolving financial environment. But worry not, you've landed at the perfect starting point!
This comprehensive guide for beginners will dive deep into the crucial concept of cryptocurrency fundamental analysis. This potent tool can assist you in making informed investment decisions in the dynamic universe of digital assets.
Whether you're a crypto enthusiast taking your initial steps or an experienced investor aiming to hone your analytical skills, this article will offer valuable insights, practical advice, and a robust foundation for assessing the potential of various cryptocurrencies.
The Market Landscape
As the crypto-currency market capitalization is still very small, a cryptocurrency's value can shift in an instant. One thing is certain about the cryptocurrency market: new investors are flocking to the space in droves, with the total market cap of all crypto assets exceeding $3 trillion at its peak — a tenfold increase since early 2020.
CoinMarketCap data currently lists over 25,000 digital assets as of this writing. The industry is projected to hit $4.94 billion in global market capitalization by 2030, growing at a compound annual growth rate (CAGR) of 12.8 percent between 2021 and 2030. Beyond the numbers, cryptocurrency is attracting a younger demographic. According to a study by the University of Chicago's National Opinion Research Center (NORC), most cryptocurrency traders are under forty.
Given the volatility, tracking what's working and what needs improvement is a challenge. Trading the crypto market can be risky, but employing fundamental and technical analysis can mitigate this risk. Some investors are deterred by the same factors that make cryptocurrency attractive to others. Firstly, due to the market's fast-paced nature, a small investment could yield a significant return in a short timeframe.
Several key differences exist between cryptocurrency and the traditional stock market, but some similarities also exist. The fundamental analysis trading strategy is beneficial not only for traditional markets but also for cryptocurrencies.
Understanding the Types of Trading Analysis
Trading is an economic concept that involves buying and selling assets. These can be goods or services, with the buyer compensating the seller with money. In some cases, the trading parties may exchange goods and services.
The assets traded in the financial markets are referred to as financial instruments. These include stocks, bonds, currency pairs on the Forex market, options, futures, margin products, and cryptocurrencies.
Trading can be categorized into different strategies like day, swing, trend, etc.
A solid grasp of fundamental, technical, and sentiment analysis is crucial to trade crypto assets profitably. If you're unfamiliar with these terms, we'll introduce them in a future Kryll Blog article but basically the summary of each is:
- Fundamental analysis involves assessing the intrinsic value of an asset by examining internal and external factors like financial health, industry trends, and market conditions. In cryptocurrencies, it includes reviewing the coin's whitepaper, team background, and project roadmap.
- Technical analysis is a method that uses historical price data and market trends to predict future price movements. It focuses on patterns of price movements and trading signals to evaluate a security's strength or weakness.
- Sentiment analysis gauges market mood towards a specific cryptocurrency based on public communications like social media posts and news articles. It helps traders understand the psychological factors driving market movements.
Let's explore fundamental analysis and how to utilize it to make better decisions.
Understanding Fundamental Analysis (FA)
Fundamental analysis is a method used by investors to ascertain the intrinsic value of an asset or business. It involves evaluating various internal and external factors to assess whether an asset or business is overvalued or undervalued.
Analyzing factors such as financial statements, industry trends, market conditions, and competitive landscape provides investors with insights into the long-term prospects of the asset.
Fundamental analysis (FA) was first introduced in a book titled "Security Analysis," published in 1934. The authors argue in this text that investors should consider all the fundamentals surrounding a security before investing in it.
Traders use fundamental analysis to predict an asset's or business's "intrinsic value." Their primary goal is to forecast whether an asset or business is overvalued or undervalued by examining various internal and external factors. Fundamental analysis is a valuable trading strategy that aids traders in making informed decisions and enhances profitability.
Traditional Financial Market Fundamental Analysis
Traditionally, the fundamental analysis of the stock market involves metrics used to determine the actual value of a company. For instance, indicators include Earnings per share (EPS) and price-to-book ratio.
Earnings per share is the profit a company makes for each outstanding share. The price-to-book ratio is how investors value the company versus its book value.
They could do this for several businesses within a niche to see how their potential investment compares to others. After completing the fundamental analysis, experts seek to evaluate if the asset is overvalued or undervalued. Thus, traders can use this conclusion to make investment decisions in cryptocurrency.
Crypto Fundamental Analysis
Crypto fundamental analysis may incorporate an emerging branch of data science called on-chain metrics, which is concerned with public blockchain information. These fundamental analysis indicators may include the network hash rate, top holders, addresses, transaction analysis, etc.
While fundamental analysis indicators are extensively employed in the stock and Forex markets, it is less appropriate for crypto assets in their current state. Because this asset class is new, there needs to be a defined, all-encompassing framework for assessing market valuations.
Fundamental elements have a limited impact on the price of a cryptocurrency. However, as the market evolves, more accurate approaches to crypto asset valuation may emerge. So let's delve deeper and examine the fundamental analysis's elements.
What Should You Consider When Performing Fundamental Analysis in Cryptocurrencies?
There are three types of crypto FA metrics. They are:
- On-chain Metrics
- Project Metrics
- Financial Metrics
On-Chain Metrics (Blockchain Metrics)
Cryptocurrency is the first asset class in which investor activity can be extracted from massive data sets via each crypto-public asset's ledger, which records all on-chain transactions in history. We can identify criteria of economic activity in these networks because blockchains are a treasure trove of open, incorruptible financial data. We can measure market sentiment and investor behavior by collecting and analyzing this data.
An on-chain analysis is based on fundamentals rather than hype, market sentiment, or technical analysis. This type of analysis compares different crypto assets to identify their market value. It can also focus solely on one crypto asset by looking at historical trends.
The actual value of crypto, such as BTC, can be divided into speculative and utility values. The on-chain analysis is critical for distinguishing a cryptocurrency's speculative value from its utility value. For example, we can determine whether the fundamentals of a coin justify its current price by examining user adoption and miner activity using blockchain data.
Sources of On-Chain Metrics
The blockchain network is valuable, but manually extracting information from raw data can be time-consuming and resource-intensive. Fortunately, various application programming interfaces (APIs) offer tools to help investors make better decisions. For example, The Block's on-chain analysis of Bitcoin provides a good breakdown and helpful charts/graphs that can give you an idea of the top metrics for a cryptocurrency's fundamental analysis which are Hash rate, status, active addresses, transaction values, and fees.
Let's consider each of them below.
The hash rate gauges the total computational power of a blockchain network using the proof-of-work (PoW) consensus mechanism to process blockchain transactions. It can also be used to determine how quickly a crypto miner's machine completes these computations. The higher the hash rate, the more difficult it is to mount a 51% attack.
An increase over time may indicate a growing interest in mining, likely due to lower overheads and higher profits. Conversely, a decrease in the hash rate suggests miners are leaving the network because it's no longer profitable for them (miner capitulation).
The asset's current price, the number of transactions processed, and the fees paid can all impact the overall mining costs. However, the direct costs of mining (electricity, computing power) must also be taken into account.
Understanding Hash Rate
Miners use computers to solve complex mathematical puzzles based on transaction data. These systems generate millions and billions of guesses per second on the solutions to these puzzles. These hashes are randomized alphanumeric codes that identify a single, unique piece of data.
The goal is to be the first miner to generate a block of transaction data containing the correct solution and meeting all valid criteria. Then, In proof-of-work networks, full nodes will verify transactions without them being a block and without mining a block because the process of mining does not alter the transaction. When a block is validated, it is added to the chain, and the miner is rewarded with newly minted cryptocurrency.
Bitcoin, the world's most popular cryptocurrency, currently uses proof of work to validate transaction blocks before they are added to the blockchain network. Other altcoins such as Bitcoin Cash, Bitcoin SV, Dogecoin, Litecoin, and Monero also use proof-of-work.
Active addresses are blockchain addresses that are active during a specific period. There are different methods to calculate an active address, but one common approach is to count each transaction's sender and receivers over predetermined periods (e.g., days, weeks, or months).
Some track the number of unique addresses cumulatively, which means they keep track of the total over time. Another method is to add the number of unique addresses over a set period and then compare the results.
Transaction Value and Fees Paid
A consistently high transaction value indicates that a digital currency is constantly circulating. For instance, transaction fees can be compared to auction bids in that users compete with each other to have their transactions included promptly. The gas in Ethereum is an example of a fee paid, but each cryptocurrency can have transaction fees.
Those who bid more will have their transactions confirmed (mined) sooner, while those who bid less must wait longer. In addition, the primary proof-of-work (PoW) blockchain network provides a block reward. In some cases, it consists of a block subsidy and transaction fees.
For events like Bitcoin halving, the block subsidy is reduced.
The cost of mining tends to rise over time while block subsidy decreases. Therefore, transaction fees gradually increase — otherwise, miners would lose money and begin to leave the network. This has a knock-on effect on the chain's security.
In terms of fundamental analysis, the project metric takes a qualitative approach and focuses on internal and external factors. In project metrics, the fundamental analyst examines the crypto token's whitepaper, its team's background, competitor analysis, and the upcoming roadmap.
Team's Background Check and Analysis
Old school billionaire Warren Buffett, one of the top American business magnates and philanthropists, and currently the chairman and CEO of Berkshire Hathaway, believes that the team members behind any project and their experience are among the top factors to consider, as teams can make or break a project.
Like stock market companies, the team members of crypto projects are also listed on their websites. Therefore, it is crucial to conduct an in-depth analysis of team members' track records to predict the success of tokens. Once you have completed your research, ask yourself the following questions:
Have any of the team members previously been successful in this industry?
Are their skills and experience sufficient to meet their projected milestones?
What does the developer community look like in the absence of a team?
Have they been a part of any suspicious projects or scams?
The team members' experience and accomplishments on GitHub should be well documented, providing insight into the team you rely on to execute the plan. Also, determine the number of contributors and activity level on the project's public GitHub.
A coin with a consistent future development path may be more appealing than one with a repository that has yet to be updated in several years.
A whitepaper is a crucial document that every potential investor should read; it illuminates two vital aspects of a digital currency project: its purpose and the technology that powers it.
Every coin has a "whitepaper" storing all its information. It contains historical performance data as well as other crypto-related information. A whitepaper can also help a coin stand out from the crowd.
Aside from providing information, a whitepaper lends legitimacy and a professional appearance to a crypto project. A well-written whitepaper is enticing, whereas a poorly written one is repulsive. A whitepaper proposal includes who, what, when, and why an investor should choose that project over others.
Bitcoin's whitepaper is still one of the most lucid. Satoshi Nakamoto, a pseudonymous person or persons credited with developing Bitcoin, published the paper in 2008. He described the vision that led to the creation of Bitcoin and started a decentralized financial revolution.
In cryptocurrency fundamental analysis, competitive analysis is a technique for identifying competitors and understanding their strengths and weaknesses compared to the project in which you are looking to invest. It assists you in determining how to contain competitors and fine-tune your strategy.
A cryptocurrency may appear appealing at first glance, but we can see its true potential after conducting competitor analysis on other altcoins.
A roadmap is a business planning technique that lays out a project's short and long-term goals within a flexible estimated timeline. Most crypto products have a future roadmap that shows the timeline for testnets, releases, and new features. Internally, the roadmap serves as a strategic vision for the development team, providing clear goals and milestones for shipping a finished product.
The roadmap should clearly outline what is to come in the future. It also assigns a level of importance to specific tasks based on the intended structure of the finished product. The roadmap provides insight into the project's direction and vision for investors. It also lets them gauge the speed and success of the evolving product.
We can use the roadmap to track milestones and make better investment decisions.
The forex market fundamental analysis includes both quantitative and qualitative factors. Likewise, the cryptocurrency fundamental analysis also has quantitative aspects.
This section will examine five critical financial metrics that many investors and traders use to determine whether to purchase a cryptocurrency. They include market capitalization, supply, and volume.
Market Capitalization (Market Cap)
A company's market capitalization is the total dollar value of all its shares.
In the case of the cryptocurrency market, the market cap refers to the total dollar value of all the coins that have been mined.
In cryptocurrency, market capitalization is calculated by multiplying the total number of coins mined by the current price of a single coin. Market cap can be a rough proxy for how stable an asset is likely to be. It's worth noting that even Bitcoin, the cryptocurrency with the highest market capitalization, experiences volatility. However, just as a larger ship can safely navigate rough seas, a cryptocurrency with a larger market cap is more likely to be a stable investment than one with a smaller market cap.
Digital currencies with smaller market capitalizations are more susceptible to market whims – and can experience massive gains or dramatic losses.
Here's how it works:
Market Cap = Current price of digital asset X Current supply in circulation.
Market capitalization is a popular financial metric among traders because it shows the amount of money invested in the network. It also allows traders to compare the market cap of one coin with another. The larger the market cap, the more stable the project. On the other hand, smaller market-cap coins frequently have more room to grow.
Liquidity and Trading Volume
Liquidity refers to the ease with which an asset can be converted into cash in the financial markets. In cryptocurrency markets, liquidity refers to a coin's ease of conversion into cash or other coins.
Liquidity is required for all tradable assets, including cryptocurrencies. Low liquidity generally implies high volatility, and extremely low liquidity may prevent you from selling your asset. In contrast, high liquidity in cryptocurrency trading equates to a stable market with fewer price fluctuations and lower investment risk.
As a result of increased market participation, it is easier to buy or sell digital assets in liquid cryptocurrency markets, as buy or sell orders are filled more quickly.
A surge in a cryptocurrency's price and a rise in the trading volume are more likely to be sustained. Conversely, price fluctuations with insignificant trading volume can be blips on the radar.
A high trading volume indicates a healthy market and gives investors confidence in a project because it suggests lots of buying and selling activity in the crypto market.
The circulating supply of a specific digital asset refers to the total number of coins trading in the market. Unlike the total supply, the circulating supply can change over time as the project unveils more crypto tokens in the market.
Developers can increase the number of coins or tokens circulating in a centralized supply. For instance, mining operations can increase the circulating supply of mineable cryptocurrency.
It's important to note that supply isn't a precise number. However, it can be challenging to determine which tokens are still in the hands of long-term investors and which have been burned, lost, or forgotten about.
For instance, of Bitcoin's current supply of 19 million, an estimated 3.7 million Bitcoin have been permanently removed.
During fundamental analysis, checking the supply can help ensure that you are independent of the 'unit price bias,' a phenomenon in which people want to buy tokens simply because they have a low market price.
The maximum amount of coins that will ever be circulated is the maximum supply. There will always be, at most, 21 million bitcoins. There are currently 19 million coins in circulation, with only 2 million more to be mined, but only some coins have a limit on their supply.
Decisions can be influenced by maximum supply, circulating supply, and inflation rate. Some coins reduce the number of new units they produce over time, making them appealing to investors who believe the demand for new units will outstrip supply.
A few quick tips:
- Find projects with high growth potential.
- Identify projects that have a high degree of network impact.
- Avoid decisions that are influenced by biases.
The digital economy is expanding quickly, so much new information is available daily. It's crucial to perform fundamental analysis to extract invaluable insights into cryptocurrencies that technical analysis cannot. When trading, distinguishing between the current market price and a network's "true" value is a valuable skill.
Of course, technical analysis is crucial because it helps us with the entry and exit price level. On the other hand, fundamental analysis can help us predict future price movements. As a result, many traders now use a combination of technical and fundamental analysis.
These simple financial metrics can provide a quick overview of any project. Hopefully, this article has helped you understand crucial fundamental analysis factors to consider before entering or exiting positions in a crypto asset.
Is it all too much to consider for the time you have?
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