This year was plagued by crypto scams. One of the things that could keep you safe in such a scenario is understanding the fundamentals of the project you’re investing in. That’s why cryptocurrency fundamental analysis is important.
It involves looking at a bunch of things that could help you assess whether the project is safe. With fundamental analysis, you can find answers to questions such as: How do you identify good cryptos? Is an investment sound for the long term
What is cryptocurrency fundamental analysis?
Trading in complex assets like crypto requires a considerable amount of skill. And acquiring that skillset is easier said than done. However, cryptocurrency fundamental analysis can help you get there. It can give you that edge you need to beat market volatility and generate returns.
Fundamental analysis is an approach used to determine the intrinsic value of an asset. This asset could be a business, a publicly-traded stock, a mutual fund, or a crypto.
It involves looking at several internal and external factors to figure out whether an asset, at its current value, is undervalued or overvalued.
Traders can use the information generated to make better trades or investment decisions.
Technical analysis, which is the study of charts and trading data, can also yield insights about a business. But the insights generated are of a different kind. Investors using technical analysis can, with a certain degree of accuracy, predict price movements based on previous patterns.
Fundamental analysis, on the other hand, focuses more on the long run. It can be used to predict short-term price movements, too. But it is considered more accurate and reliable for long-term investments.
How to create a strategy by applying fundamental analysis to crypto
A white paper is a great place to get started. It is a technical document that describes the crypto project in detail. All the information needed to understand the project, its mechanics, the demographic that uses it, the problems it solves, the relevant coin’s tokenomics, and the vision of the founders are usually found in the white paper. This document helps you separate the wheat from the chaff to some extent. However, while it is a good starting point, you almost always need to go beyond it.
It will take you a long way if you look for other sources, too, and try to understand the following things.
1. The problem the project wants to solve
The token you are considering investing in must be part of a project that provides a tangible solution for a problem through its business. A credible project would usually offer an explanation of its approach toward the problem and details how it plans to solve it.
Some untrustworthy projects, like Aquoin, claim that they are working on a problem to con investors. But a little digging would show that they are not able to establish what exactly the solution looks like. A framework should involve in-depth research and point to potential use cases to be considered sound by industry experts.
2. The team behind the project
The team behind a project can also speak to its credibility and reliability in the long term. So, in addition to reading the white paper, it is a good idea to verify the background of the team members. Projects associated with well-known names from the industry are less likely to pump and dump.
Like the Aquoin example mentioned above, some projects are not run by persons whose credentials match the needs of the project that is described. This is a huge red flag.
Platforms like Github, Bitbucket, GitLab, Google Cloud Source Repositories, Phabricator, and RhodeCode can be used to find out more about the team and individual contributions to their respective fields.
3. Use cases and competition
You should not only be able to understand the potential use cases of the project, but also identify its competition. Even when a project looks appealing by itself, there may be others doing a much better job already.
While this is how you do fundamental analysis in a broad sense, there are many more things to look into specifically.
The problem with crypto fundamental analysis
Stocks and crypto are, well, fundamentally different. Crypto projects should therefore not be assessed in the same way as businesses. Cryptos, including the few that have a centralized issuing authority behind them, are a lot more like commodities than securities. So, we need to be careful about the kind of metrics we use to study crypto markets.
It is not wise, for example, to judge the value of a crypto project by relying only on its social media presence. Because creating fake accounts and inflating one’s socials is too easy in this era. Instead, a better way to analyze the fundamentals of a crypto project may involve looking at on-chain metrics or its use cases.
A good framework for crypto fundamental analysis
There are, of course, a lot of metrics that investors look into before making a decision. The choice of metrics and patterns can also depend on the kind of investment you’re looking to make. Here are some options that are commonly used.
Equity markets don’t have on-chain metrics, but since cryptos do, it is important to look at them. Since the blockchain is transparent, information about a project and its transactions are usually readily available. You could take a variety of things into account, as far as on-chain metrics are concerned.
Active addresses, hash rates, staked amounts, transaction fees, and volumes can all help judge the health of a project. Some of these metrics are discussed below:
- Fees: Studying fee structure trends can help you understand the future of that particular crypto. Some projects (like Ethereum) are made for the development of applications and software, and others (like Cardano) are made for rapid transfers. Their fee structures, naturally, differ hugely.
- Hash rates: This is the total computational power being used to process transactions. A higher hash rate means a healthier network.
- Active addresses: The higher the number of active addresses for any given coin, the more people interact with the project and its token. This is generally good news because a large active user base is always a desirable quality.
Financial metrics cover information related to the economics of the token—a.k.a. its “tokenomics.” They can highlight how the token is behaving, how its supply could impact price action, and even some potential red flags.
Some key financial metrics are discussed below:
- Market cap: In crypto, the market cap is calculated by multiplying the total number of coins that have been mined by the price of a single coin at any given time. The larger the market cap of a cryptocurrency, the more stable it is likely to be.
- Liquidity and volume: The ease with which a token can be bought or sold in the market or in a specific exchange is called liquidity. The volume, on the other hand, denotes how many units of the token are being traded at any given time.
- Supply: Limiting the supply of a token is one way of preventing its value from falling too much. So, it is important to understand how often and when tokens are released. Look for the total supply, the circulating supply, and other such numbers related to a coin. This will help you see whether it is worth investing in.
While fundamental analysis can give you a bigger picture of what is happening in the crypto markets, technical analysis and consumption of the latest news are just as important. A combination of these elements will make sure that your investment decisions are sound and risk-adjusted.