Fundamental Analysis of Cryptocurrencies: Everything You Need to Know
Below is a guide that is designed to educate new and fairly experienced traders on the building blocks of Fundamental Analysis. Considering the hype element that’s unique to cryptocurrencies, it is vital that a trader master the art of identifying worthy digital assets using the criteria mentioned below. We’ll also cover the challenges and expected roadblocks. Once you read through this guide and combine the insights gained with technical analysis, it will be only a matter of time before you improve your trading performance.
In 2019, cryptocurrency scammers and fraudsters made $4.3 billion, tripling the profits made in 2018. According to Chainalysis’ crypto crime report, the reason crypto scams are so prevalent is that most investors are very unfamiliar with the crypto market.
Sadly, traders and investors get into the market to make a quick buck but end up falling prey to valueless token sales, fake services or blackmail scams. Much of the tumult that has been clear in the crypto scene results from emotionally driven traders yielding to the fear of missing out (FOMO).
Traders that make it big in cryptocurrency trading employ a technique called fundamental analysis to ensure that they have reliable data when purchasing. This helps them to beat any market hype and gives them “eyes” to see through the smokescreen of fallacy.
Fundamental analysis is a study of an asset’s underlying value. It subjectively scrutinizes the quantitative and qualitative data points of digital assets since there are many factors that impact the true value of a digital asset. Subjective as it may be, it is still critical to understand what may — or actively drives the price of a digital asset from a broad framework.
Admittedly, every trader in the market has his or her homegrown version of fundamental analysis. Therefore, Fundamental Analysis will differ as per an individual’s trading strategy or investment goal. The asset type will also determine the asset review’s data points.
The need to assess an asset’s intrinsic value as per its economic data is the brainchild of the investor, academician, and economist, Benjamin Graham. Graham, the father of value investing, asserted that an asset’s intrinsic value is in a business’s details such as earnings, assets, or dividend payouts.
The Challenge of Cryptocurrency Fundamental Analysis
A review of a financial asset class such as stocks can be straightforward because companies provide heavily audited financial statements. In contrast, the world of digital currencies is new and lacks robust regulation.
Most crypto-assets do not have revenue, earnings, profits, and other financial health data points. An emerging industry, most of the information available on assets is technical and often riddled with confusing computing jargon.
Cryptocurrency developers hardly form corporations. The viability of a crypto asset directly depends on its community participation rather than revenue generation. Besides, most assets are in their development stage and have few real-world uses and applications.
There are therefore no performance track records to study, as it with stock market assets. These challenges should however not hinder crypto fundamental analysis. Traders and investors can evaluate these assets via a different method. Below is a proposed crypto assets fundamental analysis guide.
How to do Fundamental analysis for Digital Assets
Unlike the stock market, there are no mounds of data to sift through as a trader tries to understand the possible drives of price. The crypto scene may, at this stage, be highly speculative. Consider the following when analyzing any crypto:
1. Governance and Consensus Mechanism
The size (market capitalization) of a cryptocurrency is not synonymous with token/coin growth. In equities, a growing company is synonymous with stock value growth. Crypto assets, however, are not a share in a company.
The token’s developers do not have any binding obligation towards crypto-asset holders. An Initial Exchange Offering (IEO) or Initial Coin Offering (ICO) could generate massive amounts of capital, but that value might not pass on to the token holders. The value that a crypto development makes could, therefore, remain constant holding its token holders in limbo.
A trader, therefore, needs to determine that an asset’s governance cares about the value that the technology will bring to investors. The very first data point that an investor needs to establish is the consensus mechanism of the blockchain asset.
This factor determines the asset’s security and its viability. The token’s governance should not be free to decide or change without consensus from token holders. The token’s management should also have the investor’s interests at heart.
Crypto assets do not have cash flows as stocks do. A trader therefore cannot use future cash flow expectations to gauge the value of digital currency. Warren Buffett’s trading advice, that price is what a trader pays while the value is what they get is very important when analyzing a digital currency’s market potential.
In the 2017 ICO fever, tons of valueless crypto projects raised cash from investors by using buzzwords such as decentralization and blockchain. Traders paid top dollar and got zero value from most of them.
Bitconnect (BCC), for instance, hit the scene in January 2017 promising an astronomical return on investment. Its token holders could exchange their Bitcoin for the BCC token and enjoy a lending program that lent BCC out for interest.
BCC had a Ponzi scheme form of the referral system and soon had cease and desist orders from financial regulators. Bitconnect has left a litany of lawsuits over lost funds shutting its exchange and lending scheme.
An excellent product should be in use beyond referrals and lending and should have users that contribute to its sustainability. Examine the utility of an asset. Look for the value that justifies its existence. The projects’ thoroughness and use cases should be outlined on its website and white paper.
A choice asset should convert to popular fiat easily. That’s what liquidity is — the ease of converting a digital asset to cash. Your selected digital asset should have a ready market to ensure easy purchase and sales of a token at transparent and stable prices.
Some of the factors that determine liquidity include;
· Listed exchanges
When a cryptocurrency is listed in mainstream crypto exchanges, it will be liquid and robust. For an asset to feature at a top exchange such CryptoAltum, it has to excel in its market fundamentals. Top exchanges also have extra liquidity, enabling rapid selling at minimal value losses, at all times.
· Trade volumes
The asset’s volumes of trade are an upfront indicator of its popularity. Trade volumes show the amount of the asset that has changed hands over a set time. Low volumes signify depressed demand.
4. Market capitalization
Most investors often check the market cap of an asset first when performing a crypto fundamental analysis.
This metric signifies the average market value of an asset in dollar amount. It is a data point that can highlight the token’s room for growth. It is, however, common to find a low-cost asset with higher circulating supply sharing the same market cap values as a high-cost token.
A high circulating supply implies that the asset will need higher investment values to enjoy a boom as fast as Bitcoin did. Ripple (XRP) price, for instance, is close to a 95 percent low of its all-time high. Ripple, the majority owner, has been releasing massive amounts of XRP increasing its circulating supply.
XRP now has the highest inflation rate of the top large-cap assets, of 20 percent compared to Bitcoin’s 1.8 percent (it fell from around 3.8 percent after halving).
The rule of thumb is the lower the market cap, the higher the asset’s growth potential.
5. Potential roadblocks
Factors such as competition and legal challenges could drive a potential crypto asset to doom. If the project has copycat projects, its capital allocation will be divided. The project has to differentiate itself from its competitors.
Investors should also study the legality of a project. Litigations against the asset’s company or developers will adversely affect the project’s growth.
Investors should also analyze other growth impediments such as the asset’s;
- Nature of supply
- Token burn
The Reason a Crypto Fundamental Analysis Is Crucial
Consider this real-life scenario:
Ethereum and OneCoin hit the crypto shelves in 2014. OneCoin sold itself as a cryptocurrency whose real-world applications lie in trading educational material purchases. Traders would purchase educational packages and then earn tokens to mine OneCoin.
An idea proposed by Vitalik Buterin in 2013, Ethereum’s first crowd sale funding was in mid-2014. Its system went live in 2015 and has since become one of the most recognizable blockchain assets in the world.
Ethereum’s fundamentals receive a lot of praise due to its smart contracts capabilities. Over the years, Ethereum has become synonymous with decentralized finance applications and digital identity contracts. Today, the asset is a gold mine with a market cap of over $26 billion as each coin retails at $236 at the time of press.
On the other hand, the embattled OneCoin has a $1,198.37 market cap and has a Ponzi scheme label. It was clear from the very onset that OneCoin had a pyramid-like organizational structure. The token lacked blockchain development that was not a cryptocurrency. The scam’s managers have scammed over $19.4 billion from investors.
Fundamental analysis of both Ethereum and OneCoin would have revealed the opportunities and dangers that both assets held, helping traders judge their viability and profitability. A savvy long term crypto investor would have made Ethereum their choice investment avoiding the scam that OneCoin is.
While CryptoAltum offers an unparalleled crypto trading experience that includes zero trading commission charges and secure trading, we encourage all traders to use the fundamental analysis steps above. This will ensure that your trading capital is protected from emotional trading losses.
As a recap (and this may not be an exhaustive list), as part of your crypto fundamental analysis checklist, do this:
- Check the project’s governance and consensus mechanism. This by extension gauges its security and viability.
- What’s the token’s utility? In a world which is largely unregulated, it will be a mistake to hold a valueless token with no utility and worse, a security.
- Check its liquidity. How many exchanges do list the token/coin? Ensure that the token purchased can be easily sold for cash and vice versa.
- Market cap counts. Make sure you check its market share and the coin’s general market activity.
- Investors should also study the legality of any project. If there are legal troubles, its growth (and therefore profits) will be hampered. As a rule of thumb, steer clear of projects bent on proliferating illegalities.
- Check its roadmap and whether milestones are regularly struck. This is a metric to gauge the team’s determination.
- Are tokens destroyed on a regular? If so, what’s its impact on price?