How to Analyze a Cryptocurrency Using Fundamental Analysis

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Investing in cryptocurrencies requires careful research and evaluation of all available metrics. Most projects will provide ample information about the purpose of the coin, token economics, the team behind the currency, and its development to date. Using a combination of quantitative and qualitative factors, you can derive a view on crypto using fundamental analysis

A myth among new entrants is that cryptocurrencies cannot be valued based on fundamental analysis because of high market volatility. Even though the asset may be subject to the whims of global traders, it’s still possible to form an educated opinion on its value.

Understanding fundamental analysis helps you evaluate whether a cryptocurrency is worth buying or selling. We’ll take you through how to analyze cryptocurrency using fundamental analysis, including the key factors to consider and look at how cryptocurrency analysis is different from the traditional asset analysis. 

What Is Fundamental Analysis?

Fundamental analysis determines the intrinsic value of an asset, which is meant to be an objective measure of its worth. Evaluating the underlying information about crypto projects provides guidance on whether the coin is undervalued or overvalued as an asset. 

Cryptocurrency markets are notoriously volatile. Even established currencies like Bitcoin and Ethereum are subject to sudden fluctuation. Investing in newer coins and tokens comes with significant risk unless you understand what you’re putting your money into. 

Performing fundamental analysis enables non-technical investors and seasoned traders to trade market movements with confidence. Armed with fundamental analysis, traders can create informed strategies with better odds of profitability.

As compared to technical analysis is helpful for traders and investors who have an open interest that aims to forecast the financial market direction through the use of technical indicators like RSI, MACD, and Bollinger Bands.

How Is Crypto Fundamental Analysis Different?

In 1934, Benjamin Graham and David Dodd published Security Analysis, which is often considered the bible for securities valuation. To this day, investors test financial assets using the metrics explained in their classic book. For example, when evaluating stocks quantitatively, you can use earnings per share (EPS) or the price-to-earnings ratio (PE ratio) to determine the intrinsic value of a share.   

Cryptocurrency isn’t necessarily subject to international regulation when it comes to reporting requirements, unlike publicly listed companies that often have to make quarterly reports using recognized accounting standards. Traditional business metrics, like liquidity ratios that look at the solvency of conventional companies, go out the window. The entire ethos is that no single company or entity is meant to own or be responsible for the project, and the information flow takes on a different nature.

Within crypto markets, all transactions can be publicly “audited” on the blockchain, and the founding team must keep the community informed of their road map.

Conceptually, investors still need to develop insights into the underlying project, but the metrics are completely different from those used for analyzing traditional markets.  

Factors to Consider When Analyzing Crypto Fundamentally

The main goal of crypto fundamental analysis is to reduce investor risk and evaluate the profit potential of the asset. 

Fundamental analysis can be applied in three broad categories:

Blockchain Metrics (On-chain Metrics)

The blockchain is a valuable resource, but pulling information manually from the raw data can drain time and resources. Fortunately, a range of application programming interfaces (APIs) provide tools to empower investment decisions. Leading cryptocurrency exchanges have developed reporting tools that provide an abundance of actionable information such as the number of active users, total transactions, and transaction value.

The three most fundamental metrics to a cryptocurrency’s fundamental analysis are hash rate, status, and active addresses, as well as transaction values and fees. Let’s take a closer look at how this data grants trading insights.  

Hash Rate

Blockchain plays a significant role in securing the network, and diving into the data proves to be valuable for crypto fundamental analysis.

Bitcoin and Ethereum are two examples of cryptocurrencies that run on a Proof-of-Work (PoW) blockchain. PoW requires crypto miners to solve a computational puzzle that verifies each transaction while preventing malicious attackers from gaining 51% majority control of the blockchain. Doing so would allow the controlling entity to alter or stop other transactions that don’t belong to them, or double-spend their own currency. 

Bitcoin Hashrate
Image CC: Hashrate Glassnode

The hash rate is the combined computational power used in mining to perform calculations on a PoW blockchain. Hash rates are estimated based on publicly accessible data, but the true hash rate is never actually known. 

Hash rates are seen by many crypto investors as proof of the health of the cryptocurrency in question. The higher the hash rate, the more miners are incentivized to mine for profits, and the more secure the network. Calculating a personal hash rate can also help miners determine their own profitability. 

However, when the hash rate begins to decline, miners might begin to find the cryptocurrency unprofitable, leading to miner capitulation. Capitulation often happens when markets spiral lower, creating pressure for miners to sell off their hardware. Lower hash rates indicate a loss of interest on the part of investors. 

Status and Active Addresses

Bitcoin Active Addresses
Image CC: Bitcoin Active Address chart on Glassnode

Active addresses measure the number of active blockchain addresses over a period of time. One of the simplest approaches is to total the number of sending and receiving addresses over various periods. Tally the active addresses over a period of days, weeks, or months and compare the growth or decline to gauge activity and interest in the coin or token.

Another approach is to total the number of unique addresses within predefined periods, and then compare the results. 

Transaction Value and Fees

As compared to technical analysis, the fundamental analysis also prioritizes the assessment of transaction values. If there were five Bitcoin transactions of $250 each all on the same day, the daily transaction value would be $1,250.

A consistently high transaction value shows a currency in steady circulation, while comparisons reveal data concerning potential future market movements. 

Fees reflect the demand on the blockchain, or how many transactions are paying to be added to blockchains as quickly as possible. Ethereum’s gas is an example of fees paid, but every cryptocurrency can have its own transaction fees. 

Assessing fees paid over various periods gives you an idea of how secure the coin or token is. Transaction fees can naturally increase over time, with the block subsidy or block reward reduced relative to the mining difficulty. Without adjusting the reward, crypto miners would begin working at a loss and start dropping off the blockchain. 

Financial Metrics

The goal of fundamental analysis is to produce a quantitative value for an investor to analyze the prospect of an asset. By assessing crypto financially involves understanding the trading conditions of assets including their liquidity, surrounding factors, and market response.

All of these proves to be valuable crypto fundamental analysis, especially when assessing the prospect before formulating an investment plan.

Market Capitalization (Market Cap)

The market capitalization value is the representation of a network’s value. It can be calculated by multiplying the current price by the supply of coins in circulation. Market capitalization can offer misleading valuations if you fail to factor in other metrics, such as liquidity. After all, a poorly circulated altcoin with a total supply of 50 million and a handful of transactions exchanged at $1 doesn’t mean that each one of those coins is worth $1.

In general, investors may believe that low market cap coins have higher growth potential, though high market caps can also point to stronger infrastructure and lasting power. Even though forgotten currency, lost wallets, and irretrievable keys mean that we’ll never really know precisely how many coins are in circulation, market capitalization offers an approximation for a coin’s network value.

Liquidity and Trading Volume

Liquidity is a measure of how easy it is to buy and sell an asset. If a cryptocurrency asset can be quickly bought or sold without drastically altering the market value, then liquidity is strong. A liquid cryptocurrency coin or token will have many buyers and sellers in an order book waiting to be filled. This, in turn, narrows the bid-ask spread, which is a solid measure of liquidity. 

Trading volume is a useful indicator of a coin or token’s ability to sustain momentum. The measure shows how many units of an asset have changed hands over a specific period. If an upward trend in value is backed by a high trading volume, the gains may be more likely to stick. Conversely, price fluctuations without significant trading volume may just be blips on the radar. 

Circulating Supply

The circulating supply of a cryptocurrency refers to the total number of coins in active supply that are accessible to the public. Different from the total supply or the maximum potential supply, the circulating supply isn’t static and can change over time since coins can be burned. 

Developers may increase the number of coins or tokens circulating in a centralized supply. With a mineable cryptocurrency, mining activities can increase the circulating supply. 

Project Metrics

Project metrics take a qualitative approach to evaluating the performance of a cryptocurrency. They focus on internal and external factors, such as the purpose of the cryptocurrency and how the cryptocurrency project operates.

Background Analysis

Crypto project websites will include a list of their team members. Carefully researching team profiles and their track records can shed light on the likely success of the current project. Past experience and accomplishments should be well documented, providing insight into the team you’re trusting to follow the road map. You may also consider any early backers or advisors to the project in order to assess credibility.

Crypto White Paper

The crypto white paper is a technical document that outlines the purpose and operation of the project. It is the most important of the project documents and should at a minimum contain the following information:

  • Blockchain technology solutions
  • Use cases for the currency
  • Planned features and upgrades
  • Token economics and sale information
  • Team Information

Examine the white paper with a good dose of skepticism and look out for third-party reviews about the project.

Competitor Comparison

Market competition weeds out winners from losers. Doing a thorough search for market competitors identifies the landscape in which each project must compete. Understanding the overall ecosystem is crucial to evaluating the potential of a project.

Product Road Map

Most crypto products have a road map for the future, showing the timeline for test nets, releases, and newly planned features. The road map should offer a clear outline of future developments. Use the road map to measure the achievement of milestones.

Tokenomics and Utility

Tokenomics is the economics of token supply and demand. Supply and demand drive the value and price of cryptocurrencies. The higher the demand relative to supply, the higher the price. Tokenomics theory also includes the incentive structure used to motivate behavior on a network.

The utility of a token represents the role it can play. A token with more real-world use cases may attract more users and attention.   

What Else for Cryptocurrency Analysis?

Quantitative analysis is great to give investors an overview of the financial metrics considering the factors that can be measured numerically. However, it does not capture the company’s aspects or risks unmeasurable by a number. That is especially when crypto is a target market with such a wide range of external factors to be considered. That said, social politics and user behavior can greatly impact the business fundamentals surrounding an asset.

Sociopolitical Environment  

The Covid-19 pandemic gave investors a taste of a truly global crisis and its impact on financial markets. As the pandemic unfolded, all assets, including cryptocurrencies, actually sold off. Bitcoin crashed 58% between Mar 7–13, 2020. This risk-off attitude drove investors to flee speculative assets.

In response to the crisis, governments around the world passed trillions of dollars in stimulus packages, and crypto came into favor again. With central banks flooding the system with fiat currencies, investors may turn to cryptocurrency as a store of value and an inflation hedge. 

Uncertain regulatory frameworks can also interfere with crypto markets, with sudden bans from countries like Turkey and China sending signals that governments still have their say.

User Behavior

Fundamental analysis is supposed to give investors a holistic overview. And user behavior is one of the most difficult factors to evaluate. Social media, crypto community, and marketing, in general, can all have a major impact on user behavior and market participants, but the effects can be hard to predict.

After all, a few tweets from Elon Musk may spawn a field of dog coins and memes coins. In general, taking into account the followers and engagement of a network indicates the level of commitment users have to the project. 

Analytical Tools

As cryptocurrency trading has grown, the popularity of analytics — ranging from network statistics to technical market analysis — have proliferated. The educational challenge mainly lies in filtering all the publicly available data into a usable format.

Charting tools like TradingView, news aggregators, portfolio rebalancing, and block explorers all enhance a data-rich crypto environment.

Every Last Drop

As institutional demand for crypto grows, traditional methods of valuing cryptocurrencies justify their trading prices. Understanding fundamental analysis in crypto is a slightly different ball game from traditional markets, but the resources available are also expanding. Liquid exchange platforms, crypto trading bots, and active communities all contribute to a flourishing ecosystem. 

As with any investment, it is important to do your due diligence. Investors who do careful research and fundamental analysis can profit handsomely in cryptocurrency markets. Information and research mitigate investment risk. So do your homework and diversify your investment portfolio. 

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