Embarking on a voyage through the intricate realm of crypto investments requires a multifaceted comprehension of various analytical frameworks. With a significant surge in the popularity of digital currencies, ensuring intelligent and strategic investments in this field has become crucial.
This article will focus on exploring fundamental analysis (FA) and its adaptation to the crypto domain, shedding light on the numerous metrics and qualitative factors that potential investors should consider before venturing into the vibrant yet volatile crypto market.
What Constitutes Fundamental Analysis (FA)?
Fundamental analysis (FA) serves as a methodology in which investors determine the intrinsic value of an asset or company. This is achieved by examining a variety of internal and external factors with the main objective of determining whether the asset or business entity is over or underpriced. This insight then becomes crucial for investors to strategically navigate their entry or exit from investments.
On the other hand, technical analysis provides valuable trading information but offers different insights. Practitioners of technical analysis believe that future price movements can be predicted by analyzing an asset’s historical performance. This is done by identifying specific patterns in candlestick charts and carefully studying key indicators.
Traditional fundamental analysts typically analyze business metrics to determine what they perceive as the true value of a company. Utilized indicators may include earnings per share (a measure of a company’s profit per share) or the price-to-book ratio (a comparison of how investors value a company against its book value). This analysis can be conducted across various businesses within a specific sector to determine how a potential investment measures up against its competitors.
Challenges in Conducting Cryptocurrency Fundamental Analysis
Evaluating cryptocurrency networks presents unique challenges compared to traditional business assessments due to their distinct characteristics. For example, more decentralized cryptocurrencies like Bitcoin (BTC) resemble commodities rather than traditional businesses. Even when considering more centralized digital currencies issued by specific entities, conventional fundamental analysis indicators offer limited insights.
Hence, it is crucial to explore alternative analytical frameworks. The first step involves identifying robust metrics that are resistant to manipulation. Metrics such as X (formerly Twitter) followers or users on Telegram and Reddit may be less reliable as they can be artificially inflated through the creation of fake accounts or the purchase of engagement on social platforms.
It is important to note that no single metric can provide a comprehensive view of the network under scrutiny. Even if there is a significant increase in active blockchain addresses, it does not necessarily provide substantial information. This spike could simply be a single entity moving funds between new addresses to create the illusion of activity.
What are the On-Chain Metrics?
On-chain metrics, derived from blockchain data, offer a way to analyze the activities on a network. While it is possible to acquire this data independently by running a node and extracting data for a chosen network, it can be resource-intensive and time-consuming, especially for investment decision-making purposes.
Transaction Count
The transaction count serves as an indicator of the activity happening on a network. Monitoring the number of transactions over specific intervals or using moving averages reveals fluctuations in network activity over time. However, caution must be exercised when interpreting this metric, as there is a possibility of a single entity transferring funds between their own wallets to simulate active on-chain activity.
Transaction Value
Unlike the transaction count, the transaction value reveals the total amount transacted within a specified period. For example, if ten Ethereum transactions, each valued at $50, were executed in one day, the daily transaction volume would be $500. This metric can be measured in a fiat currency like USD or in the protocol’s native unit (ETH).
Active Addresses
Active addresses refer to blockchain addresses involved in transactions within a specific timeframe. The methodology for calculating this metric may vary, but a common approach involves counting both the sending and receiving entities in each transaction over predetermined intervals (e.g., daily, weekly, or monthly). Some analyses also consider the number of unique addresses on an accumulative basis, tracking the cumulative total over a period of time.
Fees Paid
Fees paid on a network, while more relevant for some cryptocurrencies than others, provide insights into the demand for block space. This can be seen as a bidding process in an auction where users compete to have their transactions included promptly. Higher bidders are more likely to have their transactions confirmed sooner, while those bidding lower may experience delays.
For cryptocurrencies with diminishing emission schedules, observing this metric is insightful. Major Proof of Work (PoW) blockchains, for example, provide a block reward that includes a block subsidy and transaction fees in certain cases.
As the block subsidy undergoes periodic reductions (such as during Bitcoin halving events) and the cost of mining generally increases over time, transaction fees would logically need to increase to prevent miners from operating at a loss, which could compromise network security.
Hash Rate and Amount Staked
Given the various consensus algorithms used by different blockchains, each with its own mechanisms crucial for network security, delving into relevant data can be instrumental for fundamental analysis.
In PoW cryptocurrencies, hash rate often serves as an indicator of network health. A higher hash rate not only increases the difficulty of successfully executing a 51% attack but also, when trending upwards over time, indicates increasing interest in mining, likely driven by reduced costs and higher profits.
Conversely, a decreasing hash rate indicates miners leaving the network (“miner capitulation”) as it becomes economically unviable for them.
The overall costs of mining can be influenced by various factors, including the asset’s current price, transaction volume, and fees paid, among others. The direct expenses of mining, such as electricity and computing power, are also crucial components to consider.
In consensus models like Proof of Stake, staking is a related but operationally different concept. Here, users stake their holdings to participate in block validation. Therefore, analyzing the quantity staked at any given point can provide insights into levels of interest or disinterest in participation.
Assessing Project Metrics
In contrast to on-chain metrics that focus on tangible blockchain data, project metrics involve a qualitative analysis, examining aspects such as the competency of the team (if there is one), the insights provided by the whitepaper, and the future developments outlined in the roadmap.
The Whitepaper
Before investing in any project, a thorough review of its whitepaper is essential. This technical document provides a comprehensive overview of the cryptocurrency project.
A well-crafted whitepaper should outline the network’s objectives and ideally provide insights into:
– The technology used (is it open-source?)
– The targeted use case(s)
– The development roadmap, highlighting future upgrades and features
– The supply and distribution plan for coins or tokens
Astute investors should verify this information by cross-referencing it with community discussions about the project, scrutinizing for potential red flags, and evaluating the feasibility of the goals.
The Team
Assessing the caliber of the team, if there is one, behind a cryptocurrency network involves evaluating their track records to determine if they possess the necessary skills to realize the project.
Questions to consider include: Have team members led successful initiatives in the sector before? Do they have the expertise required to achieve their stated milestones? Have they been involved in any questionable projects or scandals in the past?
In the absence of a specific team, investigating the developer community becomes crucial. Checking a public GitHub repository for the project to gauge the number of contributors and the level of activity can provide insights. A cryptocurrency with consistent development activity may be more attractive than one with a stagnant repository.
Competitors
A comprehensive whitepaper should also clarify the use case targeted by the cryptocurrency asset, allowing for the identification of competing projects and the legacy infrastructures it aims to replace.
The fundamental analysis of these competing entities should be equally rigorous. While an asset may appear attractive on its own, applying the same evaluative criteria to similar crypto assets may reveal it to be less robust than its counterparts.
Exploring Tokenomics and Initial Distribution
Examining the tokenomics and the initial distribution framework of a project sheds light on crucial aspects of its potential viability and risk. Sometimes, projects may create tokens that, despite the project’s potential, may not have a tangible utility within its context. Therefore, verifying the genuine utility of a token is vital. Subsequently, evaluating whether such utility will be recognized and valued by the broader market is also crucial.
Another important aspect to consider is the methodology of the initial fund distribution. Was it conducted through an Initial Coin Offering (ICO) or an Initial Exchange Offering (IEO), or was it possible for users to mine the tokens? In the case of the former, the whitepaper should outline the proportion reserved for founders and the team, as well as the amount made available to investors. In the case of the latter, an evaluation might consider evidence of pre-mining by the asset’s creator (mining on the network before public announcement).
Examining the distribution is crucial for identifying potential risks. For example, if a majority of the supply is concentrated among a limited number of entities, it may be inferred that this poses an investment risk, as those entities may have the ability to manipulate the market in the future. Such insights are essential for navigating the complex landscape of cryptocurrency investment, ensuring that decisions are well-informed and deliberate.
Conclusion
In the rapidly evolving cryptocurrency ecosystem, thorough analysis through fundamental and macroeconomic analysis has become the foundation for making informed investment decisions. This article has embarked on a journey, unraveling the layers of on-chain and project metrics, and exploring the subtle nuances and vital parameters that can influence the profitability and sustainability of crypto investments.
By navigating the uncharted territories of crypto investing with an informed perspective gained from a nuanced understanding of underlying metrics and qualitative factors, investors can not only protect their investments but also contribute to the maturation of the digital asset market.
