A Guide to Cryptocurrency Fundamental Analysis

Table Of Content

• Content

• Conclusion

• FAQ

• You May Also Like

• External Links

For the purposes of cryptographic fundamental analysis, all accessible data pertaining to a certain financial asset is thoroughly examined. Possible factors to consider include the project's crew, the number of users, and the types of problems solved by the product.

The aim is to decide whether or not the asset is fairly valued. Once you have this information, you may use it to guide your trading decisions.

Introduction

Trading in an asset with the same degree of volatility as cryptocurrency takes some expertise. There is a learning curve associated with choosing a strategy, comprehending the wide world of trading, and becoming an expert in technical and fundamental analysis.

Technical analysis knowledge can be passed down from traditional financial markets to some extent. Many participants in the cryptocurrency market employ the same technical indicators used in the foreign exchange, stock, and commodity markets. Technical analysis indicators like the Relative Strength Index (RSI), the Moving Average Convergence Divergence (MACD), and Bollinger Bands all attempt to foretell the future of the market. As a result, technical analysis tools are also widely used in the bitcoin market.

While the methodology behind fundamental research on cryptocurrencies is comparable to that of traditional markets, traditional methods of analysis cannot be applied to crypto assets. Accurate FA in cryptocurrency necessitates an understanding of the underlying value proposition.

In this piece, I'll try to help you find measurements that you may utilize to create your own indicators.

What is fundamental analysis (FA)?

Investors use fundamental analysis (FA) to determine the "intrinsic value" of a company or a particular asset. The primary objective is to find out if the asset or business is overvalued or undervalued by considering a variety of internal and external criteria. Based on that data, they may make informed decisions about when to enter or exit a trade.

The information gleaned via technical analysis is likewise useful for traders, but it provides a different kind of insight. The premise of TA is that it may be used to accurately forecast how an asset's value will change in the future. To do this, it is necessary to recognize candlestick patterns and understand key indicators.

When trying to determine what they believe to be the true value of a company, traditional fundamental analysts typically look to financial measures. Earnings per share (the amount of profit a company makes for each outstanding share of stock) and the price-to-book ratio are two examples of such indicators (how investors value the company versus its book value). This might be done for multiple companies in the same industry to compare and contrast potential investments.

The problem with crypto-fundamental analysis

It's difficult to compare cryptocurrency networks to more conventional enterprises. Decentralized services, such as Bitcoin (BTC), are more akin to commodities. Traditional FA indicators, however, don't tell us anything about even the most centrally issued cryptocurrencies (such as those issued by organizations).

As a result, we have to start thinking about other models. Finding reliable measurements is the first step. We refer to those that are difficult to manipulate as "strong." Because of the ease with which fraudulent accounts can be created or participation can be purchased on social media platforms like Twitter and Telegram/Reddit, these are probably not good measures.

An evaluation of a network cannot be completed with a single metric since no one metric can capture all aspects of the network. The number of functioning addresses on a blockchain has likely been steadily rising. However, that doesn't give us very much information on its own. Perhaps it's just one person using several addresses to send and receive money indefinitely.

There are three types of crypto FA metrics that we'll examine below: on-chain metrics, project metrics, and financial data. Though not comprehensive, this list will serve as a solid starting point from which to develop indicators in the future.

On-chain metrics

On-chain metrics are those that can be directly monitored by utilizing the information made available by the blockchain. Of course, we could do this ourselves by hosting a node on the target network and then exporting the data, but that would be a time-consuming and potentially costly endeavor. especially if we're only thinking about the money and don't want to expend any effort.

Obtaining the data from websites or APIs made with the express aim of guiding financial investments is a simpler option. By analyzing Bitcoin's blockchain, CoinMarketCap provides us with a wealth of data. For further information, you can also check out Binance Research's project reports or the data charts on Coin metrics.

Transaction count

The volume of transactions on a network is a reliable indicator of its health. We may see the trends in activity over time by showing the numbers for different time intervals (or by using moving averages).

This metric should be used with caution, so keep that in mind. Just as we can't be sure that there isn't a single party moving money around in their own wallets to artificially inflate the on-chain activity, we also can't be sure that there aren't multiple parties doing so.

Transaction value

The transaction value, which is distinct from the transaction count, reveals the total monetary worth of all transactions within a certain time frame. If, on a given day, ten Ethereum transactions were sent, with an average value of $50, we would claim that $500 was transacted. We might use a conventional unit of measurement like the US dollar, or we could use the unit of measurement inherent to the protocol itself (ETH).

Active addresses

In blockchain terminology, "active addresses" denote those that have been used within a specific time frame. It can be calculated in a number of ways, but one common technique involves tracking the number of senders and receivers in a certain time frame (e.g., days, weeks, or months). Some studies also look at the overall number of unique addresses over a period of time.

Fees paid

Fees paid can reveal the demand for block space, which may be more relevant for some cryptocurrencies than others. It's not unlike an auction, when users submit bids in the hopes that their transactions will be featured in the next round. Those who bid more will have their transactions validated (mined) more quickly than those who bid less.

It's an intriguing measure to look into for coins that have declining emission schedules. Block rewards are offered by the most popular blockchains that rely on proof-of-work (PoW). In other cases, it is composed of transaction fees and block subsidies. Periodically, the block subsidy will diminish (in events such as the Bitcoin halving).

It is reasonable to expect transaction fees to rise as the cost of mining increases and the block subsidy is gradually decreased. Without this, mining would be unprofitable, and miners would leave the network. The integrity of the chain is compromised as a result.

Hash rate and the amount staked

Today's blockchains employ a wide variety of consensus algorithms, each with its own set of rules and procedures. Due to their crucial function in maintaining network safety, it would be instructive to delve deeply into the available information regarding them.

For proof-of-work coins, the hash rate is a common indicator of the network's overall functioning. The higher the hash rate, the more difficult it is to launch a 51 percent attack. There may be a growing interest in mining as a result of low costs and rising earnings if the number of miners has been rising gradually over time. When the hash rate drops, it means that miners are giving up on protecting the network and going offline (also known as "miner capitulation").

The asset's current price, the volume of transactions, and the amount of fees paid are just a few of the factors that might affect mining expenses as a whole. Naturally, it's also vital to think about the mining process's direct costs (such as electricity and computing power).

Similar game theory underlies staking (as seen in Proof of Stake), another related subject. While the results are the same, the methods themselves are different. The goal of block validation is for users to stake their own assets. So, we may use the current wager size as an indicator of overall interest (or lack thereof).

Project metrics

In contrast to the quantitative focus of on-chain metrics, which examine publicly available blockchain data, the qualitative approach of project metrics evaluates intangibles like the quality of the team, the clarity of the whitepaper, and the promise of the future.

White Paper:

Prior to putting money into a project, it is strongly suggested that you read the project's whitepaper. This is a white paper detailing the cryptocurrency initiative from a technological perspective. In a perfect world, the white paper would tell us:

Can we learn more about the technology behind this?

target scenario(s)

The plan for future enhancements and additions

Schemes for minting and distributing currency

It's smart to refer back to this data while having project-related conversations. How do other people feel about it? Have any warning signs been triggered? Do the objectives make sense?

The team

If there is a team behind the cryptocurrency network, looking at their past work will show if they have what it takes to see the project through. Is there a history of members taking on and completing projects in this field with success? Will their level of experience allow them to complete the goals they have set? Have they taken part in any dubious schemes or projects?

With no team, how does the development community function? If the project's GitHub is accessible to the public, you can see how active the community is and how many people have contributed to the project. There may be greater interest in a currency with steady growth than in one whose repository hasn't been updated in two years.

Competitors

With any luck, the whitepaper for this cryptocurrency will shed some light on its intended market. Right now, it's crucial to pinpoint the existing projects it's up against and the outdated systems it aims to upgrade.

These should be subjected to the same level of rigour in their fundamental analysis. On its own, an asset may seem promising, but when compared to other crypto assets that are conceptually comparable, we may find that we are not as strong.

Tokenomics and initial distribution

Some projects create tokens as a solution looking for a problem. Despite the project's potential, the coin it uses may not be appropriate here. This necessitates investigating the token's practicality. And, by extension, whether the market as a whole will recognise this utility and, if so, at what price it will likely value it.

The initial distribution of the funds is also a significant consideration here. Which came first, the ICO or the IEO, or the ability to mine it? In the former situation, the whitepaper should specify the percentage of funds that will be allocated to the company's founders and employees, as well as the percentage that will be made available to investors. For the latter, we could check for premining (mining on the network before it's publicised) activity on the part of the asset's creator.

The distribution may help us gauge the extent of the risk. For instance, if a small group of people controlled the vast majority of the supply, we may conclude that this is an unsafe investment since the group has the potential to abuse its position.

Financial metrics

Fundamental analysis can benefit from knowledge of the asset's present trading activity, historical trading activity, liquidity, etc. However, measurements regarding the crypto asset's protocol's economics and incentives may also be included here.

Market capitalization

Multiplying the current price by the total supply yields the market capitalization (or network value). It is the theoretical price at which all of the crypto asset's units may be purchased (assuming no slippage).

Market capitalization on its own can be deceptive. Ten million of a worthless token might be issued with no effort. With a $1 price tag on a single token, the market valuation would skyrocket to $10,000,000. This price is obviously inflated, as widespread market interest in the token is unlikely to materialise in the absence of a compelling value proposition.

In a similar vein, it is not possible to know with certainty how many coins or tokens are in circulation. Money, coins, and keys can all be easily misplaced or destroyed. To exclude coins that are no longer in circulation, approximations are used instead.

Despite this, market capitalization is widely used to predict how rapidly a network will expand. Some cryptocurrency traders believe "small-cap" coins have a higher growth potential than "large-cap" ones. Others argue that large-caps have more powerful network effects and are therefore more likely to succeed than less well-known small-caps.

Liquidity and volume

The term "liquidity" refers to an asset's ease of purchase and sale. An asset is considered liquid if it can be easily sold at the market price. Similar to this is the idea of a competitive market where several offers and bids are constantly being made and accepted (leading to a tighter bid-ask spread).

A possible issue with an illiquid market is that we will be unable to sell our assets at a "fair" price. There are no takers for the deal, so we may either reduce the offer price or wait for liquidity to improve.

Liquidity can be gauged, at least in part, by looking at trading volume. It can be calculated in several ways and serves as an indicator of the total amount transacted during a certain time frame. Daily trading volume is typically plotted on charts (denominated in native units or in dollars).

Understanding liquidity can be useful when conducting fundamental analysis. In the end, it serves as a gauge of the level of enthusiasm the market has for a given investment opportunity.

Supply mechanisms

Some investors place a high value on the supply mechanisms of a currency or token. Bitcoin advocates are increasingly turning to models like the stock-to-flow (S2F) ratio.

Decisions can be influenced by factors including the maximum possible supply, the current supply, and the inflation rate. If the coin's creators gradually reduce the number of new coins created, demand for new coins may outnumber supply.

However, some investors may worry that a strictly imposed ceiling will hurt their portfolios in the long run. This raises the possibility that users will be less likely to spend their coins or tokens and instead choose to hold on to them in the hope of a price appreciation. Another complaint is that it favours early adopters over later ones, whereas a more gradual inflationary approach would be more equitable.

Fundamental analysis indicators, metrics, and tools

Metrics are data, both quantitative and qualitative, that can be used for simple analysis, as we've already established. However, these measurements rarely provide a complete picture on their own. Checking out indications is a great way to dig into the meat and potatoes of a coin.

Indicators frequently use statistical algorithms to integrate many metrics into a single, more easily analysed relationship. Still, there is a great deal of fuzzyness in the distinction between a metric and an indicator.

Having a count of all the wallets that are now in use is helpful, but we can get even more out of the information if we combine it with other pieces of information. This might be expressed as a fraction of the total number of wallets, or the market value of a coin could be divided by the number of wallets in use. Using this method, you may determine how much money is typically kept in each functioning wallet. Both of these would let you infer information about the network's activities and users' trust in retaining the asset. In the following paragraph, we'll go into further detail.

To compile all these measurements and indications, fundamental analysis tools are helpful. Blockchain explorers let you view the raw data, but a dashboard or aggregator will save you a lot of time. You can make your own indicators using the metrics you care about by using certain tools.

Combining metrics and creating FA indicators

Now that we've covered the distinction between metrics and indicators, we can move on to discussing how we combine measurements to gain a more complete picture of the financial status of the assets in question. What's the point? We've seen that there are problems with each statistic we've discussed so far. In addition, you're missing a great deal of context if all you're doing is looking at a list of data for each cryptocurrency project. Take the following into account:

The difference between the two options cannot be understood solely by comparing active addresses. In a very basic sense, we could conclude that in the past six months, there have been more addresses associated with Coin A than Coin B. However, this is by no means conclusive. Where does this number fit into the overall market value? Also, how many sales were made?

A more logical strategy would be to develop a ratio that could be used to evaluate certain aspects of Coin A and then compared to similar aspects of Coin B using the same ratio. This will prevent us from doing a haphazard comparison of the many parameters of each coin. Instead, we can establish an impartial benchmark for coin valuation.

We may, for instance, conclude that the correlation between market value and the number of transactions tells us far more than market value alone. Then we may possibly get the average transaction size by dividing the total market capitalization by the total number of transactions. We get a ratio of 5 for Coin A and a ratio of 0.125 for Coin B.

If we were to base our assessment of the two coins' true worth solely on this ratio, we might conclude that Coin B has more intrinsic value than Coin A. Therefore, it may appear that Coin B is more useful than Coin A, or that Coin A is being overvalued, as the volume of transactions in Coin B is significantly higher in comparison to its market capitalization.

There is no intention for either of these comments to be taken as investing advice; rather, they serve as an illustration of how we might go about painting a portion of the greater picture. Whether the somewhat lower transaction quantity on Coin A is good or bad, it requires knowledge of the projects' aims and the currencies' functions.

The NVT ratio is a similar metric that has gained traction in the digital currency industry. Network value to transaction ratio, a concept coined by analyst Willy Woo, is sometimes referred to as the "price to profit ratio of the crypto industry." This ratio is calculated by dividing the market capitalization (or network value) by the amount transacted (typically on a daily chart).

When it comes to indicators, we have just scratched the surface. To value projects consistently, fundamental analysis focuses on creating a framework that can be applied universally. Better research yields more information.

Key FA indicators and metrics

Many different kinds of indicators and metrics can be used. For those just getting started, it's recommended that they start with the most common ones. You should include multiple indicators in your research because each one provides just partial information.

Network Value to Transactions Ratio (NVT)

The network transaction value indicator (daily) can be thought of as akin to the price-to-earnings ratio in the context of stock market analysis. Simply divide a coin's market valuation by its 24-hour transaction volume to get its average daily volume.

For the sake of this article, we will substitute a coin's daily transaction volume for its true intrinsic worth. This idea is based on the concept that a system's value increases in proportion to the volume of transactions taking place within it. If the market capitalization of a coin rises while the volume of its daily transactions remains low, a bubble may form in the market. There is an increase in price without a corresponding increase in value. On the other hand, even when daily transaction volume increases, the price of a coin or token may remain unchanged. Potentially, this situation represents a good buying opportunity.

As the ratio rises, it is more likely that a bubble will form.When the NVT ratio rises above 95, it is considered to be at this level. When the ratio goes down, the cryptocurrency becomes less expensive.

Market Value to Realized Value Ratio (MVRV)

Realized value is an important metric for cryptocurrencies, but it's important to know what it implies before diving in. Simply multiplying the current price by the total number of coins in circulation yields the market capitalization of a certain cryptocurrency. Discounts, on the other hand, are applied to the realised value of any coins that are missing from unreachable wallets.

As an alternative, the market worth of coins that have been sitting in wallets is determined by their last period of activity. For example, a Bitcoin lost in a wallet since February 2016 will only be worth roughly $400.

Our MVRV metric is calculated by dividing the market value by the value that was actually realized. The ratio will be large if the market capitalization exceeds the realised capitalization by a wide margin. An overvalued coin may trigger a sell-off if the price-to-value ratio rises beyond 3.7.

At this price, it seems as though the coin might be overvalued. This is visible just before the 2014 (MRVR of around 6) and 2018 (around an 80% drop) Bitcoin sell-offs (MRVR of approximately 5). The market is considered undervalued if the value is less than 1. As the demand for the item rises, the price will also rise, making this an ideal time to make a purchase.

Stock-to-flow model

The stock-to-flow indicator is a prominent indicator of the price of a cryptocurrency, often with a restricted supply. The approach looks at each cryptocurrency as a fixed, scarce resource analogous to precious metals or stones. Because there is a known limited supply without new sources to be uncovered, investors use these assets as a store of value.

For this measure, we divide annual production by the total amount in circulation around the world. This is possible in Bitcoin with the use of publicly available information about the currency's supply and demand. With diminishing mining profits comes an increased ratio that accurately reflects the asset's scarcity, increasing its value. Every two years, the Bitcoin network's reward halved, and this was reflected in the rate at which new bitcoins entered circulation.

Stock-to-flow has been an acceptable predictor of Bitcoin's value, as we can see. Price data for Bitcoin has been overlaid on the ratio's yearly average, and the two lines seem very similar. However, the model is not without its flaws.

A stock-to-flow ratio of 60 indicates that the current rate of gold production would require around 60 years to deplete the resource. Within the next 20 years, the value of Bitcoin is expected to more than double, reaching a ratio of around 1600, with a market valuation exceeding the entire world's wealth.

If deflation occurs, the resulting negative price throws off stock-to-flow models as well. As bitcoin wallets are lost and new coins are no longer created, the ratio will go negative. In a graphical representation of this, the stock-to-flow ratio would increase to infinity and then decrease to negative infinity.

Examples of fundamental analysis tools

Baserank

Baserank is a crypto asset research platform that compiles data and reviews from experts and investors. Following the averaging of the review scores, the coin is given an overall score between 0 and 100. While subscribers have access to exclusive reviews, everyone may read an in-depth summary of reviews organised into categories like "team," "utility," and "investment risk" for free. An aggregator such as Baserank is useful when you have limited time but still want a quick summary of a project or coin. However, before putting money into a project, you should always learn more about it.

Crypto Fees

The name of this programme should give you a hint as to what it does: it displays the costs charged by each network over the preceding day or week. When examining the activity and utilisation of a blockchain network, it's a simple statistic to employ. In most cases, high-priced networks are in high demand.

But don't take this metric at face value. Comparisons between networks might be difficult because certain blockchains are designed with low costs in mind. In such circumstances, the number needs to be viewed with the total value of the transaction or some other statistic for proper context. Coins with a large market cap, like Dogecoin and Cardano, that have low transaction fees, like Litecoin and Dash, tend to rank lower in the overall charts.

Glassnode Studio

Glassnode Studio provides access to a dashboard that shows various on-chain metrics and data. It requires a subscription model similar to other available solutions. Nonetheless, the level of detail and suitability for novice investors is impressive given the fact that all of this data is available for free on the blockchain. When searching for something on the blockchain, it can be difficult to find all the relevant data in one location. The sheer depth and breadth of Glassnode's statistic categories and subcategories is its greatest asset. However, there is little to do here if you're looking for BNB chain-related initiatives.

Glassnode Studio incorporates TradingView, complete with all of its charting capabilities, for anyone looking to integrate their analytics with technical analysis. When making judgments, investors and traders often use a hybrid approach, combining insights from several disciplines. Having a central location to accomplish this is convenient.

Conclusion

When carried out properly, fundamental analysis can shed light on cryptocurrency markets in ways that technical analysis cannot. Separating the "real" value of a network from its market price is a valuable ability for traders to have. There are, of course, insights that TA provides that cannot be anticipated by FA. As a result, many modern traders employ a hybrid approach.

As is the case with many tactics, there is no universally applicable playbook for football. With any luck, this essay has shed some light on the questions you need to ask yourself before buying or selling cryptocurrencies.

FAQs

In terms of analysis, what is the most effective method for digital currency?

The cryptocurrency market and its evolution may be tracked most effectively and quickly with the help of Cointelegraph's study of cryptocurrencies. Bears are active at higher levels, as evidenced by the recent decline in BTC and key altcoins.

So, what exactly are the building blocks of cryptocurrency?

Cryptocurrencies are a sort of digital currency developed through the use of encryption techniques. Cryptocurrencies are both a medium of exchange and a form of virtual accounting because of the underlying encryption technologies. You need a cryptocurrency wallet in order to store and spend cryptocurrency.

In the year 2022, which cryptocurrency do you think will see the most growth?

Ethereum. Crypto enthusiasts predict that the second-largest cryptocurrency by market cap will expand in 2022 and 2023. Some estimates place Ethereum's value between $8,000 and $10,000 by the end of 2022.

That's all for today, see ya tomorrow! If you want more, be sure to follow our Twitter (@croxroadnews)

DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.

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External Links

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