Trading financial assets as volatile as cryptocurrencies require some level of proficiency. A trader who wants to understand the market needs to know what makes the price of crypto assets fall, rise, and remain stagnant. Discerning the world of trading, picking out a workable trading formula and possessing mastery of technical and fundamental analysis come with paying the price to learn the ropes.
In traditional markets like stock and forex trading, technical analysis involves using technical indicators and tools to predict market momentum. Technical tools like MA, Bollinger Bands, and RSI are used to determine buy and sell points for crypto traders as they are used by traders in traditional markets.
Fundamental analysis of crypto assets which is the focus of this article, takes a different dimension, unlike in more traditional markets. When assessing cryptocurrencies for fundamentals, it is crucial to search for what gives them value. Therefore, this guide endeavors to showcase metrics you should look for when running fundamental analyses on cryptocurrencies.
What is Fundamental Analysis?
Fundamental analysis (FA) is one feature of the various market research methods used to measure cryptocurrencies. It involves analyzing crypto assets for their intrinsic value rather than current market prices. Analysts use this strategy to evaluate all variables that affect the cost and value of a crypto asset, such as use cases, internal and external factors, management teams, influencers, and other facts.
Fundamental analysis aims to discover the actual value of an asset to know whether it is undervalued or overvalued. When a crypto asset turns out undervalued, the possible step a trader takes is to buy the underlying asset and sell or restrain from buying when overvalued.
Traditional markets use fundamental indicators that aren’t so effective when analyzing cryptocurrencies. We then have to turn to other dominant metrics peculiar to cryptocurrency, which crypto projects can’t manipulate without altering the whole blockchain. Although the list of metrics to analyze crypto assets fundamentals are non-exhaustive, we will look at three keys to forming a foundation for analysis: In-chain metrics, project metrics, and financial metrics.
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On-chain Metrics
On-chain metrics are observable data available on the blockchain. Analysts could run checks on desired networks to export data, although it is time-consuming and costly. The way out here is to use crypto exchanges and Application Programming Interfaces (APIs) that provide the tools and information necessary to make financial decisions. For instance, CoinMarketCap provides an on-chain analysis of Bitcoin, giving valuable information about the asset. Other sources include Binance Research and Coinmetrics.
Here are significant factors to look at when analyzing the on-chain metrics of crypto assets.
Hash Rate
Blockchains employ various consensus algorithms to secure the network, each owning its mechanism. Getting our hands on data about these is one powerful key to conducting fundamental analysis because analysts view it as a health-proof of a crypto asset in question. Hash rate measures a machine’s mining capability to effectively and efficiently carry out hashing computations in Proof of Work (PoW) blockchains.
The hash rate of mining is directly proportional to the security and rewards miners receive for mining. A higher hash rate signals the chances of adding new blocks and receiving a reward for each block created. Also, higher hash rates give the blockchain a 51% chance of avoiding attacks while being profitable for miners. Lower hash rates indicate that mining is not promising and could see miners capitulate from mining and securing the network. Finally, the current price of an asset, fees, and the number of processed transactions, amongst others like costs of electricity and computing power affect the cost of mining.
Transaction Value
Fundamental analysis isn’t complete without researching the transaction values of underlying crypto assets because it indicates the acceptability of the crypto asset for transactions. Transaction value calculates the value of all transactions on the blockchain at a particular time. For instance, if there are 100 Bitcoin transactions in a day, each worth $1000, the daily transaction value is $100,000. To measure transaction value, the network’s native currency (BTC) or fiats like USD come in handy.
Transaction Count
Transaction count measures the activities that occur on a network. Using different timeframes can reveal the changes in activities over time. However, treat this metric with caution because there is no certainty of whether one individual transfers funds around different wallets to inflate on-chain figures.
Fees
The fees traders pay for transactions inform us about the competition to add orders to the blockchain as soon as possible or later. The process is similar to an auction, where people with higher bids have their transactions included on the blockchain quicker than those who bid at a lower price.
The fee users pay over time gives access to information about the security of an underlying crypto asset. Blockchains that run on Proof of Work/(PoW) provide block rewards for miners and tend to decrease periodically, while transaction fees naturally increase. A decrease in the block rewards and mining difficulty means that transaction costs can get so high and potentially frustrate miners to leave if the payout (from fees) doesn’t increase.
Active Addresses
Active wallet addresses indicate the number of blockchain addresses that are functional and available at a given time. One way to calculate active addresses is to combine the transfer and receiving addresses at a particular period to approximate the growth or decline of activity on a crypto asset. Another way is to total unique addresses to derive and compare results according to their periods.
Project Metrics
Project metrics deviate from on-chain metrics’ focus on blockchain data, favoring a qualitative approach. It looks at characteristics such as measuring team performance, competition, whitepaper, operations, and all the workings behind the project.
The Whitepaper
Reading through a crypto project’s whitepaper is very important before investing. The whitepaper is a technical document that contains everything you need to know about a crypto project. It defines the goals, team information, roadmap to achieving targets, tokenomics, target demographics, parent blockchain technology, its solutions, and supply and distribution mechanics responsible for the project’s growth.
The Team
Many cryptocurrency projects provide details of the team members behind the project’s development. One could trace the details of the team members to reveal if they possess the requisite skills to deliver on their promises. Surveys into whether they have taken on successful projects in the past are involved in shady scam projects, and if their skillset is sufficient to achieve their targets is possible too.
For crypto projects with no known team or anonymous developers, search for its developer community. Look for how active they are, if they have a public GitHub and the number of contributors. A project that updates its profile is much more appealing than one that hasn’t been updated in a long time.
The Competition
A whitepaper gives details about the use case a crypto project targets. It is essential to make comparisons of the projects it is in direct comparison with and the system it plans to change. Conducting your analysis this way will reveal projects that are in for the long term and those that merely add to the growing number of cryptocurrencies that offer little to nothing.
Tokenomics, Utility, and Demand
Tokenomics deals with the economics of token demand and supply. Demand and supply stimulate the value of cryptocurrencies. Cryptocurrencies in high demand against their supply tend to possess high price value. One significant factor that controls the pressure for a token is its utility. Discover market recognition to reveal the demand for a token and its value. Also, before investing in any crypto asset determine the utility of its token if it solves a problem(s) or isn’t viable and valuable.
Finally, consider the initial distribution of a token. Check if it was through Initial Coin Offering (ICO), Initial Exchange Offering (IEO), or Initial DEX Offering (IDO) or mining to earn tokens or coins. The whitepaper should outline the number that investors would mine and those kept for the project’s developers. It is vital to look out for the pre-mined at testnet (test mining). Taking the time to go through these rigors is helpful in those cases where there are risks like a few addresses controlling an enormous supply of crypto.
Financial Metrics
Financial metrics in fundamental analysis aim to provide a quantitative and qualitative valuation of crypto assets. Potential investors can access a crypto project financially by considering trading conditions like information on the current crypto asset traded, liquidity, previous trades, market reactions, and external variables, among others.
Market Capitalization
The first thing investors look at before investing in cryptocurrencies is their market capitalization. Market capitalization, also known as network value, is calculated by the multiplication of the current price of an asset by the circulating supply. What you get after multiplication is a hypothetical value to buy single units of the underlying asset. It is essential to consider other factors because market capitalization might mislead investors. However, many investors are likely to go for low market cap than big market cap crypto because they think the low-cap cryptos have more potentials to grow in the short or long term.
Trading Volume and Liquidity
An asset’s liquidity is a measure of how it can easily be bought and sold. Liquid assets can be bought and sold at their trading price without altering the market value drastically. An illiquid asset is difficult to trade at modest prices, making investors crave liquid assets. Traders willing to sell in an illiquid market are under compulsion to lower their ask because no buyers want to make a trade. The competition to complete trade orders is contained in the bid-ask spread, with buyers and sellers narrowing the bid-ask for liquidity.
The trading volume of an asset is an indicator used to determine the liquidity of an underlying asset at a specific time. Typically, it helps to measure the value of traded units of a crypto asset, showcasing its momentum: uptrend and downtrend.
Supply Mechanisms
From an investment perspective, investors should pay attention to the supply mechanisms of a crypto asset. The circulating supply, total supply, and inflation on a crypto asset contribute to how it is perceived by investors. Some crypto assets reduce the number of units that can be mined or produced over time, attracting investors who believe that an underlying asset’s value increases when the demand exceeds the supply.
Importance and Drawbacks of Fundamental Analysis
Like every other cryptocurrency analysis strategy, fundamental analysis has its benefits and negatives.
Pros
- Fundamental analysis helps investors to get crypto assets at a fair price even if they are not at their fair value.
- It allows users to make informed trading decisions due to access to data about an underlying asset.
- Traders can make long-term views about the growth of the market. Using the value they generate for an underlying asset to be worth, investors can evaluate the current price to know whether it is oversold or overbought.
Cons
- Results of fundamental analysis don’t favor short-term decision-making. Traders might have to settle for technical analysis to predict short-term market opportunities.
- Analyzing the market using fundamentals consumes a lot of time because of the multiple processes needed to complete it
- Although fundamental analysis provides a much more in-depth view of the market, negative fundamentals can break down. positive growth within a brief moment.
Final thoughts
Fundamental analysis is a valuation tool used to determine whether a crypto asset is overvalued or undervalued in the market. When properly implemented, fundamental analysis gives rare insight into cryptocurrencies in ways traders can’t get from technical analysis. The ability to spot the ideal value of a crypto asset from its market price is a great skill to have as a trader. However, given there are things fundamental analysis can’t predict, a combination of technical analysis is highly recommended.
