Embarking on a journey through the intricate world of crypto investments necessitates a multifaceted understanding of various analytical frameworks. With an immense surge in digital currency popularity, ensuring smart and strategic investments in this domain has become paramount.
In this article, the emphasis will be placed on exploring fundamental analysis (FA) and its adaptation to the crypto domain, illuminating the multitude of metrics and qualitative factors that potential investors should consider before navigating through the vibrant yet volatile crypto market.
What Constitutes Fundamental Analysis (FA)?
Fundamental analysis (FA) serves as a methodology whereby investors ascertain the inherent worth of an asset or company. This is achieved by scrutinizing a variety of internal and external elements with the primary aim of discerning whether the given asset or business entity is priced above or below its actual value. This insight then becomes pivotal for investors to navigate strategically their entry or exit from investments.
Conversely, technical analysis provides valuable trading information but derives distinct insights. Practitioners of technical analysis harbor the belief that future price trajectories can be predicted by scrutinizing an asset’s historical performance. This is achieved through the identification of specific patterns in candlestick charts and the careful examination of key indicators.
Conventional fundamental analysts typically examine business metrics to ascertain what they perceive to be its genuine value. Utilized indicators might encompass earnings per share (a reflection of the profit a company generates per each share available) or the price-to-book ratio (the comparative analysis of how investors value the company against its book value). This analysis might be performed across various businesses within a specific sector to determine how a prospective investment measures against its contemporaries.
Challenges in Conducting Cryptocurrency Fundamental Analysis
Evaluating cryptocurrency networks presents distinct challenges when compared to traditional business assessment due to their unique characteristics. For instance, more decentralized cryptocurrencies like Bitcoin (BTC) bear a resemblance to commodities rather than conventional businesses. Even when considering more centralized digital currencies—those that are issued by specific entities—the conventional indicators of fundamental analysis (FA) offer limited insights.
Hence, it becomes imperative to explore alternative frameworks for analysis. The initial step involves pinpointing robust metrics – those resistant to manipulation. Metrics like X (formerly Twitter) followers or users on Telegram and Reddit might be less reliable as they are susceptible to artificial inflation through the creation of bogus accounts or purchasing engagement on social platforms.
It is crucial to acknowledge that no single metric can furnish a comprehensive view of the network under scrutiny. Even if a notable increase in active blockchain addresses is observed, it doesn’t necessarily provide substantive information. This spike could simply be a single entity, moving funds between new addresses to feign activity.
What are the On-Chain Metrics?
On-chain metrics, derived from blockchain data, offer a lens through which the activities on a network can be scrutinized. Although acquiring this data independently by running a node and extracting the data for a chosen network is feasible, it often emerges as a resource-intensive and time-consuming endeavor, especially if the sole objective revolves around investment decision-making.
Transaction Count
The transaction count serves as a viable indicator of the activity transpiring on a network. Monitoring the number of transactions over designated intervals (or utilizing moving averages) reveals fluctuations in network activity over time. However, caution is warranted in interpreting this metric since the possibility of a single entity transferring funds amongst their own wallets to simulate vibrant on-chain activity cannot be discounted.
Transaction Value
Distinct from the transaction count, the transaction value discloses the sum transacted within a stipulated period. For example, if ten Ethereum transactions, each valued at $50, were executed in one day, the daily transaction volume would be declared as $500. This metric can be gauged in a fiat currency like USD or in the protocol’s native unit (ETH).
Active Addresses
Active addresses denote blockchain addresses engaged in transactions within a specific timeframe. Methodologies for computing this metric can vary, but a commonly adopted approach entails 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, thereby tracking the cumulative total over a span of time.
Fees Paid
Fees paid on a network, while more pertinent to some cryptocurrencies than others, shed light on the demand for block space. This can be envisaged as a bidding process in an auction where users vie against each other to get their transactions included promptly. Higher bidders are likely to have their transactions confirmed sooner, while those bidding lower may experience delays.
For cryptocurrencies following diminishing emission schedules, observing this metric is insightful. Notably, major Proof of Work (PoW) blockchains deliver a block reward, comprised in certain instances of a block subsidy and transaction fees.
As the block subsidy undergoes periodic reductions (for instance, during Bitcoin halving events) and the cost to mine generally trends upwards over time, transaction fees would logically need to escalate to avoid miners operating at a loss, which could compromise network security.
Hash Rate and Amount Staked
Given the multitude of consensus algorithms utilized by various blockchains, each with their own inherent mechanisms pivotal for network security, diving into relevant data can be instrumental for fundamental analysis.
In PoW cryptocurrencies, hash rate frequently serves as an indicator of network health. A higher hash rate not only augments the difficulty of successfully executing a 51% attack but also, when trending upwards over time, can hint at escalating interest in mining, likely spurred by reduced overheads and amplified profits.
Alternatively, a diminishing hash rate indicates miners withdrawing from the network (“miner capitulation”) as it ceases to be economically viable for them.
The overall costs of mining can be influenced by a multitude of factors, including the asset’s current price, transaction volume, and paid fees, among others. Naturally, the direct expenses of mining, such as electricity and computing power, are also vital components to consider.
Conversely, in consensus models like Proof of Stake, staking emerges as a related yet divergently operational concept. Here, users stake their holdings to partake in block validation. Therefore, the quantity staked at any given point could be analyzed to interpret levels of interest or disinterest in participation.
Assessing Project Metrics
In contrast to on-chain metrics that focus on palpable blockchain data, project metrics undertake a qualitative analysis, examining aspects such as the competency of the team (if one is present), the insights provided by the whitepaper, and the prospective developments outlined in the roadmap.
The Whitepaper
Investment in any project should be prefaced by a meticulous review of its whitepaper. This technical document provides an encompassing overview of the cryptocurrency project.
An effectively crafted whitepaper should delineate the network’s objectives and ideally offer insights into:
- The technology employed (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
Vigilant investors would do well to validate this information through cross-referencing with community discussions about the project, scrutinizing for potential red flags, and evaluating the realism 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 ascertain whether they possess the requisite skills to realize the project.
Questions to consider include: Have team members spearheaded successful initiatives in the sector previously? Do they have the expertise needed to achieve their outlined milestones? Have they been implicated in any dubious projects or scandals in the past?
In the absence of a specific team, investigating the developer community becomes paramount. Checking a public GitHub for the project to gauge the number of contributors and the level of activity can be insightful. A cryptocurrency with consistent development activity might be more attractive than one with a stagnant repository.
Competitors
An effective whitepaper should also elucidate the use case targeted by the cryptocurrency asset, allowing for the identification of competing projects as well as the legacy infrastructures it intends to supplant.
The fundamental analysis of these competing entities should ideally be equally stringent. While an asset may appear attractive in isolation, applying the same evaluative criteria to analogous crypto assets might expose it as being less robust than its counterparts.
Exploring Tokenomics and Initial Distribution
Scrutinizing the tokenomics and the initial distribution framework of a project sheds light on crucial aspects of its potential viability and risk. Sometimes, projects may spawn tokens which, despite the project’s potential, may not have a discernible utility within its context. Therefore, confirming the genuine utility of a token becomes vital. Subsequently, evaluating whether such utility is something that will be acknowledged and valued by the broader market is also crucial.
An additional pivotal aspect to ponder is the methodology of initial fund distribution. Was it orchestrated via an Initial Coin Offering (ICO) or an Initial Exchange Offering (IEO), or was it possible for users to mine it? In instances of the former, the whitepaper should delineate the proportion reserved for founders and the team, and the amount made accessible to investors. In instances 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 instrumental in perceiving potential risks. For example, if a predominant majority of the supply is concentrated among a limited number of entities, it might be inferred that this poses a risky investment since those entities might possess the capability to manipulate the market in the future. Such insights are essential to navigating the intricate landscape of cryptocurrency investment, ensuring that decisions are informed and deliberate.
Conclusion
In the fast-advancing ecosystem of cryptocurrency, meticulous scrutiny through fundamental and macroeconomic analysis has emerged as a bedrock for making informed investment decisions. This article embarked on a journey, unfolding the layers of on-chain and project metrics, and exploring the subtle nuances and vital parameters that hold the potential to influence the profitability and sustainability of crypto investments.
Navigating through the uncharted territories of crypto investing with an informed compass, garnered from a nuanced understanding of underlying metrics and qualitative factors, paves the way for not only safeguarding investments but also contributing to the maturation of the digital asset market.
