Before investing in any project, it is always advisable to perform an analysis to ensure the worth of the project. One of the popular analysis techniques is fundamental analysis. In the crypto world, fundamental analysis plays a crucial role in making investment decisions. This article will discuss the fundamental analysis and various techniques involved.
Introduction to Fundamental Analysis
Investors use fundamental analysis to determine the intrinsic value of an asset or project. Investors consider internal and external factors in determining whether the proposed asset or project is overvalued or undervalued. This information gives guidance in deciding on entry or exit from the project.
The basic idea behind fundamental analysis is that an asset could be undervalued or overvalued. When the market corrects its positions, the asset’s real value is reflected. This analysis helps investors determine an asset’s actual valuation against market performance.
In the traditional method of fundamental analysis, analysts consider business metrics to estimate the project’s real value. Parameters like price-to-book ratio (to analyze the investors’ value against the book values) or earnings per share (to calculate the amount of profit a company earns against per outstanding share) are considered.
Investors do a comparative study for competitor businesses within a niche to ascertain the profitable investment option.
But with cryptocurrency, it isn’t easy to apply all the traditional fundamental analysis techniques. Decentralized offerings like Bitcoin (BTC) are like commodities. In the case of cryptos issued by organizations, market experts could not apply traditional FA techniques as investor reviews on social media often are fake and managed artificially.
Techniques in the crypto market.
1. On-chain metrics or blockchain metrics
Blockchain plays a crucial role in the crypto world, but manually extracting raw data from blockchain networks can be time-consuming. A wide range of APIs (application programming interfaces) can make investment decisions.
Many crypto exchanges provide:
.Actionable information like total transactions.
.The number of active users.
.Transaction value.
The three main metrics applied are hash rate, active addresses, and status. Let us now discuss these metrics.
Hash Rate: Two popular cryptos, Bitcoin and Ethereum, apply Proof-of-Work (POW) consensus mechanism in their blockchain. Crypto miners need to solve a computational puzzle while using POW for transaction verification. One of the primary advantages of adopting POWs is that it prevents malicious transactions from achieving a 51% majority for control.
While mining, the hash rate denotes the computational power per second. For calculation of this rate, publicly accessible data is considered. Crypto investors consider the hash rate as an indicator of the health of the proposed cryptocurrency. A high hash rate encourages miners to mine for profits and shows a more secure network. Lower hash rates lead miners to leave the cryptocurrency. Investors do not consider that crypto profitable for investment.
Status and Active Addresses: Active addresses are the number of dynamic blockchain addresses in a particular period, like days, weeks, or months. The most popular method for calculating active addresses is finding unique addresses in pre-defined periods to compare the results.
Transaction Value: Transaction value shows the total value transaction within a predetermined period. For example, if investors sent 20 Ethereum transactions on the same day, worth $100 each.
Then the daily transaction value becomes $2000. It can measure the transaction value in terms of the protocol’s native unit (ETH) or fiat currency, like GBP or USD.
2. Project Metrics: Project metrics also play a crucial role in traditional market indicators resembling the stock market. Crypto’s whitepaper is the most critical project metric. The crypto developers issue whitepapers to outline the project, from its purpose, technology, prospects, goals, etc.
Investors want to know more about a project in a comprehensive and informative manner that is not dishonest, overly ambitious, or unrealistic. Another factor influencing the project metrics is the team or creator behind the cryptocurrency. The team’s record can assure their trustworthiness and guide the project’s success.
The whitepaper gives information about the following:
.Its aim with use cases
.Adopted technology like open source, etc
.The roadmap for new features and upgrades
The distribution and supply scheme for tokens or coins
2. Financial Metrics: Financial metrics cover all the information about the current asset trades, the previous record of the transactions, liquidity, etc. Other factors considered in the financial metrics are:
Market Capitalization is calculated by multiplying the current price by the circulating supply. It is a historical cost for buying a unit of crypto asset. Industry experts do not consider the market capitalization method the full proof method as it is practically impossible to calculate the total number of available tokens.
Investors believe that low market cap coins possess high growth potential. But in actuality, a high market cap represents high lasting power and more substantial infrastructure.
Liquidity and trading volume: Liquidity denotes how easy the crypto is to buy or sell in the market. In an illiquid market, the investors might face the problem of selling the asset at a fair price. They might have to wait for liquidity to increase or lower the asking rate.
Liquidity can be determined using the indicator trading volume that can be calculated. Charts are typically used to display the trading volume (mentioned in dollars or native units.)
Supply Mechanisms: In supply mechanisms, models like Stock-to-Flow (S2F) ratio are gaining popularity. Similarly, investors consider factors like circulating supply, maximum supply, and inflation rate while making informed decisions. Some projects limit the number of coins available to attract investors to believe that demand for new units will increase their availability.
Final thoughts:
If calculated correctly, fundamental analysis can show valuable insights about cryptocurrencies. While doing the trading, investors who can separate the true value and the market price using fundamental analysis tools can trade safely. Some insights can be given by technical analysis techniques as well. In the upcoming article, we will discuss various technical analysis tools.
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