In traditional stock markets, fundamental analysis is a common tool to determine a company’s intrinsic value and growth potential. In the fast-paced world of cryptocurrencies, the application of fundamental analysis is just as important—if not more—given that crypto prices are largely and relatively more affected by daily occurrences, news, and developments surrounding a particular project.
In this article, we explore how to carry out fundamental analysis or ‘FA’—as it is popularly called—and the importance of fundamental analysis in the crypto market. We also discuss how fundamental analysis can be used to engage in regular crypto-trading activities, identify undervalued assets (or gems), and evaluate a crypto project’s overall health and growth potential. Additionally, we will look at key metrics for analyzing crypto projects.
Reading this article will lend you a deeper understanding of how to conduct proper fundamental analysis in the crypto market, which will in turn help you to make more informed and profitable investment decisions.
What is fundamental analysis and why is it important?
Fundamental analysis is a method of evaluating an asset by examining its basic properties and getting conversant with the details of a project, including its use cases and future developments.
In the stock market, fundamental analysis is used to determine a company’s intrinsic value, that is, the true value of a company’s assets, liabilities, and future growth prospects. This involves analyzing the company’s financial statements, including the income statement, balance sheet, and cash flow statement. By analyzing these statements, investors can assess a company’s profitability, liquidity, and solvency.
n the cryptocurrency market, fundamental analysis is applied similarly but with some key differences. Notably, the lack of regulation and oversight in the crypto market particularly makes fundamental analysis a necessity for investors. Unlike the stock market, there is no central authority or agency that regulates the crypto market; meaning there is a higher risk of fraud. Therefore, investors need to conduct thorough research and analysis to determine the legitimacy and potential of a crypto project.
The absence of sufficient historical data is another trait of the crypto market that makes fundamental analysis a necessity. In contrast to the stock market, the cryptocurrency market is relatively new and has a limited track record. This makes it difficult for investors to fully assess the long-term prospect of crypto projects. Though with the establishment of crypto asset data platforms, including Coinmarketcap, access to and availability of historical data are less difficult today.
But by conducting fundamental analysis, investors can understand the underlying standards of a crypto and blockchain project, including network activity, team credibility, developer activity, and tokenomics among others to aid in making informed investment decisions.
3 Major Things to Note in Fundamental Analysis
As a cryptocurrency investor, there are important metrics you should know in order to properly carry out a fundamental analysis of any crypto project. On-chain metrics, financial metrics, and project metrics are the 3 key metrics you need for a proper fundamental analysis of a crypto project..
1. On-chain Metrics
On-chain data refers to the information stored on the blockchain. Metrics such as the size of the blockchain, the number of smart contracts, and the number of decentralized applications (dApps) can provide insight into the level of adoption and usage of a particular cryptocurrency. High on-chain data indicates a healthy and growing network, which can be a positive sign of a crypto project’s long-term potential.
The three most basic metrics in on-chain data are hash rate, active addresses, transaction value, and fees. Let’s take a closer look at how this data can provide trading insights.
The hash rate is the combined processing power used in mining to perform calculations on a proof-of-work (PoW) blockchain. The hash rate is estimated from publicly available data but the true hash rate is never really known. Many cryptocurrency investors see the hash rate as proof of the health of the associated cryptocurrency. Noteworthy is that the higher the hash rate, the greater the incentive to mine profitably and the more secure the network becomes. Calculating an individual hash rate also helps miners determine their profitability.
When the hash rate starts to drop, it indicates that miners are finding the cryptocurrency unprofitable, causing miners to capitulate. A capitulation usually occurs when the market goes down and miners are pressured to sell their hardware. A lower hash rate indicates a loss of investor interest. For instance, bitcoin hashrate increased from around 60 million tera hashes per second (TH/s) in January 2020 to over 150 million TH/s in January 2021. This indicated an increasing confidence in the profitability of mining bitcoin among miners. Extensively, increase in hashrate also shows a high demand for BTC from investors. It further signifies miners’ confidence in the long-term prospects of any cryptocurrency.
Transaction Value and Fees
Fundamental analysis also prioritizes evaluating trade value over technical analysis. A consistently high transaction value indicates that the crypto asset is in steady circulation.
Fees reflect demand on the blockchain or how many transactions need to be added to the blockchain as quickly as possible. Each cryptocurrency can have its unique transaction fees. For example, Ethereum gas is an example of a transaction fee. Evaluating the fees paid over different periods can give you an idea of how secure your tokens or coins are. Transaction fees will naturally increase over time while the block subsidy or block reward decreases relative to mining difficulty. If the rewards are not adjusted, cryptocurrency miners will start working at a loss and start abandoning the blockchain.
Status and Active Addresses
Active addresses are blockchain addresses that have been active for a specific period. One of the simplest ways to deduce active wallets is to count the total number of sending and receiving addresses over different periods. Another approach is to count the total number of unique addresses over a predefined period and compare the results. Increasing active addresses could signify high interest or adoption of the crypto project. This could also imply that such a project is a solid one and might do well in the future.
2. Financial Metrics
The goal of fundamental analysis is to generate quantitative value for investors to analyze an asset’s prospects. Evaluating cryptocurrencies from a financial perspective involves understanding an asset’s trading conditions, including its liquidity, trading volume, and market reactions. All of these have proven to be valuable crypto fundamentals, especially when evaluating prospects before creating an investment plan.
Market Capitalization (Market Cap)
Market cap is a proxy for a crypto project value. It is calculated by multiplying the current price of a crypto asset by the supply of the coin in circulation. You can use Coinmarketcap or Coingecko to track the market cap of your favorite cryptocurrency to get an idea of how popular that coin is and how much investment has gone into the project.
Meanwhile, the market cap can give a misleading valuation if you don’t consider other metrics like liquidity. After all, a poorly circulated altcoin with a total supply of 50 million and a handful of transactions exchanging for $1 doesn’t mean every one of those tokens is worth $1.
Liquidity and Trading Volume
Liquidity measures how easy it is to buy and sell an asset. Liquidity is strong when a crypto asset can be bought and sold quickly without drastically changing its market value. A liquid cryptocurrency will have an order book with many buyers and sellers waiting to be filled.
On the other hand, trading volume is a useful indicator of a coin or token’s ability to maintain momentum. This metric shows how many units of an asset have changed hands over a given period. When the uptrend in the price of an asset is supported by high trading volume, the price rally is more likely to continue. Conversely, a price move without significant trading volume may just be a red flag. Hence, it is pertinent to watch the liquidity and trading volume of any asset you intend to invest in.
The circulating supply of a cryptocurrency is the total number of coins in the active supply that is available to the public. Unlike total supply or maximum potential supply, circulating supply is not static and will change over time as tokens can be burned. Burning a token refers to the process of taking a certain volume of crypto out of circulation forever. The common method of token burning is sending them to a dead wallet – a wallet that cannot be accessed.
3. Project Metrics
Project metrics take a qualitative approach to evaluating the performance of any crypto. They focus on internal and external factors including, the value proposition of a crypto project, how it works, and use cases.
The crypto project’s website will feature a list of its team members. A close examination of the team profile and track record can give a hint of where a particular project is headed. Past failures, experiences, and successes of the founding team should always be well considered. You can likewise consider any early supporters, partners, or advisors to the project to gauge its credibility.
A cryptocurrency whitepaper is a technical document that describes the purpose and workings of a project. It is the most important project file and should contain at least the following information:
- Blockchain technology solutions
- Use cases
- Planned features, developments, and upgrades
- Token economy and sales information
- Team information
It is your responsibility as a potential investor to carefully review a project’s whitepaper or litepaper, with lots of critique. Also, be alert to third-party reviews of the project. Here, a thorough Google search—and yes, ChatGPT—can be your friend. Other vital information may not be in the public. So ensure you do your own research (DYOR) beyond readily available sources.
Most crypto products have roadmaps for the future, showing a timeline for testnets, releases, and new planned features. The roadmap should give a clear overview of future developments. Use the roadmap to measure the milestones the project envisions and how they are on course to achieve each milestone. A well-defined roadmap could imply that the project is futuristic and sustainable whereas a poor roadmap might just be another red flag you shouldn’t ignore.
Fraud and scam are prevalent in the cryptocurrency market. And where fraud or scam is not intended by crypto project founders, promoters, or marketers, a common problem is that the crypto project may just be simply weak or not feasible. Fundamental analysis, popularly known as ‘FA’, is an important tool in the cryptocurrency market that allows investors to gain a deeper understanding of a project’s growth potential and intrinsic value. This analytic concept encourages crypto investors to be thorough researchers and great risk managers.
But it is important to remember that no one method of analysis is foolproof and past performance is no guarantee of future results. Therefore, it is imperative to combine other concepts, including technical analysis, with fundamental analysis in order to get the best out of the highly volatile, risky, and uncertain crypto market.
We hope this article has given you a solid understanding of fundamental analysis and how it can be used to evaluate crypto projects.
Credit: Ndianabasi Tom
A crypto journalist and content writer who has been talking about cryptocurrency and blockchain technology since 2018, Ndianabasi is a Writer at Crypto Asset Buyer (CAB).
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