Fundamental Cryptocurrency Analysis (Part 1): Value Investing

What differentiates a valuable coin from a worth-less coin?

In the case of Crypto-asset Value Investing we need to combine classical company stock value investing with Venture Capital Investing with Foreign Exchange Investing so we will analyze briefly these approaches, then combine them with extra factors appearing in the crypto arena.

Traditional value investing in company stocks, according to Benjamin Graham [1], must be focused on the following 3 factors:

1. Cash Flow: Quality ratings regarding Earning and Dividends: How much dividends is distributing the company or how much can you expected to get in dividends in the future? Also look for avoidance of declining or negative earnings in the last years. Checking if the stock is currently paying dividend is a method of profiting while waiting for another investor to join you as stockholder, sometimes the wait period before the stock skyrockets can be long.
2. Business Sustainability: Low debt load companies, i.e. companies with a Total Debt to Current Asset Ratio that is small: How can the company deal with an existing or new weak economy with tight lending? Can the fully repay their debt? Can the refinance their debt? Similar metric is Current Ratio: current assets divided by current liabilities.
3. Bargain: Consider price to earnings per share (P/E) ratio. We are looking for a good value at a bargain price, so we need to screen this metric. Also, price to book value (P/BV) is very useful because involves assets minus liabilities so is less misleading than earnings alone.

In the Venture Capital universe of technology businesses, the following factors have been empirically proven very important in determining the future success of the tech venture:

1. Expected Profitability Factor: How long before the business if profitable, for how much time time and how big is the profit?
2. Technological Opportunity Factor: How the underlying sciences and technologies are ready for the kind of advancement proposed? Other authors focus more on technological market context to analyze if the market can assimilate and commercialize the innovations proposed.
3. Development Risk Factor: How difficult is to complete the development of the product on time, within budget and satisfying the specifications? The team building the technology can be including as a core development variable.
4. Appropriability Conditions Factor: this includes the debate between classical intellectual property (IP) versus open source approaches for software or hardware development. Gans and Stern [4] identifies that appropriability can be achieved either through strict controls of IP such as patents; or via execution, developing rapid time-to-market capabilities that can be leveraged for profit. How exclusive is the technology developed?

Now, we will add empiric factors influencing on Foreign Exchange Rates of National Currencies [5]:

1. Inflation and Interest Rates: government spending causes inflation and they also use interest rates to control inflation (high interest rates) or accelerate economy (low interest rates).
2. Country’s Balance of Payments: the same as Earnings for companies, if the country is cashing in due to exports more than is expending in imports, is an indicator of a good public administration. Similar to this metric are the Terms of Trade, the ratio of export prices to import prices, that improves if its exports prices rise at a greater rate than its imports prices.
3. Government Debt: same Debt to Assets Ratio, a closer look is done for country to assess if their finances are sustainable and for how much time. Usually government have much more assets than a private company at their disposition, so they are expected to default their debt only in very rare situations. This is also related to metrics of Political Stability.

In the case of Crypto-currencies and crypto-assets we can normalize some of the following metrics that are analogous to established metrics we have seen for Stocks, Venture Companies, and Foreign Exchange Rates:

1. Investor and Community Value: #Followers in Twitter.
2. Engineer Community Value: #Stars (favorites) in Github.
3. NVT Ratio: similar to P/E ratio, as a service the crypto network has some earning, we are comparing this with the market capitalization of the coin [6].
4. Security: Hashrate Power, Block time, Audits, #Serious Bugs Fixed. #Advisories in https://cve.mitre.org/ (good, less scrutiny means more obscurity).
5. Markets: Exchange Volume, Liquidity (Spread), Order Book Depth , Implementation Shortfall.
6. Decentralization: Gini Index for Mining Power and Gini Index for Coin Holding [7].

As an example of Scoring that can be used for Value Investing we will compile information from CoinMarketCap [8] to asses the following metrics:

1. Speed of Money: related to NVT ratio we compute the ratio between the Daily Volume in USD and Market Capitalization in USD, of the coin we are analyzing. A high speed is indicating that there is a lot of current interest in the coin (high trade volume) but the market is still underdeveloped (market capitalization is not comparable in size). We called a normalized 100-point score of this metrics as Market Hype. For example we can use daily trading volumes. If some players are pumping and dumping the coin, this alone is not a good metric of future ore long-term value.
2. Search Engine Trends: using search engine trend analytics we can assess the general interest on the coin. We developed a normalized 100-point version of this metrics using weekly trends and we called it Web Hype. If some players are promoting the coin with huge budgets, this alone is not a good metric of future ore long-term value.
3. Open Source Developer Activity: as we mentioned earlier, we will analyze how many developers in GitHub marked aa favorite the coin project. We will test a normalized version of this metrics for commits on a 4 week period. We called the normalized 100-point metric Tech Hype. If the coin has a lot of software development but has no public interest nor trading activity, this alone is not a good metric of future ore long-term value.
4. Final Score: integrating all three 100-point scores on a single 100-point score give us a balanced coin scoring including market, web and tech hype, on different time scales such as daily, weekly and monthly.

As an example will compute the dimensional and final score for top market capitalization coins [8]. We consider that summing up three different dimensions for the final score gives a wide idea of the impact of the coin and is more difficult to game than just using one dimension. We did not include Tether (USDT) because is specifically pegged to USD and has a lot of volume based on being equivalent to US dollar.

We present top 10 coins for Market Hype (January 17th, 2018):

We present top 10 coins for Web Hype (January 17th, 2018):

We present top 10 coins for Tech Hype (January 17th, 2018):

Finally, we present top 20 coins per final Coin Score (January 17th, 2018):

As a conclusion, we can argue that we found an interesting scoring that considers both current utility value as observed in exchange and network fees that are summarized in Market Hype, and also for future expected utility value as reflected on Tech and Web Hype [9].

Sources:

[1] Graham, Benjamin, 1894–1976. (1959). The intelligent investor: a book of practical counsel. New York :Harper.

https://cabotwealth.com/daily/value-investing/benjamin-grahams-value-stock-criteria/

[2] Key success factors for technological entrepreneurs’ R&D projects

http://ieeexplore.ieee.org/document/1317177/?part=1

[3] The sources of innovations — looking beyond technological opportunities http://www.tandfonline.com/doi/abs/10.1080/10438590410001628143

[4] Endogenous Appropriability By JOSHUA S. GANS AND SCOTT STERN*

https://www.aeaweb.org/conference/2017/preliminary/paper/rFkBybAT

[5] The Theory of Exchange Rate Determination

http://www.nber.org/chapters/c6829.pdf

[6] CoinMetrics: Network Value to Transactions Ratio https://coinmetrics.io/nvt/#assets=btc

[7] Quantifying Decentralization https://news.earn.com/quantifying-decentralization-e39db233c28e?gi=c22088e8f4c2

[8] CoinMarketCap http://coinmarketcap.com

[9] The Crypto J-Curve https://medium.com/@cburniske/the-crypto-j-curve-be5fdddafa26

Originally to be posted at CoinFabrik’s Blog https://blog.coinfabrik.com/

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any employer of the author. Examples of analysis performed within this article are only examples. They should not be utilized in real-world analytic products as they are based only on very limited and dated open source information. Assumptions made within the analysis are not reflective of the position of any employer of the author.