Understanding Cryptocurrency-based Projects Part II - Analysing Project Price
For analysing project value, check out part I of this article here.
(Disclaimer: This post is for general information purposes only. It does not constitute investment advice or a recommendation or solicitation to buy or sell any investment and should not be used in the evaluation of the merits of making any investment decision. This post reflects the current opinions of the author and is not made on behalf of bitgrit or its affiliates nor does it necessarily reflect the opinions of bitgrit.)
Introduction
Last time we looked at how to evaluate if a project has inherent value — if it does something new and makes sense. This time we’ll be looking at factors that are directly tied to its price only. Depending on the type of investment you want to make, it’s important to know the mechanisms behind prices that aren’t tied to value. Safer investors want to buy big projects at a discount, while riskier investors are looking for the next “low-cap” gem.
In this article, we’ll be looking at:
1. Project Stage(Pre-ICO, Post-ICO, On the Rise, Stabilisation)
2. Tokenomics & Market Capitalisation
3. The Health of the Sector
4. Global Economy
Project Stage — Pre-ICO, ICO, On the Rise, Stabilisation
Looking at where the project is in its timeline is important when analysing the price of a project. The earliest stage of investment is the Pre-ICO (Initial Coin Offering), or the “seed round”. Although private investors have no access to this seed round, it’s important to understand that a large number of tokens are being sold at a discount to Venture Capitalists (VCs), a discount that could be as little as 20% or as large as a tenth of the price offered at the public ICO. [1]
Although a project with a lot of VC backing may seem appealing at first, future price movements are at the mercy of these VCs who stand to make a profit regardless of whether the price goes up or down. Conversely, a project with the lack of a seed round can also be a potential red flag, as it means it’s untested, hasn’t been reviewed by an experienced VC team, and may lack the funding it needs to create the product. This approach is marketed as a “fair launch” in many cases, but whether it’s truly fair to you or to them is something for you to explore.
The next stage is the ICO, where the token becomes available to the private investor. There are many mechanisms that have been devised to work out the token price and availability, some of which we’ll go over now.
- Dutch Auction
Investors offer to buy tokens at a price they feel comfortable with. Once the auction ends, starting from the highest bids, tokens are distributed down the list. The price of the token is set to the lowest winning bid in the auction, with higher offers getting a refund on their investment. This ensures that the price is uniform and doesn’t penalise those who risked more capital. [2] - “First Come, First Serve” Whitelist Auction
The price and amount of tokens are set by the project, and investors will have to be on the whitelist to access the sale. This is popular for many projects as, to get onto the whitelist, you are made to do marketing work and spread awareness for the project. This method is more project-centric than dutch auctions and can be seen as a potential red flag, due to its similarity to Ponzi schemes and decreased levels of funding. - Uncapped Auctions
Not as popular as they once were, uncapped auctions allow investors to invest as much as they wish, with the token price being calculated after the auction ends. One potential issue for investors is that the price of the token is only available after the end of the auction, and could run for a lot higher than anticipated, and is difficult to buy the token “at a bargain”. [3]
Tokenomics & Market Capitalisation
Tokenomics is a popular term used to refer to a token’s distribution between all involved parties, such as the team, partners, private and public sales, and reserves for the operation of the project in the future.
One common red flag utilised in many recent crypto “projects” (read: scams) is distributing an insanely high number of tokens, creating tokens that are worth several decimal places below a cent. The idea of this is purely psychological, a token moving from $1 to $10 seems like a larger jump than a token going from $0.0001 to $0.001. The reality is the amount of investment required for both of these jumps is exactly the same. Market capitalisation, or the total investment made in the project, is a much better indicator of the health of a project. High-cap projects offer price stability, while low-cap projects offer the opportunity for increased growth (and decline).
The Health of the Sector
Most projects are released on Ethereum. These projects also tend to have an ETH liquidity pool pair on Uniswap, meaning the price of Ethereum directly affects the price/market cap of the project itself. This is easily proven, as whenever Ethereum drops (or Bitcoin for that matter), the cryptocurrency space as a whole goes down with it. Knowing whether Ethereum is in a “bear” or “bull” market is important to reference information, as a project with decent fundamentals could be experiencing a temporary price dip due to this influence.
(Note: Bear markets refer to a period when the volume of selling is higher than the volume of buying. Bull markets are the opposite.)
Keep in mind that there are certain risks involved in buying into project tokens during bear markets, as a dip in any layer one cryptocurrency represents a dip in confidence at the very foundations of the crypto space. One such dip saw Bitcoin lose 65% of its value in one month in 2018.[4]
External Factors / Global Economy
What do cryptocurrencies really do? The gaming, art, social and financial aspects of crypto are all yet to be adopted widely, paling in comparison to their mainstream counterparts. Bitcoin, or “digital gold” still only has a quarter of the market cap of actual gold, and the decline of the S&P500 results in the fall of bitcoin more times than not (which is very much unlike gold.)[5] What happens in the world, and therefore stock markets will have an effect on the price of cryptocurrencies. One good example of this is during 2021, where the combined market cap of cryptocurrencies almost doubled (187.5%).[6] One factor that analysts have attributed to this rise is the longer amount of time spent at home and online, as well as more people using their money for cryptocurrency investment as recreational spending declined due to quarantine measures. Knowing what’s happening in the world, analysing its effect on crypto, and making a prediction is a great way to avoid reactive investment that’s based on short-term price swings.
Watching out for publicly listed companies making a serious commitment to blockchain/cryptocurrency-based initiatives is also a great way to get into a particular sector of crypto early. One recent example is how the world’s first NFT auction at Christie’s London acted as a catalyst for the NFT boom last year.
This brings us to the end of Part II of Understanding a Cryptocurrency-based Project. Together with Part I of this article, you’ll now have the basic equipment for the modern digital gold rush. It’s now up to you to sift through the sand to find the treasures.
References:
[1] https://techcrunch.com/2021/12/05/vcs-eye-investment-in-polygon/
[2] https://corporatefinanceinstitute.com/resources/knowledge/finance/dutch-auction/
[3] https://medium.com/tokensmarketplace/ico-school-4-what-types-of-ico-auction-exist-fa51fdaf9a0
[4] https://en.wikipedia.org/wiki/Cryptocurrency_bubble
[5] https://www.reuters.com/business/finance/goldman-sachs-says-bitcoin-will-compete-with-gold-store-value-2022-01-05/
[6] https://www.weforum.org/agenda/2022/01/top-cryptocurrencies-performance-2021/
