What is fundamental analysis in crypto trading
Fundamental analysis is one of the key aspects of everyday life for every trader and investor who is fascinated with cryptocurrency. This type of analysis involves taking a deep dive into everything about a cryptocurrency token. The primary goal of undertaking any fundamental analysis is to reach a conclusion about whether or not an asset you are going to invest into, is worth it.
What is fundamental analysis
Fundamental analysis or FA for short is an approach that is used to evaluate the intrinsic value of an asset. The main goal of FA is to combine internal and external factors related to a certain asset to identify whether it is worth investing in. The information provided from fundamental analysis can serve as a leverage to strategically enter or exit positions.
In a traditional way, the FA approach takes business metrics to figure out the real value of an asset. The indicators that are used in traditional FA are as follows:
- Earnings per share — how much a company makes for each share.
- Price to book ratio — investor evaluation of a company versus its book value.
Still, when we talk about FA for cryptocurrencies, we must tweak the approach a little bit.
Crypto fundamental analysis difficulty
The first difficulty with FA for crypto is that cryptocurrency projects can’t be evaluated as traditional businesses. Due to the decentralised nature of cryptocurrencies, traditional fundamental analysis methods do not actually work. However, there are metrics and data you can explore when carrying out FA. So, let’s start with the very basics.
On-chain data
The first thing you need to do is to obtain data for your crypto project of choice. I recommend using CoinMarketCap or CoinGecko when starting your FA. The straightforward on-chain analysis can provide you with a lot of information about a cryptocurrency.
Start with transaction count. It’s a good measure of activity within the network. However, you need to be cautious when handling this data. It might involve funds being transferred between the same wallets.
Transactional value is the second parameter you should review. This indicator informs us about the volume of funds that have been transferred within a certain period of time.
The number of active addresses in the Blockchain can indicate whether the Blockchain is still alive and running. The approaches of how to calculate these numbers may vary. The most popular method is to count the number of senders and receivers of each transaction during a certain time period.
Do not forget about the fees paid in the Blockchain. It can tell you a lot about the demand for block space. They might look like auction biddings — the more bidders, or in our case miners, you have on the Blockchain, the better the blockchain is.
The raw data that you obtain from CoinMarketCap and CoinGecko will certainly be useful. What you also must take into consideration is the hash rate and the amount staked.
Hash rates and amount staked
Hash rate is used to measure network health in Proof of Work algorithm cryptocurrencies. The higher the hash rate, the more difficult it is to successfully launch a 51% attack. The increase in hash rates also indicates the growing interest in mining. At the same time, the lesser the hash, the lesser the number of miners.
The key factors that might influence the mining process are:
- current price of the asset
- number of processed transactions
- fees
The amount of stakes is related to the Proof of Stake consensus of cryptocurrencies. The more stakes you see on the network, the better the chances that this network will be valued more in the future.
Now, when we have finished examining on-chain data, we must look into project metrics.
White paper analysis
A white paper on cryptocurrency can be defined as a company’s business plan. It contains all the information you need before deciding whether to invest in a project. Ideally, any good white paper contains the following information:
- The technology that the project uses
- The use cases of the project
- The roadmap of future upgrades and new features
- The supply distribution scheme
- The consensus protocol
When you have sufficient information on the goals and technologies behind the project, you should start digging up information on the project team.
Team of developers
If there is a specific team behind the project you are looking to invest in, then you must read about them. The track record of team members should reveal a lot about their skills and experience. The point here is that you need to determine if the team has enough developers with the needed expertise to pull off the project.
One more thing that you need to identify when analysing the team is their reputation. You don’t need to have coins with a dubious reputation in your wallet.
But what if there is no team? In this case, there is usually a public Github page for the project. You will need to look at the developer community of the project. See how active it is.
Competitors
Do not forget to investigate the competitors of the project you analyse. A white paper usually gives you an understanding of what audience the crypto project is targeting. Identify this audience and look for other projects which also seek the approval of the same audience. Your first project of choice might be appealing but only when you compare it with other similar projects, will you be able to see the weaknesses.
Tokenomics
Another thing that you need to pay attention to is tokenomics — whether a token has real utility. This utility is also something that the majority of the market must recognise and evaluate.
One more thing about tokenomics is to learn how the funds were initially distributed. Was it through ICO, IEO or by mining? The white paper should clearly provide this information. The initial distribution might provide some idea of any risk that exists on the project blockchain.
Financial metrics
Well, when you have gone through all non-financial metrics that the project has to offer, it’s time to get down to its financial metrics.
The first thing that you need to pay attention to is the market capitalisation of your project. The easiest way to calculate the market cap is to multiply the total circulation supply and the current price. However, capitalisation might be misleading. In theory, a project can have ten million coins with the trading value of one dollar for each coin, but most of these coins might just be “dead”. Meaning that they exist, yes, but nobody develops, sells or buys them. For now, they are useless.
Nonetheless, market capitalisation is used extensively to figure out the growth potential of networks.
Liquidity and volume are two other important financial indicators. Liquidity means how quickly and easily you can exchange your asset for another one. Trading volume helps to determine liquidity. You can see the trading volume from the charts for a certain time period. The more volume you see, the better the liquidity.
Supply mechanism is the most interesting financial indicator used in fundamental analysis. Some projects reduce their coin supply over time while others, on the contrary, create new coins over time. In both cases, it should affect the price of coins and you must determine whether it’s good or bad for your overall investing strategy.
Done correctly, your fundamental analysis can provide essential insights into the project you are analysing. Do not forget that the true value of crypto is hard to calculate and the market might sometimes be wrong.
Fundamental analysis is just a way of predicting the future value of an asset. Sometimes an asset that might have been appealing in the past will not be the same in the future. That’s just the reality of any trader or investor’s life.
