Cryptocurrencies: How to separate the good from the bad
Here at Lunafi our goal is to help make cryptocurrencies easier for the everyday person. There are tons of cryptocurrencies out there and sometimes it’s hard to differentiate the promising from the not-so-promising. You’re not just investing in companies, you’re investing in the software and protocols that have the potential to be the backbone of our society’s technological infrastructure in the next decade or so.
In this post, I’m going to go over our approach to critically assessing a cryptocurrency. If you’re looking for advice for day trading, this probably isn’t for you. It’s nearly impossible to predict short-term price movements, instead this guide will give you the tools to do your own research to hopefully find promising long-term projects.
I’ll break up this guide into three sections:
- Part 1: Looking at the numbers
- Part 2: Looking at the product
- Part 3: Looking at the team
First off: Disclaimer, I’m not a financial adviser and this is not legal or financial advice. This is simply the approach that we take to assessing cryptocurrencies. Considering this is a highly volatile market, you should never invest more than you’re willing to lose.
This diagram is a cheat sheet of everything we’ll cover in this post:
Where to find cryptocurrencies?
CoinMarketCap is by far the most popular tool right now for finding cryptocurrencies. They list virtually every coin out there and have lots of good data and links for more information.
Another good option is CoinGecko. Apart from listing each coin they also provide ratings for public interest, developer activity and other metrics.
The golden rule: don’t buy the hype!
There is a LOT of money to be made by building hype for a coin. Be skeptical of everything you read online. There are tons of fake twitter accounts, fake reddit accounts, fake blogs, and sponsored news articles to make it appear as if a cryptocurrency has a surge in interest when in reality it’s completely orchestrated by only a few people who are trying to pump the price up to make a quick profit. Just like the stock market, you can make short-term gains off some hype but it’s not a guarantee for long-term growth. Be skeptical and do your own research.
Part 1: Looking at the numbers
Circulating supply
Price has a LOT to do with circulating supply, which is the total number of a certain coin currently in existence. Let’s look at the top 3 coins right now by market cap:
- Bitcoin is #1, price $14,368
- Ethereum is #2, price $1,381
- Ripple is #3, price $1.97
The price differs because there are different circulating supplies for each.
Total supply vs. circulating supply
Total supply isn’t the same as circulating supply. Circulating supply is the number of coins that exist right now, total supply is the most of a coin that will ever exist. For example, there will only ever be 21 million Bitcoins created so its total supply is 21 million. If a coin has a low circulating supply right now but a massive total supply, that could change its potential price point over time as more become available so take that into consideration.
Circulating supply vs. market cap
This exercise can help determine how much room for growth a coin has. Ask yourself, if a coin suddenly became the #20 largest by market cap, what would the price be? We can calculate the market cap of the coin with the following formula:
Market cap = circulating supply * price
Inversely, we can calculate what a coin’s price would be at any hypothetical market cap with the following:
Hypothetical market cap ÷ circulating supply = hypothetical price
For example, as of writing DigitalNote (XDN) is #100 largest coin by market cap and has a circulating supply of 6,893,991,066 coins. Currently the #20 largest coin is RaiBlocks with a market cap of $3,255,714,560. If DigitalNote suddenly jumped from #100 to #20 and had the same market cap as RaiBlocks, we can calculate what it’s price would be:
$3,255,714,560 market cap ÷ 6,893,991,066 coins = $0.4722 price
Right now DigitalNote is at a price of $0.053094. So if it jumped from #100 largest by market cap to #20, that would be a 8.76x increase in price. That’s pretty good! Now it’s up to you to decide if it really could reach that market cap or not.
Current market cap rating
This metric is pretty basic, but it’s still an easy and quick way to assess a coin. If a coin is #5 right now, how much room does it really have to grow? Adversely, if it’s #400 right now, there’s probably a reason nobody’s buying it. Maybe it’s just been released and you’re lucky enough to get in early, or maybe it’s a total flop without any chance of success in the future.
Pre-mined and reserved coins
Most cryptocurrencies are created through a process called “mining”. Some teams “pre-mine” a number of coins, meaning they take a number of coins and automatically reserve them for the team. This can be good if the price goes up because it can fund the team and ensure they have resources to continue development and marketing, but it can also be a red flag. If a team takes 45% of all coins, that’s probably a get-rich-quick scheme for them and you should avoid it. If 10% are pre-mined, perhaps that’s acceptable if the team puts it to good use. Some successful coins which included a pre-mine are Ripple, Cardano, Stellar and NEM. Many coins have had success without the need for any pre-mined amount.
Daily volume
Volume is how much money was traded in total in a day, represented in its U.S. dollar amount. Don’t be fooled, there are very wealthy people out there manipulating the markets every day by strategically moving around massive amounts of money. If a coin has a low daily volume (<$10 million or so) its price can easily be manipulated by a few wealthy investors (a.k.a. “whales”). A high daily volume shows there’s a lot of interest and trading going on that day for a coin, and it’s harder for a few individuals to manipulate the price.
Part 2: Looking at the product
White paper
Every project has a white paper available on their website, a scientific paper describing the project’s goals and design. The Bitcoin white paper started it all and it’s still open for public viewing. This should really be an impressive paper, read it and ask yourself if it seems like it was written with passion and intelligence or with haste. If a project doesn’t even have a white paper, that’s a bad sign.
One important thing to note is that you can buy a white paper on sites like fiverr.com to make a scam seem legitimate, so they can’t always be trusted. This is an example of a search for “white paper” on Fiverr:
You can use tools like TurnItIn.com to automatically detect plagiarized content.
Market fit
This concept applies to any new product or technology: it should have its place in the market. Does the coin solve a real problem in an existing market? Does it create an entirely new market?
One example we can look at is something like HempCoin (THC). It’s claim is that it’s a cryptocurrency for the cannabis industry to facilitate transactions between hemp farmers, distributors, and dispensaries. It’s built on the code of Bitcoin, but it’s only for cannabis. Why does this industry need its own currency? Why can’t they just accept something like Bitcoin or Litecoin? Does every industry need its own coin? Do I need a special coin just for my bath products? Probably not, so these types of coins don’t typically seem too promising unless they have a lot of industry contacts and a real reason to exist.
Real world use
Blockchain technologies are still very much in their early days, we’ve yet to see their full potential on a large scale. Many cryptocurrencies are valued at a high price because of the speculation of what they will someday achieve, but some like Bitcoin and Ethereum are actually being used by corporations and accepted as payments by real vendors, and their prices reflect that. Any cryptocurrency that has been adopted and is being used for what it’s meant to do is a big sign that it has a promising future.
When considering tokens like Binance Coin (BNB), one thing to note is the difference between utility tokens and security tokens. A security token is essentially just a stock, it’s an investment in a company and nothing else. A utility token is an investment in a company but the token is actually used for something. In the example of Binance Coin, it was used to raise funds for the company but the coins can actually be used for things like paying fees on the Binance platform, so the coin has real world use. Utility tokens will rise in price as the platform that uses them increases in use because it drives demand, so that’s great to see.
Roadmap
Every good project will have a roadmap front and center on their website. If they don’t have a publicly available roadmap, it’s probably not worth your time. Have they met their milestones so far? How legitimate or attainable do their future milestones appear?
Falling behind schedule is an unfortunate truth of software development so that’s not always a bad sign as long as progress is being made, but a team should be working on the right things. Is creating a store to sell branded swag really the best use of resources?
Looking at the team
Developer activity
Some teams have more marketers than engineers. You’re purchasing technology, not hype, so that’s not a great sign. These projects should have active developer teams who are constantly improving their code. It’s easy to take a look at what an engineer team has been up to since all of the code is open source and public.
All code will be on GitHub.com where pretty much every open source project lives. The easiest way to find the code for a project is just to run a Google search for the name of the coin with “github”, so for example “Bitcoin github” will find you Bitcoin’s code. GitHub has tools that let us see what’s been going on if we click on the “Insights” tab.
Open source vs. company-backed
Many cryptocurrencies like Bitcoin and Vertcoin are entirely open source and maintained by a community of passionate volunteers or individuals instead of an existing corporate entity. If it’s open source and succeeding that shows that there’s real interest by individuals. If it’s backed by an existing company that can be great if they’ve got experience and industry connections, for example in the case of Ripple being backed by a company has been a driving factor of its success. Do your own research and look into the company’s history and its founders.
Team’s track record
Most projects will list their team members on their website, try Googling around and see if you can find any other material on them. Do they have a LinkedIn with a history and lots of contacts, or is it brand new with just a few friends? Do they even exist on LinkedIn? Try Googling their name with “scam” included to see if they’ve been involved in any scandals in the past. The Tezos ICO is an example of a well-known scam.
Many coins are tokens that are used within some industry, if that’s the case partnerships with other companies can be a big deal. For example Waltonchain (WTC) is using tokens on the blockchain to track where physical goods have been and improve transparency of the supply chain industry. Since this is very specific, seeing WTC have real-world partnerships with businesses in this industry is a great sign for its future.
Funding
Engineering is expensive, and most teams pay for marketing as well. Because of this, looking at a team’s funding can be a good indicator of how much headroom they have. Did the team get funding through an ICO? If so, they might be sitting on a mountain of (digital) cash.
One example is Lisk, which raised the equivalent of $6 million in Bitcoin during their ICO. That same amount of BTC is now worth approximately $235 million. That’s a lot of money, they’ve got plenty of funds to hire a good team and keep working on their product for years to come.
Social media
There’s no denying that the majority of exposure to new technologies and products these days is through places like Twitter and Reddit. Find a coin’s Twitter account, do they have a lot of followers? If not, maybe you’re lucky enough to find it early! If they do have a large following, that’s a great indicator that there’s real public interest.
Search for how many people are talking about a coin, search Twitter for a hashtag or a keyphrase. Of course, don’t just check how many tweets include a hashtag of a cryptocurrency but also the content. If everyone on Twitter is saying horrible things about a coin, there’s probably a reason.
Wrapping up
Whew! If you’ve made it this far, hopefully you’ve learned a few things. That was a lot of information, hopefully you’re feeling more confident in doing your own research and making informed choices.
If all of this seems overwhelming we’re here to help you out. You can sign up for our newsletter at Lunafi.com where every week we post highlights of our favorite cryptocurrency projects (both safer long-term and riskier short-term choices), the latest crypto news, and one cryptocurrency that you may not have heard of in our Coin Spotlight. Here’s an example of a newsletter from January 15th 2018.
If you’re interested in this type of content, you can follow us on Twitter, Facebook, LinkedIn and reddit.
