While technical analysis (TA) is a very universal tool for assessing whether a particular asset is undervalued or overvalued and can thus be applied in crypto, forex, stocks or even commodities trading, fundamental analysis (FA) is rather unique for every category.
The whole process of crypto fundamental analysis includes research and evaluation of numerous different metrics, which can be divided into three parts. In the first two parts the investor has to go over Blockchain metrics and Project metrics. These two aspects of cryptocurrency fundamental analysis are rather unique for the crypto world, while the third aspect - Financial metrics is similar to fundamental analysis used in equity markets.
Today’s blog will focus on financial metrics you have to assess in order to evaluate a crypto project, but will also briefly outline what you can expect from the following two parts in the sequence. Let’s get right into it!
What is Fundamental Analysis?
As already mentioned, it is a research of factors that affect the value of a crypto coin. Its end goal is to give investors an insight into the intrinsic value of an asset. Based on the derived conclusion, investors get an insight into whether a particular coin is valued fairly, undervalued or overvalued. In its essence, a conclusion that a particular project is undervalued acts as a buy signal and vice versa.
What is the Problem with Crypto FA?
The problem is that most crypto projects can’t be evaluated the same way as a business. For instance, the most popular cryptocurrency - Bitcoin, is in some sense more closely related to commodities. Even when it comes to more centralized cryptocurrencies that are similar to traditional businesses, there just isn’t that much data to assess. Since the crypto industry doesn’t have to (at least yet) comply with all types of regulation publicly traded companies are subject to, crypto projects don’t have to disclose all of this financial information.
It’s important to note that individual investors can come up with different conclusions looking at the same information, meaning that forecasting with fundamental analysis can be very subjective. On top of that, the majority of fundamental analysis relies on past data, which should remind us that any conclusion needs to be taken with a grain of salt. The solution is to also perform technical analysis in order to gain another insight into ‘fair’ valuation and come up with the final conclusion by combining the two analyses. Because lots of cryptos are still largely sentiment-driven, it is recommended to also keep an eye on the sentiment. Thanks to our AI Sentiment Tool you don’t have to do any of the hard work when it comes to sentimental analysis, as our algorithm gathers all the important data and gives you a price prediction on numerous timeframes.
What financial metrics are relevant in Crypto FA?
Financial metrics are related to a cryptocurrency’s economics. Many of these are quantitative factors, so they’re easier to find and measure. As already mentioned, some of them are also used in evaluation of stocks. These are often the first things investors will look for, but it’s important not to stop there and also look at blockchain metrics and project metrics (which will be covered in the following articles).
The first thing investors look at in crypto fundamental analysis is a coin’s Market Capitalization. You can look up the market cap of any project at CoinGecko or CoinMarketCap. It is calculated by multiplying a crypto’s current price by its circulating supply. Market cap is used to determine the potential for growth. Projects with smaller market capitalizations most likely have bigger growth potential relative to projects with higher market capitalizations, though high market caps can also point to stronger infrastructure and lasting power.
Keep in mind that market capitalization can offer deceiving valuations, if investors don't take into account liquidity and volume. Liquidity measures how easily you can buy or sell an asset based on how many buyers and sellers are waiting for their order in an order book to get filled. This financial metric can be a little harder to define, but it is generally measured with the bid-ask spread (the gap between the highest bid and the lowest ask). The lower the spread, the higher the liquidity.
How does that help with evaluation of a crypto? In simple terms, you want to invest into liquid projects, so you’re able to sell your cryptos at a ‘fair’ price. If the project is illiquid, you might have to significantly lower the ask in case you wanted to liquidate your assets quickly or wait a long time until either liquidity or price increased, so you could sell at the desirable price.
Another indicator that can help us determine liquidity is Trading Volume. Because it measures how many units of an asset have changed hands over a specific period, it shows how much interest there is for a particular coin. If there is a lot of interest, and lots of trading, this could be a token that’s high in demand.
Another aspect of crypto fundamental analysis is considering how a currency handles its supply. Stock to Flow (S2F) model is an example of a model that is based on supply mechanisms for Bitcoin. When evaluating a crypto coin, you should keep your eye on maximum supply, circulating supply and rate of inflation. Since the market price of a coin is a result of supply and demand forces, coins that have their supply capped at a fixed maximum amount, have bigger future growth potential than coins that have an ever growing supply.
Demand is probably going to play a more significant role than supply in determining the future market price of a token, therefore you should look at tokenomics and utility of the project. More on that in the Crypto Fundamental Analysis Part 2/3 which will be released next week. Stay tuned!