Table of Contents
- Fundamental Analysis in Crypto Vs. TradFi
- Financial Metrics
- On-Chain Metrics
- Project Metrics
Fundamental analysis is the process of evaluating an asset to judge its potential as an investment.
To evaluate a project, an investor considers internal and external factors that could contribute to the performance of the projects in the future.
These include the project’s management team, the resources available to the project, along with economic factors such as token supply and distribution. Other factors that affect the token’s demand and supply such as the token’s utility should also be considered.
Before deciding to invest in a cryptocurrency, it’s best to start by doing careful research into all of the project’s available metrics. Through a mix of qualitative and quantitative factors, including the token’s purpose, tokenomics, team, use cases, and community, an investor is better placed to understand if the token is undervalued or overvalued by the market.
Regardless of whether you’re considering established cryptocurrencies or newer tokens, it’s important to understand what you’re investing in. In this article, we’ll look at how to do your own research through fundamental crypto analysis, along with an in-depth look into the different quantitative and qualitative factors to consider.
Before that, let’s start by looking at how fundamental analysis in crypto differs from traditional finance.
Fundamental Analysis in Crypto Vs. TradFi
Traditionally, the fundamental financial analysis relies on data like the state of the economy, the company’s quarterly and annual reports, and other publicly available financial data that could influence its future price.
Company shares or bond issuance can be compared to token supply and distribution in the crypto space. However, while companies can issue new shares in a future round of investment after top-down approval from its board of directors, the decentralized nature of crypto adopts a bottom-up approach, where the community votes to decide whether or not changes should be made to a project’s tokenomics and supply distribution, such as increasing the maximum token supply.
Shares and bonds are also solely issued by a company under the regulation of a securities commission. In contrast, token distribution by cryptocurrency projects is comparatively underregulated, where tokens can be distributed via airdrops, staking programs, or on-chain token generation activities like mining and staking.
With the above differences in mind, let’s look at how to do your own research with fundamental analysis when evaluating a cryptocurrency’s investment potential.
A project’s financial metrics include data on the traded asset, liquidity, and supply mechanisms. You can use a platform like CoinGecko to do research on a project’s financial metrics, with all the necessary information in one place.
Market capitalization shows a cryptocurrency’s total value at a point in time. It is calculated by multiplying the current price per token and the circulating supply. Asset tracking platforms like CoinGecko provide you with an overview of the token in circulation, its current price, and the total market cap.
On CoinGecko, you’ll also be able to view the token’s Fully Diluted Valuation (FDV), which looks at the total token supply and calculates what the project’s valuation would be if these tokens were in circulation.
By taking into account the project’s FDV and market cap, an investor can decide whether the token is likely to grow past the current level. On CoinGecko, you can compare the market cap and FDV of similar projects as a way of getting a hint of the valuation a project truly deserves.
Trading Volume and Liquidity
An asset’s trading record is a good gauge of its financial viability, so another key metric to look at is its 24 hour trading volume.
The trading volume of an asset shows the collective value of the asset bought and sold over a period of time. Beyond the overall 24 hour trading volume, you can also look into the 24 hour volume of specific asset pairs on individual exchanges listed on CoinGecko.
A consistently high trading volume suggests a thriving project, and investors look out for this as proof of sufficient demand and liquidity as well.
Liquidity measures how easy it is to buy and sell an asset. If it can be bought and sold quickly without major fluctuations in the market value, the project has strong liquidity. However, if the market is illiquid, it becomes difficult to trade assets at a competitive price.
Knowing the importance of this data to investors, shady cryptocurrency projects have devised a means to create fake volume and liquidity for their assets. This tricks investors into believing in the viability of the asset. This is known as a Honeypot scam. Honeypot projects create fake buy and sell orders to trick investors into believing that the asset can be easily bought and sold.
Unfortunately, investors who buy into this trick will have a hard time selling the asset as the presented liquidity doesn’t exist. This practice is more prevalent in projects listed on decentralized exchanges.
You can use a website like Honeypots.is to help you detect honeypot scams using the asset’s contract address. To use this tool, visit the website, input the asset’s contract address in the search bar and click the ‘Is it Honeypot?’ to check if the token is a honeypot.
Token Supply Economics
Token supply economics is generally referred to as ‘tokenomics’, encompassing everything about the mechanics of the crypto coin, from its supply, token distribution, and utility of the tokens with regards to supply and demand. This defines how tokens are brought into circulation, and how these tokens are managed for project growth. For select tokens, CoinGecko’s tokenomics feature displays this data for each tracked asset.
Tokenomics data details how the tokens and allocations (if applicable) are scheduled. For smart contract tokens, the tokenomics data shows the number of tokens released at launch, whom they were allocated to (or what they were allocated for), and information about vested tokens. This includes the amount vested, the reason for vesting, and release schedules.
For native coins like bitcoin, Ethereum, and Fantom, information like the number of coins issued to miners or validators per block and the maximum number of coins that can be mined should also be considered.
The rate at which new coins or tokens are released and sold into the market also affects price development. In the absence of sufficient demand to override the supply rate, this could damage the asset’s profitability.
Exchanges Listed On
Another important consideration when doing your research is to look into the trading platforms on which the asset is listed.
When a major exchange lists an asset, there is the implication that there is trust in a project and its related digital asset, especially when it is listed on a major exchange. To qualify for an exchange listing, reputable cryptocurrency exchanges may require complete identification of project team members and their project roadmap.
Also, by listing it as a trading pair with BTC, or one of the other major exchange pairs like ETH or BNB, this indicates that there is sufficient liquidity for an accurate price discovery to take place.
You can also look at acquiring tokens that have not been listed on an exchange yet if you believe it meets your qualitative and quantitative standards. It’s possible for prices to rise rapidly after listing, but this usually happens for a very short interval of time while price discovery is taking place.
In this instance, a good way to estimate how much a cryptocurrency project’s technology and token are gaining traction is through looking at its on-chain metrics.
On-chain metrics are data obtained from the project’s records on the decentralized ledger that showcases user growth and adoption. Some of the popular on-chain metrics to consider while doing your research includes:
Number of Transactions
The blockchain records every transaction conducted by each user. These records are available to anyone who wishes to access them. Data stored on the blockchain are mainly records of transactions involving the native coin and tokens in a smart contract blockchain. To assess how much a blockchain is being used, the number of transactions executed at a period of time is a good way to start.
Certain analytical tools like blockchain explorers can collate these transactions and record them in set periods like 24 hours, 2 days, and so on, while providing a graph to illustrate the trends. At a glance, an investor can evaluate how active the project is through the number of unique transactions and how they have improved over time.
Transaction value differs from trading volumes as these are the transactions tracked on the blockchain.
This can also give you an idea of how much other investors are committing to a project. This suggests how confident they are in their investment and also gives a hint of the impression the project has had on other investors.
Huge buys, if not manipulated, are indicative of strong conviction and high expectations. Low-value buys might indicate that investors are taking precautions as they are unsure of what to expect from the project. A large number of sales may be an indication of exits.
This data should always be used together with other metrics such as the current state of the crypto market and some events particular to the project.
New and Active Addresses
How many people are transacting using a coin or a token and how many more users have it gained in the past week? This information can be easily obtained from the blockchain. The number of active addresses is a reliable usage statistic. For projects with special utilities, it gives a hint of how many people are adopting the technology being propagated by the project. For blockchain-based payment solutions like bitcoin, it shows how many people are transacting with the decentralized electronic currency.
New users will also need to create a wallet on the chain or transfer the smart contract token to their wallet. When any of this is done, it reflects on the chain as a new address. ‘New address’ data can be used to assess how many new investors and adopters the project has gained in a period of time.
This data can be used to ascertain the number of people being served by the project and if this adoption rate is comparable to the current valuation. A high adoption rate and a comparatively low valuation are usually a show of undervaluation, and the asset is a prospect for price growth. If it’s the other way around, the project is probably overvalued.
Hash Rates in Proof-of-Work
In a Proof-of-Work blockchain, participants of the network are required to run a node and contribute to the security and decentralization of the network. Community members who participate in this way benefit from the coin generation process through receiving miners’ rewards. The ease with which the miners earn this reward is determined by the network’s hash rate. The hash rate of a blockchain network varies with the amount of computational power committed to the network. This is also determined by the number of devices setting up a mining node.
As more miners join the network, the hash rate increases and the coins become harder to mine; however, the network becomes more secure and decentralized. The reverse is the case when miners leave the network. As an investor, the network usage and security can be evaluated using hash rate data.
Bitcoin’s value has a history of a proportional relationship with its hash rates. Generally, bitcoin’s value tends to improve when the hash rate and mining difficulty increase.
Like other on-chain metrics, the cumulative fee paid by users is another way to gauge the usage of a blockchain.
To verify a transaction, users will need to pay a fee in the native coin of the blockchain. This fee is usually within a known range. An increase in the fees paid is usually an indication of increased usage.
Apart from blockchain networks, decentralized applications like DeFi projects and projects trading on decentralized exchanges charge a fee for liquidity provision and other services. Some projects channel this fee into further development as a source of revenue. For projects like this, the fee paid, in addition to being a usage metric, is also used to evaluate the financial condition of the project as more fees mean more funds for development or token buyback as the case may be.
To complete research on the project you wish to invest in, another factor to consider is the project’s profile and a closer look into the project’s management. This is done by evaluating the project’s materials and personnel data. We will collectively call these project metrics.
Now that we’ve studied the current state of the project by looking at the project data available, it’s time to look into qualitative considerations like the project’s plan for the future and how they line up against their competitors.
The Project’s White Paper
A white paper is an official informational document that outlines the features and goals of a project. It describes the initial design of the technology, the project team, and their vision, focusing on presenting a detailed explanation of the core design of the project and the system put in place to actualize this design. The whitepaper can also contain a breakdown of the tokenomics and the project’s roadmap.
The white paper is a must-read document for every investor doing their due diligence. If the project is already live, investors should compare the product presented on the white paper with what the project has put in place. If the project is already deviating from the initial design without a good reason, investors might want to reconsider their investment plans.
CoinGecko makes it easy for investors to access projects’ white papers through the Whitepaper feature on the platform. To view a project’s white paper, click on Whitepaper on the asset page.
The Team, Partnerships, and Social Media Channels
Who is behind the project, what external parties are involved in the project and how is the project communicating with their community?
Evaluate the core members of the project’s team, their past involvements in the space, and the role they played in these. Past projects can fail for many reasons, but if a key team member has been repeatedly involved in rug pulls, this could be a sign for caution.
Also extend your analysis to the project’s partners, their background, and the role they play in the project.
Tokenomics and Initial Distribution of Tokens
Beyond what was discussed earlier with regards to tokenomics, remember to look at the vesting period and the unlock schedule of coins. The vesting period prevents token holders such as employees and other early investors from selling all their tokens at once, causing an oversupply and potential crash in the coin’s value.
A roadmap is a presentation of a project’s plans for the future. Roadmaps usually contain projections and what the project plans to achieve at a stated time in the future. A project’s roadmap could extend deep into the future (like 5 years or more) or just state plans for the near future (like a year or less).
Roadmaps outline the desired financial and technological heights a project hopes to attain. If you’re planning to adopt a hodl approach to your crypto investment, this is essential data to consider. The roadmap also serves as a way to measure the project’s achievement of its milestones.
What other projects have similar technology to the project you wish to invest in? Understanding these projects will aid your investment decision. How does your project measure up against the competitors? Does it have better technology, a more experienced team, a more reliable plan for the future, or do they just have a better marketing team?
If it is a developing project, your project of interest might face stiff competition from older, more established, and more financially stable projects.
When investing in a volatile asset like cryptocurrency, it’s important to take your risk appetite into account. Doing your own research and looking into the project specifics outlined above will help you avoid pitfalls like obvious rug pulls and honeypot scams, but the likelihood of extreme price swings remains, even in the case of so-called blue chips like bitcoin and ether.
Finally, when storing cryptocurrency, remember to use non-custodial wallets to maintain full control of your funds – not your keys, not your coins!
Note: Every piece of information contained in this article is purely educational and no part of this content was designed to be financial advice.