A comprehensive dive into the available information about a financial asset is required for crypto fundamental analysis. You could, for example, look at its use cases, the amount of individuals who use it, or the project’s team. Your objective is to determine if the asset is overvalued or undervalued. At that point, you can utilize your knowledge to guide your trading decisions.
Trading assets as volatile as cryptocurrencies necessitates a certain level of expertise. Choosing a trading strategy, comprehending the huge world of trading, and mastering technical and fundamental analysis are all skills that require practice.
When it comes to technical analysis, certain knowledge can be passed down from previous financial markets. Many cryptocurrency traders employ the same technical indicators that are used in Forex, stock, and commodity trading. RSI, MACD, and Bollinger Bands are indicators that attempt to anticipate market behavior regardless of the asset being traded. As a result, these technical analysis tools are very popular in the bitcoin community.
Despite the fact that the technique is similar to that employed in traditional markets, you can’t really utilize tried-and-true tools to evaluate crypto assets. We need to understand where cryptocurrencies get their value in order to undertake proper financial analysis on them. We’ll try to uncover metrics that can be used to create your own indicators in this article.
What is fundamental analysis (FA) and how does it work?
Fundamental analysis (FA) is a method used by investors to determine an asset’s or company’s “intrinsic value.” Their major purpose is to assess if an asset or organization is overvalued or undervalued by examining at a variety of internal and external criteria. They can then use that information to enter or leave positions strategically.
Technical analysis produces useful trade data as well, but it delivers different insights. Based on asset performance in the past, TA users believe they can forecast future price fluctuations. This is accomplished by examining vital indicators and spotting candlestick patterns.
Traditional fundamental analysts use business metrics to determine what they believe the stock’s true value is. Earnings per share (the amount of profit a company makes for each outstanding share) and the price-to-book ratio are examples of indicators employed (how investors value the company versus its book value). They might conduct this for multiple businesses within a specialty, for instance, to see how their potential investment compares to others.
The issue with fundamental cryptocurrency analysis
Cryptocurrency networks can’t be judged in the same way that regular enterprises can. More decentralized offerings, such as Bitcoin (BTC), are more akin to commodities. Traditional FA indicators can’t tell us anything about more centralized cryptocurrencies (such as those issued by organizations).
As a result, we must concentrate on several frameworks. Identifying good metrics is the first step in this process. We mean strong in the sense that they can’t be easily manipulated. For example, it’s easy to create fake profiles or buy participation on social media, so Twitter followers or Telegram/Reddit users are generally not useful indicators.
It’s vital to remember that no single metric can provide us with a complete picture of the network we’re evaluating. We can see that the number of active addresses on a blockchain has been steadily expanding. However, that doesn’t tell us much on its own. For all we know, there could be a single perpetrator sending money to themself using different addresses each time.
We’ll look at three types of crypto FA metrics in the sections below: on-chain metrics, project metrics, and financial data. This list will not be exhaustive, but it should serve as a good starting point for developing indicators in the future.
Metrics that may be noticed by looking at data provided by the blockchain are known as on-chain metrics. We could do it ourselves by setting up a node for the chosen network and then exporting the data, but this is time-consuming and costly. Especially if we’re only thinking about the investment and don’t want to waste time or money on it.
Pulling information from websites or APIs expressly geared for advising investment decisions would be a more straightforward option. CoinMarketCap’s on-chain research of Bitcoin, for example, provides a wealth of data. Coinmetrics’ Data Charts and Binance Research’s project reports are two other sources.
1. The number of transactions
The number of transactions on a network is a good indicator of network activity. We can see how activity changes over time by graphing the number for specific periods (or using moving averages). It’s important to keep in mind that this statistic should be used with caution. We can’t be sure that there isn’t just one party sending cash between their own wallets to inflate the on-chain activity, just as we can’t be sure there isn’t just one party transferring funds between their own wallets to inflate the on-chain activity.
2. The value of the transaction
The transaction value, not to be confused with the transaction count, indicates how much money has been exchanged over a given time period. For example, if ten Ethereum transactions valued at $50 each were sent on the same day, the daily transaction volume would be $500. We could use a fiat money, such as the US dollar, or we could use the protocol’s native unit (ETH).
3. Addresses in use
The blockchain addresses that are active during a specific period are known as active addresses. This can be calculated in a variety of ways, but one frequent method is to count both the sender and receivers of each transaction over a defined period of time (e.g., days, weeks, or months). Some researchers look at the number of unique addresses in aggregate, which means they keep track of the total throughout time.
4. Payment of fees
The fees paid can tell us about the demand for block space, which is perhaps more essential for some crypto assets than others. Users compete with one another to get their transactions included in a timely manner, similar to bids at an auction. Higher bidders will get their transactions validated (mined) sooner, while lower bidders will have to wait longer.
This is an intriguing metric to look into for coins with decreasing emission schedules. A block reward is provided by the major Proof of Work (PoW) blockchains. It’s made up of a block subsidy and transaction fees in some cases. The block subsidy is reduced on a regular basis (in events such as the Bitcoin halving).
Because the cost of mining tends to climb over time as the block subsidy is gradually removed, transaction fees are bound to rise. Otherwise, miners would be losing money and would leave the network. This has a negative impact on the chain’s security.
5. The staked amount and the hash rate
Today’s blockchains employ a variety of consensus algorithms, each with its own set of mechanisms. Given how important these are for network security, digging into the data surrounding them could be useful for basic research.
In Proof of Work cryptocurrencies, the hash rate is frequently employed as a gauge of network health. The more hash rate there is, the more difficult it is to mount a 51 percent attack. However, an increase over time may indicate an increasing interest in mining, which is likely due to lower overheads and increased profitability. A fall in hash rate, on the other hand, indicates that miners are abandoning the network (“miner capitulation”) because it is no longer economical for them to do so.
The current price of the asset, the amount of transactions executed, and the fees paid, to name a few, are all factors that might affect the overall costs of mining. Of course, mining’s direct costs (electricity, computing power) are also crucial factors to consider.
Staking (in Proof of Stake, for example) is a similar idea to PoW mining in terms of game theory. However, it functions differently in terms of mechanisms. The core concept is that users stake their own holdings in order to take part in block validation. As a result, we can evaluate interest by looking at the amount staked at any particular time (or lack of it).
Whereas on-chain metrics focus on observable blockchain data, project metrics take a qualitative approach, examining aspects like as the team’s performance (if any), the whitepaper, and the planned roadmap.
Before investing in any project, it is strongly advised that you read the whitepaper. This is a technical document outlining the cryptocurrency concept. It’s a good idea to cross-reference this information with project talks. What are the opinions of others on the subject? Are there any red flags that have been raised? Do the objectives appear to be achievable?
2. The team
If the cryptocurrency network has a specific team behind it, the members’ track records can tell whether the team has the necessary talents to see the project through. Have any of the members had past success in this industry? Is their experience sufficient to meet the deadlines they’ve set for themselves? Have they been a part of any dubious enterprises or schemes?
What does the developer community look like if there isn’t a team? Check to see how many contributors and how much activity there is on the project’s public GitHub. A coin with consistent development can be more appealing than one with a repository that hasn’t been updated in two years.
A strong whitepaper should provide insight into the use case that the crypto asset is aiming for. It’s critical to identify the initiatives it’s up against, as well as the legacy infrastructure it wants to replace, at this stage. Fundamental examination of them should, in theory, be equally as rigorous. While an asset may appear tempting on its own, the same metrics compared to similar crypto assets may suggest that ours is weaker.
4. Initial distribution and tokenomics
Tokens are created by some projects as a solution in search of a problem. Not to imply that the idea isn’t viable, but the token linked with it may not be very valuable in this situation. As a result, determining whether the token has real utility is critical. And, by extension, whether or not that utility will be recognized by the larger market, as well as how much it will likely be valued at.
Another crucial element to consider is how the monies were dispersed initially. Was it through an initial coin offering (ICO) or an initial public offering (IEO), or could people earn it through mining? In the first situation, the whitepaper should specify how much will be reserved for the founders and staff and how much would be made available to investors. We could seek for proof of the asset’s creator premining (mining on the network before it’s disclosed) in the latter scenario.
By concentrating on the distribution, we may be able to determine whether or not there is any risk. For example, if only a few parties possess the vast majority of the supply, we would conclude that this is a dangerous investment because those parties could someday manipulate the market.
Fundamental analysis can make use of information such as how the asset is now traded, what it was traded at before, liquidity, and so on. Other intriguing indicators that can fall into this category are those that involve the crypto asset’s protocol’s economics and incentives.
1. Capitalization of the market
The circulating supply is multiplied by the current price to create market capitalization (or network value). It essentially shows the cost of purchasing every single unit of the crypto asset that is currently available (assuming no slippage).
Market capitalization might be deceiving on its own. In theory, it would be simple to create a meaningless token with a ten million unit supply. The market cap would be $10 million if only one of those tokens were traded for $1. This valuation is obviously skewed; without a compelling value proposition, the token is unlikely to attract wider market interest.
On a related issue, it’s hard to know exactly how many units of a cryptocurrency or token are in circulation. Coins can be burned, keys can be misplaced, and money can be forgotten. Instead, we observe approximations that seek to filter out coins that have been removed from circulation.
Nonetheless, market capitalization is frequently used to estimate network development potential. Some crypto investors believe that “small-cap” currencies would increase faster than “large-cap” coins. Others argue that large-cap companies have larger network effects and, as a result, have a better chance than newer small-cap companies.
2. Volume and liquidity
The ease with which an asset can be acquired or sold is referred to as liquidity. A liquid asset is one that we wouldn’t mind selling at its current market price. A liquid market, which is a competitive market filled with asks and bids, is a related idea (leading to a tighter bid-ask spread).
One issue with an illiquid market is that we may be unable to sell our assets at a “fair” price. This indicates that there are no willing buyers, leaving us with two options: decrease the ask or wait for liquidity to improve. Trading volume is a metric that can be used to assess liquidity. It can be calculated in a variety of methods and is used to illustrate how much money has been exchanged in a specific time period. Charts usually show the daily trading volume (denominated in native units or in dollars). In the context of fundamental analysis, understanding liquidity might be beneficial. Finally, it serves as a barometer of market interest in a potential investment.
3. Mechanisms of supply
The supply mechanisms of a coin or token are considered by some to be some of the most interesting investment qualities. Indeed, among Bitcoin supporters, models like the Stock-to-Flow (S2F) ratio are gaining traction.
Decisions can be influenced by the maximum supply, circulating supply, and inflation rate. Some coins gradually reduce the number of new units produced, making them appealing to investors who believe that demand for new units will outstrip supply.
Different investors, on the other hand, may view a strictly imposed cap as harmful in the long run. Concerns include the possibility that it disincentivizes users from using the coins/tokens, causing them to be hoarded instead. Another criticism is that it favors early adopters disproportionately, whereas a steady inflationary policy would be more equitable for newcomers.
Indicators, metrics, and tools for fundamental analysis
Metrics are quantitative and sometimes qualitative data utilized in basic analysis, as we’ve already defined them. These metrics, on their own, don’t always tell the whole story. We should also look at indicators to acquire a better understanding of a coin’s fundamentals.
To make it easier to assess relationships, indicators frequently mix various measurements using statistical algorithms. However, there is a lot of overlap between a metric and an indicator, so the definition is still a little hazy.
While the number of active wallets is useful, we can use it in conjunction with other information to acquire further insight. This can be expressed as a percentage of total wallets or by dividing the market cap of a currency by the number of active wallets. This computation will provide you with the average amount of money kept in each active wallet. Both of these would allow you to make inferences about the network’s activities and users’ trust in the asset. In the next section, we’ll delve a little more into this.
All of these measures and indicators are easier to collect with fundamental analysis tools. While blockchain explorers provide raw data, an aggregator or dashboard is a more efficient use of your time. Some tools allow you to construct your own indicators based on the measurements you want to use.
Creating FA indicators by combining metrics
Let’s talk about how we combine measurements to better comprehend the financial health of the assets we’re dealing with now that we’ve learned the distinction between metrics and indicators. Why are you doing this? Every metric, as we’ve shown in the preceding sections, has flaws. Furthermore, if you only look at a list of figures for each cryptocurrency project, you’re missing out on a lot of important data.
When we compare the two offers, active addresses tell us nothing of significance. We could state that Coin A has had more active addresses in the last six months than Coin B, but it isn’t a whole picture. What is the relationship between this number and the market capitalization? Or the number of transactions?
A more conservative strategy would be to devise some sort of ratio to apply to some of Coin A’s statistics, then compare it to the same ratio applied to Coin B’s. We won’t be comparing each coin’s specific metrics blindly this way. Instead, we can develop an independent standard for valuing coins.
For example, we may decide that the link between market capitalization and transaction count is far more informative than market capitalization alone. In such instance, we may split the market cap by the number of transactions. With Coin A, we get a ratio of 5, while with Coin B, we get a ratio of 0.125.
Because the number calculated is lower, we can conclude that Coin B is more intrinsically valuable than Coin A based on this ratio alone. That means Coin B has a substantially higher number of transactions in relation to its market capitalization. As a result, it may appear that Coin B has greater usefulness or that Coin A is overvalued.
Neither of these observations should be interpreted as investment advice; rather, they are examples of how we might depict a small part of the larger picture. You can’t tell whether the lower transaction number on Coin A is a good thing or a bad thing until you know what the projects’ goals are and how the coins work.
The NVT ratio is a similar ratio that has gained some traction in the cryptocurrency markets. The network value-to-transaction ratio, coined by analyst Willy Woo, has been dubbed the “price-to-earnings ratio of the crypto industry.” It includes dividing the market capitalization (or network value) by the quantity traded in basic words (typically on a daily chart).
The types of indicators that can be employed are simply scraping the surface. The goal of fundamental analysis is to create a methodology that can be used to value projects in a variety of situations. We will have more data to work with if we conduct more high-quality research.
Financial indicators and measures of importance
There are a plethora of indicators and measures from which to choose. Start with some of the most popular ones if you’re a newbie. Because each signal only provides half of the picture, mix them up in your analysis.
Ratio of Network Value to Transactions (NVT)
The network transaction value indicator (daily) gives a similar analysis to the price-to-earnings ratio, which is used to examine companies. It’s simple to compute by dividing the market capitalisation of a coin by the daily transaction volume.
The daily transaction volume serves as a proxy for a coin’s underlying, intrinsic worth. This concept is based on the idea that the more volume moving through the system, the higher the project’s value. The market could enter bubble territory if a coin’s market cap rises while daily transaction volume falls. Prices are increasing without a corresponding growth in the underlying value. In the contrary scenario, a coin’s or token’s price may remain unchanged even while daily transaction volume rises. This scenario may indicate a potential buying opportunity.
The greater the ratio’s value, the more likely a bubble will form. When the NVT ratio is more than 90-95, this stage is reached. A falling ratio means the cryptocurrency is becoming less overpriced.
Ratio of Market Value to Realized Value (MVRV)
Before we go any further, it’s important to grasp what realized value for a crypto asset means. The total quantity of coins multiplied by the current market price equals market value, also known as market cap. On the other side, realized value accounts for coins that have been lost in inaccessible wallets.
Wallet coins are valued using the market price at the time of their most recent movement. For example, a Bitcoin that has been misplaced in a wallet since February 2016 is only worth about $400.
We just divide the market cap by the realized cap to get our MVRV indicator. We’ll end up with a reasonably high ratio if the market cap is significantly larger than the realized cap. A ratio of more than 3.7 indicates that traders may be taking profits due to the coin’s overvaluation, which could lead to a sell-off.
This rating indicates that the coin may be overvalued right now. This can be seen before two major Bitcoin sell-offs in 2014 (MRVR of nearly 6) and 2018 (MRVR of roughly 6). (MRVR of approximately 5). The market is undervalued if the value is too low and less than one. This is a favorable time to buy because buying pressure is increasing and driving up the price.
Tools for Fundamental Analysis Examples
Baserank is a crypto asset research platform that collects information and reviews from analysts and investors. After considering the average of each review’s score, the coin is given a number ranging from 0 to 100. While some premium evaluations are only available to subscribers, free users can still receive a full summary of reviews divided into groups such as team, utility, and investment risk. An aggregator like Baserank is useful if you’re short on time and need a quick overview of a project or coin. Before investing, you should always learn more about the initiatives you’re interested in.
2. Cryptocurrency Fees
This tool, as the name suggests, displays each network’s fees for the previous 24 hours or seven days. When assessing the traffic and utilization of a blockchain network, it’s a simple measure to employ. High-fee networks are usually in high demand.
This statistic, however, should not be taken at face value. Because certain blockchains are designed with low costs in mind, comparing them to other networks can be difficult. It’s best to compare the figure to the transaction amount or another metric in these circumstances. Large market cap coins like Dogecoin and Cardano, for example, sit low on the overall charts due to their low transaction fees.
3. Glassnode Studio
Glassnode Studio comes with a dashboard that shows a variety of on-chain metrics and data. It’s a subscription-based product, like most others on the market. The quantity of free on-chain data it provides, on the other hand, is suited for novice investors and quite in-depth. It’s much easier to get all of the information in one location rather than employing blockchain explorers to do so. The ability to browse a large number of metric categories and subcategories is Glassnode’s key strength. However, if you’re looking for Binance Smart Chain projects, your options are restricted.
Glassnode Studio offers a built-in TradingView with all of its charting capabilities for anyone who wishes to combine their measurements with technical analysis. When making judgments, it’s usual for investors and traders to use a combination of different sorts of analysis. It’s convenient to be able to do everything in one place.
Fundamental analysis, when done correctly, can reveal crucial insights into cryptocurrencies that technical research cannot. When trading, being able to distinguish between the market price and the “actual” value of a network is a valuable skill. Of course, there are some things that TA can tell us that FA can’t anticipate. As a result, many traders now utilize a combination of the two.
There is no one-size-fits-all FA playbook, as there is with many other methods. Hopefully, you’ve gained a better understanding of some of the aspects to examine when starting or closing positions with crypto assets as a result of this post.