If you’re a newcomer to cryptocurrencies, you’re probably overwhelmed with the huge number of coins & tokens that already exist and trade on various exchanges. Moreover, crypto derivative exchanges like Delta Exchange offer futures and perpetual swaps on altcoins like Ethereum, Ripple etc. These derivative contracts make it possible to go both long and short altcoins with leverage. Whether you trade cryptocurrencies in spot or using derivatives, your starting point has to be a view or opinion on a coin. This opinion can be formed using one or all of the types of analyses – fundamental, technical and sentiment. In this article we focus on fundamental analysis and present a systematic way of rating cryptocurrencies from fundamentals perspective. If you have wondered about questions like – “Which among the multiple coins that are trading present attractive investment opportunity?” or “Which coins are potential short candidates?”, then this article is for you.
Why a cryptocurrency rating system needed?
While in the early days of crypto, there were only a handful of different projects, today there are already a few hundred. The crypto fundamental analysis is not only about exploring the potential, but also about excluding that it is a fraudulent project. A few hundred such (exit) scams have already been uncovered and it can be assumed that this number will continue to rise.
Determining the “true” value of a cryptocurrency is a difficult matter, as many factors of different forms of analysis play a role. Fundamental analysis is one of three important tools to determine the future potential value of a crypto asset. The other two are technical chart analysis and sentiment analysis. From mid to long term perspective, fundamental analysis is certainly the most relevant. Before we explain our 6 step fundamental analysis, let’s first understand what is fundamental analysis.
What is fundamental analysis?
Wikipedia’s definition of fundamental analysis is as follows:
“Fundamental analysis is a form of financial analysis. It tries to determine the fair or reasonable price of securities (“intrinsic value”). In contrast to chart analysis, it is not based on an analysis of price trends, but on economic data and the economic environment of a company, the so-called “fundamental data.”
For a conventional asset class such as debt or equity instruments fundamental analysis is done on the basis of cash flow and the cash revenue the company produces. The entire concept for fundamental analysis is based on the basis of a business and how it generates cash.
Cryptocurrencies are a new asset class
The fundamental analysis of crypto-assets is markedly different from the analysis of traditional securities. In the case of companies, concrete financial data is available to make projections about future cashflows. However, for cryptocurrencies and tokens, such data is usually not there. Thus, fundamental analysis would not follow a similar routine such as a discounted cash flow method or a dividend discount model method to establish the intrinsic value of the token. In fact, the entire method of fundamental analysis for cryptocurrency would be different even though the research methodology is named the same.
Reasons why fundamental analysis is different for cryptocurrencies:
- The value of cryptocurrency such as Bitcoin comes primarily from the confidence of the community, comparable to conventional currencies such as dollars or euro.The value of a utility token is significantly determined by the usage possibilities and the number of users.
- New types of security tokens (STOs), in which you can participate directly in the success of a company under certain circumstances, are an exception to this rule.
- Research analysis on traditional asset classes is comparably easy to do as these asset classes have been present since decades and there is enough data to backtest it, draw conclusions from and make investment decisions. In the case of cryptocurrencies, in the best case scenario (i.e. for bitcoin), 11 years of history is available. For all other cryptocurrencies and crypto-assets, available history is much shorter.
- The technology, purposes and businesses behind tokens and altcoins can be quite varied. This makes a one-size-fit-all approach to analysing these crypto-assets impossible.
Despite the challenges mentioned above, it is still possible to gain an insight into cryptocurrencies and conduct conclusive research. If you put some effort into a structured research and analysis, you can count on a higher success rate of your investments. Below we list the 6 steps that our fundamental analysis methodology entails.
Step 1. Key metrics
The numbers are the first thing you need to check. It gives you a first feeling for the size of a cryptocurrency compared to competing projects. Even if crypto assets are not securities and there is no company behind them, there are still some key figures that are relevant for your analysis:
The market capitalization is formed from the number of coins/tokens in circulation and the current price at which it is traded (number x price = market capitalization). This figure is particularly important for new projects, as it can be used to derive possible parabolic growth. If there are two similar projects which have the same fundamental data, but the market capitalisation of one is one billion dollars and that of the other only ten million dollars, it is obvious which has more potential.
However, some cryptocurrency tokens, to gain traction have been filling in trades just to increase trading volumes and price/ market cap. This makes it essential to analyse exchange order books and trading patterns to ascertain the true market cap of the coin.
Circulation and total supply
The supply of certain assets are limited such as gold. There is only so much gold one can mine. On the other hand, there are no such hard constraints on fiat currencies. If a country’s Government so chooses, it can print currency notes at will. Let us now look at bitcoin. BTC supply has a hard cap of 21 million. To date, around 18 million bitcoins have been mined. As more and more bitcoins get being mined, we continue to move closer to the bitcoin supply cap. This scarcity of supply, in conjunction with pick-up in demand, is what makes people bullish on long-term prospects of bitcoin price.
It is worth noting that not all crypto-assets have similar supply constraints as bitcoin. Therefore, understanding the supply inflation schedule of a coin is paramount and should be taken into consideration before making an investment decision.
Historical price development
Even if this is not an article about technical chart analysis, it is necessary to take a look at the historical price development. An investment that has already seen a great deal of growth is potentially riskier than one where the big leap may be imminent.
Cryptocurrencies offer the opportunity to gain insight into how the ownership of the cryptocurrency is distributed among investors. There are a few “rich lists” show which wallets hold what percentage of the circulating supply. In the ideal case, ownership would be quite dispersed. You should make sure that the ownership is not concentrated in just a few wallets. Concentration of a cryptocurrency in a small number of wallets is a red-flag and potential risk.
Trading Volume & Order Books
The trading volume of a cryptocurrency is not a criterion for the quality of a project per se. However, sufficient liquidity should be available to build up the desired position. In this context, it is also worth taking a look at the trading platforms on which the corresponding coin/token is listed. Check the volumes of the individual trading platforms and get an overview of the size of the individual platforms themselves. If none of the big players (Binance, Coinbase) are present yet, the potential will increase considerably in the future due to possible listings at the major exchanges.
Step 2. The Idea behind a Project
The key idea that lead to the creation of a project is one of the most important factors in fundamental analysis. This will help you understand the nature of the crypto-asset that you are analysing. Is it a store of value like Bitcoin? Is it a currency suitable for payment processing, like Litecoin? Or is it something else, e.g. a blockchain platform on which other projects can be started, such as Ethereum or Komodo? What is important here is a step-by-step approach, from the micro perspective to the macro perspective.
Let’s assume it’s about cryptocurrency, similar to Bitcoin. From a micro perspective, it is important to have a unique selling point. A Bitcoin clone is not a bad thing, but you have to ask yourself why someone would prefer this particular crypto over bitcoin, or why this specific coin should increase in value?
When it comes to a utility token, you have to ask yourself if it really is needed in the network, i.e. if a real problem is solved and what role the token plays in the network. Could you run the same platform with bitcoin, ethereum or something else?
If the micro-perspective makes sense, you can go on to the macro-perspective and zoom out of the crypto-view, out into the “real world”: Is the problem being solved important for many people? Are there enough potential users for a stable and growing demand?
Understanding the idea
You should have a basic understanding of the idea. A quick look at the project’s website is a good way to do this. There you should usually get a rough overview of what the idea of the project and its areas of application are.
A whitepaper to ICO is what a Red Herring Prospectus is to an IPO. Just how you read a DRHP to make a decision on whether you should invest in the upcoming IPO, one should go through the whitepaper of these coins to make a decision and analyse the coin. Reading the whitepaper will give you a deeper insight into the “how.”
The roadmap contains various milestones, usually defined over a period of at least 1-2 months. It should be clear what the status quo of the project is and what progress is planned in the near future.
Due to a large number of already existing cryptocurrencies & tokens there is sometimes more, sometimes less intersection between different competitors. Therefore, we recommend that you check them out to see if the idea has already been validated and competitors already have a working product.
Step. 3 Technology
When it comes to the technology of a cryptocurrency or a token, there are some points that are of high priority.
So you should find out if the coin/token uses a proof-of-work (PoW) or a proof-of-stake (PoS) mechanism. For PoW coins, it is recommended to identify the exact algorithm with which coins will be mined and whether it is ASIC-resistant, for example, and can also be mined on conventional GPUs. Further key figures are the development of the block rewards and the difficulty.
If you want to delve deeper, the announcement threads on bitcointalk.org are a good place to go, as they are also frequented by technically-savvy users who are happy to answer questions.
Step 4. Team
The team is an essential factor in determining the success of a project. As with startups, it is not only a promising idea and its feasibility that matters. The project team must have the skills to implement it.
Crypto projects with anonymous teams are a special case. Many investors are afraid to invest in these projects. Simultaneously, on the other end of the spectrum, there are people who operate under clear names and are still guilty of fraud. In our opinion it is ok to invest in projects backed by anonymous teams if some points are considered in the fundamental analysis:
Are they communicative and accessible to community members?
Is there any evidence of developer activity, e.g. on GitHub?
Can they explain their idea, the technology and the long-term vision in a meaningful way?
The answers to these questions can minimize the risk of falling for a scam.
Step 5. Marketing
Even the best product needs public relations & marketing at the end of the day to be noticed by as many people as possible. Many crypto projects have difficulties with this because their founders often have a technical background throughout and “only” want to let their product speak for itself. But marketing is an essential part of success.
When analyzing this topic, you should check which marketing activities have already taken place. Were there press releases that have also been published by major platforms? Is there any targeted online advertising? Are social media channels (Twitter, Reddit, Medium, Slack, and Discord) adequately used?
If you can’t identify any marketing activities, take another look at the roadmap. Planned marketing measures are often mentioned there.
Step 6. Community
The value of crypto assets comes from the trust the community has in them. Therefore, you should take a closer look at this in your fundamental analysis. First of all, you should check the most important social media channels. In addition to quantity (number of followers & contributions), quality is just as important. Since many projects like to buy followers, especially on Twitter, a quick audit is recommended to check if the number of followers is legitimate.
More insight can be gained by viewing $ tag searches (cash tags) on Twitter, threads on Reddit and Bitcointalk.org. Here it is not only important if/ what users contribute, but also how the team communicates with them. A good team is in regular contact with the community, responding to them, answering questions, and assisting with problems with the product.
We hope you have now gained a good overview of the most important areas of fundamental analysis for crypto-assets and that in the future you will be able to better assess the potential long-term success of cryptocurrencies.