A Guide to Cryptocurrency Fundamental Analysis

Crypto fundamental analysis can help you determine an asset's intrinsic value before you invest your money or pull out. But how does it work? Find out here!

  1. Crypto Fundamental Analysis Explained
  2. Why Doesn't Fundamental Analysis Work with Cryptocurrency?
  3. What are On-chain metrics?
  4. What are Project Metrics?

Trading cryptocurrencies successfully demands skill and research. Why?

Because of their volatility.

Choosing a strategy, developing an understanding of trading fundamentals, conducting technical and fundamental analysis - there's a lot to consider. And the learning curve can be steep.

With regards to technical analysis, you could gain some expertise from legacy financial markets. Plenty of cryptocurrency traders utilize technical indicators seen in stock, commodities, and Forex trading.

And tools such as MACD, Bollinger Bands, and RSI aim to predict behavior regardless of the asset to be traded. As a result, they've become hugely popular among cryptocurrency traders and investors.

How about crypto fundamental analysis? While it may be similar to the approach used in legacy markets, you can't examine crypto assets using tried-and-tested tools. You need to actually identify where value comes from to undertake proper fundamental analysis for cryptocurrencies.

If this all appears complex, it can be. But we're here to make it a little easier to understand.

Join us as we explore the metrics you can use to make your own indicators.

Crypto Fundamental Analysis Explained

We touched on fundamental analysis above. Now, let's take a closer look.

Investors use fundamental analysis to determine an asset or business's intrinsic value. They can find out whether something has been over- or undervalued by studying a variety of internal and external factors. Later, they will leverage their findings to enter or exit positions with a sounder strategy.

Investors can also glean valuable data from technical analysis, though it does lead to different insights. Those relying on technical analysis believe future price movements can be predicted according to assets' historical performance. They do this by looking for candlestick patterns and examining essential indicators.

But investors interested in traditional fundamental analysis will study business metrics to determine what they consider to be an asset's real value. They will use multiple indicators, including earnings per share (the profit a company will make for every outstanding share) and price-to-book ratio (how investors value a business versus the book value).

Fundamental analysts may do this for a number of companies operating in a specific sector, to understand how a potential investment stands compared to others.

Why Doesn't Fundamental Analysis Work with Cryptocurrency?

You can't assess crypto networks in the same way as you would traditional companies. For a start, those that are more decentralized (e.g. Bitcoin) are nearer to commodities, but even with cryptos that are more centralized, you can't learn a great deal from conventional fundamental analysis indicators.

That's why we need to consider alternative frameworks. We can start by identifying quality metrics that can't be manipulated or faked easily. For instance, the number of Reddit users or followers on Facebook can't be considered good metrics, as fake accounts may be set up and social engagement can be purchased.

It's vital to remember that no one measure will provide a complete overview of a network being assessed. You may investigate the amount of active addresses on a blockchain and discover that this has substantially grown - but that won't tell you much in isolation. An actor could be continually transferring funds back and forth with fresh addresses.

Below, we'll explore different types of crypto fundamental analysis metrics to establish a solid foundation for creating indicators.

What are On-chain metrics?

You can observe on-chain metrics by studying data provided by a blockchain. You may complete this process by running a node for the target network and exporting said data. But that can be costly and take more time than you may be willing to sacrifice - especially if you're only considering an investment at this stage.

So, the simpler option is to gather information from websites or APIs that have been specifically built to help you make informed choices with your investments. For instance, CoinMarketCap's on-chain Bitcoin analysis offers a wealth of information, though you could also explore Coinmetrics' Data Charts instead.

What is Transaction Count?

This metric is useful for measuring activity on a network: you can chart patterns in activity over time by plotting the number for set periods or through the use of moving averages.

However, be careful when using this metric. You can't be certain that a single actor isn't transferring funds from wallet to wallet to manipulate on-chain activity (a similar issue with active addresses).

What is Transaction Value?

Transaction value may be confused with the transaction count, though they're very different.

Transaction value reveals the value that has been transacted across a certain period: so, if eight Bitcoin transactions were sent in one day, worth $20 each, the daily transaction volume would be $160. This could be measured in a fiat currency (e.g. EUR, USD) or in the protocol's native unit (BTC, in this example).

What are Active Addresses?

These are blockchain addresses that are active across a specific period. There are multiple ways to calculate active addresses, the most popular of which involves counting the sending and recipient of every transaction in given time frames (days, weeks, etc.). Alternatively, you could track the total amount of unique addresses over time.

What is Fees Paid?

The fees paid metric is more valuable for some cryptocurrencies than others. It shows the demand for block space, almost like auction bids: users compete to have their own transactions included quickly. A high bidder's transactions will be verified/mined ahead of those bidding lower amounts.

Fees paid is an effective metric for cryptos with dropping emission schedules. The biggest Proof of Work blockchains offer a block reward. In some cases, it comprises a block subsidy and transaction fees (the subsidy would decrease over time, due to particular events like Bitcoin halving).

As the mining cost typically increases and the block subsidy gradually decreases, it's logical that transaction fees must continually rise. If they didn't, miners would work at a loss and start to abandon the network, ultimately endangering the chain's security.

What is the hash rate?

Blockchains rely on a range of consensus algorithms, each of which has unique mechanisms. As they perform such an important function in keeping a network secure, studying the surrounding data may be helpful when conducting crypto fundamental analysis.

Hash rate is typically utilized to measure the vulnerability of Proof of Work crypto networks: those with a higher hash rate are less likely to be affected by a 51% attack. However, a gradual increase in hash rate may indicate a rising interest in mining (possibly due to competitive overheads and greater profits).

A drop in hash rate suggests that miners have decided that there's not enough profit to justify them securing the network, and simply walk away (a process known as miner capitulation).

The overall cost of mining can be affected by various factors, including an asset's present price, the amount of processed transactions, and the fees paid. And let's not forget more direct costs, such as computing power and energy.

Finally, let's touch on staking or Proof of Stake. This concept has similar game theory to Proof of Work mining, though the mechanisms function in a different way. Essentially, you would stake your own crypto holdings to take part in validating blocks, and you could study the amount staked at a specific time to determine the level of interest.

What are Project Metrics?

We know that on-chain metrics focus on observable data from blockchains. But project metrics relate to a qualitative process concerned with such factors as team performance, upcoming roadmaps, and whitepapers.

What is the Whitepaper?

You should read the whitepaper before you invest in a project. It's a technical document providing you with an overview, defining the network's objectives.

This should answer:

  • What technology is used?
  • What use cases is it designed for?
  • What's the roadmap for implementing new features and making upgrades in the future?
  • What's the coin/token distribution plan?

Look for more broad considerations of the project too. For example, do members of the cryptocurrency community have concerns? Are people giving you any reason to doubt the realism of the project's goals?

What is Team Research?

A cryptocurrency network may have a team behind it. If so, checking the team-members' respective track records will highlight which of them have the skills necessary to make a project succeed.

Have one or more team-members been involved in similar ventures? Or have they achieved success in other areas? Are their names linked to past scams or projects that appeared somewhat unethical?

If a network has no team behind it, there are other factors to consider. What is the developer community like? Check if the project has a public GitHub, and explore how many people contribute to it. Look at the activity levels. You may find a coin that has received ongoing development more attractive than one that hasn't been updated for a number of years.

What is Competitor Research?

A good whitepaper will provide you with an insight into the asset's targeted use case. It's vital that you understand the projects this one is in direct competition with, and the legacy infrastructure that it aims to replace.

It's best to undertake rigorous fundamental analysis of these: while assets could appear to be a safe bet, applying those same indicators to similar assets may reveal that it's actually weaker than those competitors.

What is Tokenomics?

Certain projects create tokens that are, on the whole, somewhat unnecessary. That doesn't mean those projects are unviable overall, but that the token might not be of much use in this context.

Make sure you find out if the project's token has tangible utility, and whether this is something suited to the broader market. You also need to consider what value potential users would place on said utility.

Why is Fund Distribution Important?

Think carefully about how funds will be initially distributed - ICO, IEO, or via mining?

The project whitepaper should cover how much is retained for the founders and their team, as well as the amount that will be available for investors. If mining will be involved, look into the premining that may have taken place before the announcement of the network.

By focusing on fund distribution, you can get an idea of risk involved. For example, if a small number of parties owned most of the supply, you could conclude that the investment carries real risk, as said parties may manipulate the market down the line.

This brings our guide to crypto fundamental analysis to an end. We hope this has provided you with valuable insights to make informed decisions and, hopefully, smart investments!