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Crypto Fundamental Analysis: What it is and how to use it
Swen Keller
In the crypto world Swen has consistently found success through his effective communication skills and the unique ability to navigate the details.
Cryptocurrency fundamental analysis is based on analyzing the intrinsic value of an asset to determine how useful it will be in the future. Fundamental analysis requires traders to look at various factors internal and external factors such as on-chain, project, and financial metrics. These are used to decide if a crypto asset is undervalued or overvalued.
Crypto investors can use the data provided to make an informed investment decision about when to enter or exit positions. It allows them to select the most beneficial trading strategy. In contrast, technical analysis is also used to collect but provides different insights. In this blog, we will look into what crypto fundamental analysis is, what are the factors involved, and how it is different than technical analysis.
What is Fundamental Analysis?
Traders evaluate the intrinsic value of an asset by using fundamental analysis. This method is used to determine if crypto assets are overvalued or undervalued. An undervalued asset creates an opportunity for purchase due to the reduced market price. On the other hand, an overvalued asset allows you to make large profits from its sale.
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The crypto financial markets are incredibly volatile and even well-established currencies such as Bitcoin and Ethereum can suffer from sudden shifts in market sentiment. Cryptocurrency investing comes with a lot of risks and you need to have a proper understanding of the value of an asset to make the best investment decisions. Therefore, carrying out fundamental analysis allows novice and seasoned traders to effectively tackle changes in cryptocurrency markets.
Of course, fundamental analysis still doesn’t guarantee that you’ll be making the right decision down the road. It’s merely a powerful way of raising the odds of picking a winner.
How Do Fundamental Analysis and Technical Analysis Differ?
Both of these analytical methods are used to get trading insights. Fundamental analysis is investigating various aspects of an asset that may have an impact on future growth and profitability. These include financial statements, economic conditions, industry trends, and other factors. The goal of fundamental analysis is to discover assets that have the potential to perform well over time. This discovery is made through these factors.
Technical analysis (TA) is a method of assessing statistical trends and patterns in trading data such as price and volume. This allows traders to evaluate crypto markets and forecast future price movements. Patterns, trends, and other signals that may indicate future price movements should be identified using charts and other technical indicators.
Fundamental analysis focuses on an asset’s financial health and value in a competitive landscape. On the other hand, TA concentrates entirely on a security’s price and volume changes. Fundamental analysis is often utilized by long-term investors who are interested in a security’s fundamental value. Short-term traders who want to identify short-term market changes frequently employ TA.
Fundamental analysis requires a thorough knowledge of financial accounts, economic statistics, and industry trends. TA necessitates an understanding of charting tools, technical indicators, and price activity. Fundamental analysis implies that the market is not always efficient and that equities may be overpriced based on their underlying fundamentals. Conversely, TA assumes that all market information is reflected in the price and that previous price and trading volume data can help predict future movements.
Factors That Fundamental Analysis Focuses On
The primary purpose of carrying out fundamental analysis is to determine the potential risks associated with a particular security. This allows investors to take the necessary precautions and decide the probability of profit. In traditional businesses such as stock trading, investors use earnings per share or the price-to-earnings ratio to determine the intrinsic value of a share. We will be discussing the three main categories fundamental analysis factors are divided into.
On-chain Metrics
Blockchain technology is crucial to crypto fundamental analysis as it provides traders with on-chain metrics. Even so, manually extracting information from raw blockchain data can be a difficult task. Therefore, multiple application programming interfaces give the tools to assist in trading decisions.
Reporting tools have been developed by all leading crypto exchanges to make data such as active users, transaction value, and transaction numbers available to traders. Additionally, the hash rate is the most valuable of the on-chain metrics.
Hash Rate
Bitcoin is arguably the most popular cryptocurrency that runs on the proof-of-work consensus. Crypto miners are required to solve computational problems for the verification of each transaction on the PoW cryptocurrency network. Additionally, this prevents attackers from controlling the 51% majority of the blockchain. If a 51% takeover occurs, traders can change or stop the remaining transactions.
In essence, the hash rate is the sum of the computing power required by miners to solve calculations on a PoW blockchain. While it is very difficult to calculate the actual hash rate, it can be determined by using publically available data such as the current market price.
Investors use the hash rate as an indicator of an asset’s health. The higher the hash rate, the greater the intrinsic value of an asset and the more profitable it will be. Determining personal hash rates can display their own profitably to traders. Furthermore, the hash rate is also a good indicator of how secure the network is.
In contrast, if there is a decline in the hash rate, miners will discover that their cryptocurrency is not profitable. Whenever the crypto market suffers a downward spiral, traders are pressured to sell off their securities which will lead to miner capitulation. Low hash rates express a loss of interest for the investors in the larger market.
Active Addresses
Active addresses are a measure of the quantity of transacting addresses over a particular period. The easiest way to determine this is to add the receiving and sending addresses over multiple periods. Corellating the active addresses over days, weeks, and months allows you to compare the growth potential and decline of an asset. Moreover, it lets you assess the interest in a particular asset and how much value it holds.
Transaction Count
Transaction count is one of the key factors that can be used to measure the activity of a network. Investors can follow activity changes over time by plotting the number of transactions between particular intervals. They can also use moving averages to determine the activity. Transaction count is also a good representation of transaction volume.
However, using fundamental analysis through this metric requires caution. There is a possibility that only one party may be transferring money between their wallets to inflate their on-chain activity. This issue arises due to the inability to determine the activity of some active addresses.
Transaction Value
This metric expresses the value that has been transacted over a period to traders. As an example, if 5 Bitcoin transactions having an individual value of $500 were carried out on the same day, the daily transaction value would be $2,500. Regularly high transaction values demonstrate that a particular asset is in high circulating supply. Comparison between the previous transaction values of an asset can assist traders in making predictions regarding future price movements of said asset.
Additionally, while the transaction value is increasing for one asset, it is decreasing for another. This shows a potential market shift as attention moves elsewhere. Consequently, there could be an increase in the price of one crypto asset while the other one decreases.
Transaction Fees
The fees paid to carry out a transaction are an accurate representation of the demand for crypto assets. Transaction fees can be considered to be like auction bids. According to this, traders have to compete with each other for the execution of their transactions and its addition to the blockchain.
Therefore, investors who pay a higher transaction fee will get their transactions completed earlier. When carrying out fundamental analysis, higher fees show more demand from investors to have their transactions added to the blockchain. The fees paid are also a good metric for the security of a network.
Blockchains provide miners with rewards as they process transactions and maintain the integrity of the network. Transaction fees usually make up these block rewards. Block rewards get reduced periodically if the emission schedule for a cryptocurrency decreases, which is known as Bitcoin halving.
Transaction costs are increased as block rewards are reduced to allow miners to maintain their profits. If there isn’t a significant impact on fee value with decreasing rewards, miners might leave the network as they start to operate at a loss. Consequently, the security of the network also gets reduced.
However, one needs to keep in mind that not all blockchains offer block rewards and compete in regards to transaction costs as there are different blockchain protocols. You can dive deeper into this topic here. As a matter of fact, financial institutions want predictable and low transaction costs rather than volatile and potentially high fees.
Financial metrics
These fundamental analysis metrics are crucial if you want to analyze cryptocurrency. They provide traders with an overall summary regarding the performance of a cryptocurrency compared to the past. It also allows them to make predictions about its future growth.
Market Capitalization
Market cap is a representation of the market value of a network. It is calculated by multiplying the circulating supply of cryptocurrency with the current price. However, it is important to note that the fundamental analysis insights from market capitalization can be misleading. This will occur if other factors such as liquidity are not considered simultaneously.
Market cap can be utilized to predict the potential growth of a given cryptocurrency. Many believe that a lower market cap creates a greater buying opportunity when compared to assets with a higher market cap. On the other hand, some investors think that a higher market cap displays a more robust network infrastructure. This is expected to increase market demand.
Trading Volume and Liquidity
Liquidity measures the ease with which you can buy and sell a cryptocurrency. An asset is considered to have strong liquidity if it can be sold quickly without having a significant impact on its market value. A liquid currency has multiple buying and selling orders that are waiting to be fulfilled. Consequently, the bid-ask spread gets narrowed, serving as a good measure of liquidity.
Trading volume is a good fundamental analysis metric if you want to determine the ability of a crypto asset to sustain momentum. It is a record of how many units of crypto have changed owners in a particular period. In case an upward value trend is supported by a high trade volume, it is safe to assume that the crypto prices will continue to increase. Inversely, price changes without volume changes are considered to be isolated anomalies.
Project Metrics
Project metrics take a qualitative approach to cryptocurrency analysis. Project metrics will focus on external and internal factors such as cryptocurrency purpose and project operations to provide a comprehensive analysis.
Team
The combined expertise of all individuals on a team working on a crypto project is used to determine if the group has what it takes to complete said project. Investors are looking for particulars from their project teams such as if the members have previously launched a currency successfully. Moreover, they look for previous work on a well-known cryptocurrency project and if they have any history of fraudulent activities. They may also look for teams that are backed by expert advisors for crypto projects.
White Paper
A white paper is a technical document that defines a project’s goal and operation. It is the most significant document in the project and should preferably include blockchain technology solutions and use cases for cryptocurrency. It should also include a roadmap that details future features and improvements, token economics, and information regarding the teams for the cryptocurrency projects.
Token Economics and Utility
Tokenomics refers to the token supply and distribution scheme economics, which are vital in driving the price of a currency. The price of the asset will increase with an increase in demand. Investors may be able to spot potential risks by looking at token distribution. For example, if a small number of people own the vast majority of the supply, they might eventually manipulate the market by dumping all of their holdings. This could cause the cryptocurrency’s price to fall.
The utility of tokens is another factor that should be paid attention to. Some projects will generate tokens that have a low utility. If tokens don’t have good utility, their market demand will also be low. The value of tokens is less likely to increase if they have a low market demand.
Conclusion
If fundamental analysis is carried out in the right way, it can provide traders with important insights regarding crypto assets in a way other analysis methods aren’t able to. The ability to distinguish price movements from the overall value of a network is a vital trading skill to have. Fundamental analysis entails looking into all available facts related to a digital currency. Therefore, having a detailed understanding of fundamental analysis allows an investor to better predict its trends.
FAQ
Most frequent questions and answers
When assessing a cryptocurrency’s basic strength, you must perform in-depth research and evaluate the main signals. Consider the whitepaper, development team, liquidity, security, and economic model of the project. You should check credible and current sources for the most up-to-date information on fundamentally strong cryptocurrencies. You can also get insights from financial experts or crypto analysts who are up to date on the latest market trends and developments.
The three layers of fundamental analysis are Macro Analysis, Industry or Sector Analysis, and Company-specific Analysis. Macro Analysis examines broader economic issues such as GDP, inflation rates, and government policies that influence the whole market. Secondly, Industry or Sector Analysis examines specific industries, evaluating aspects such as competition, regulatory environment, and technology changes.
Finally, Company-Specific Analysis focuses on specific businesses, assessing their financial health, management quality, and development potential. These three levels collaborate to create a full view of investment prospects, taking into account both the broader economic background and the peculiarities of industries and companies.
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