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Fundamental analysis provides traders and investors with deep insight into the value of an asset — but can get complicated. This article will explain what fundamental analysis is, how it differs from technical analysis, and explore some of the most commonly used tools and metrics.
Crypto fundamental analysis is primarily concerned with understanding an asset’s “intrinsic value” or “real value” and where that value comes from. By quantifying and assessing a range of metrics, fundamental analysis takes a businesslike approach to determine the underlying value of an asset.
Cryptocurrency traders and investors use a wide range of tools, analysis techniques, and metrics to predict the price movements of digital assets. Fundamental analysis is an analytical approach that focuses on carefully investigating all available information on an asset, including qualitative factors.
Fundamental analysis can involve assessing the total number of active addresses using a cryptocurrency, the use cases or competitors of a blockchain or crypto project, or the team behind it. The primary goal of fundamental analysis is to reach a deep understanding of an asset in order to determine whether it is undervalued or overvalued, which can then be incorporated into a trading or investment strategy.
Cryptocurrency investing and trading is complex — the crypto market is highly volatile and subject to change based on a broad spectrum of factors. Developing a strong and healthy cryptocurrency trading or investing strategy requires an understanding of both fundamental and technical analysis, each of which focuses on different metrics.
In order to gain a strong understanding of fundamental analysis (FA), it’s important to grasp the core differences between fundamental analysis and its counterpart, technical analysis.
A lot of cryptocurrency traders use technical analysis (TA) to trade crypto assets. TA is often used to assess potential market movements, market sentiments, and trends through quantitative factors like current market price, volume, and other historical market data. TA focuses on anticipating future market movements through the use of tools such as candlestick patterns, moving averages, Bollinger Bands, and other essential indicators.
Fundamental analysis, however, is primarily concerned with the causes that drive price changes in cryptocurrency markets rather than statistical analysis. It also refers to any external factors that may impact the price performance of an asset. For example, fundamental analysis may focus on the background of the founders and development team behind a project. Other fundamental analysis metrics include use cases, competitors, and market capitalization (market cap).
Both TA and FA provide valuable insights — there’s no superior approach to analysis. Good cryptocurrency trading or investment strategies commonly integrate both analytical approaches in order to gain perspective on both macro and micro trends within a market.
Technical analysis uses historical price data and patterns to predict future price trends. Fundamental analysis uses metrics such as active addresses and dev team commits to determine an asset’s “fair value.”
The metrics used to quantify and measure data through fundamental analysis can be broadly divided into three separate categories:
On-chain metrics are derived from data that can be accessed from a public blockchain — almost all blockchain networks operate in a permissionless, open manner, which allows anybody to access the data stored on them i.e. transaction data.
On-chain metrics can provide information on the number of people using a blockchain network, the cost or speed of sending a transaction on a network, or the amount of computing power used for the operation of a network. These factors can deliver insight into the potential growth and activity of a blockchain project — or lack thereof.
The most convenient and time-efficient way to access this data is to use information from third-party websites and tools that collect and publish it independently. We have compiled a list of useful on-chain analysis tools and sites at the bottom of this article.
Calculating the number of transactions made in a given time period on a blockchain network is a strong indicator of how active the network is. Transaction throughput is used to measure the speed of a blockchain and it’s typically expressed in transactions per second (TPS).
It’s important to note that while transaction count can provide actionable data for large blockchain networks, smaller networks are susceptible to on-chain activity inflation. This means that some people can manipulate activity by performing transactions between their own wallets on smaller networks.
Calculating the total value of transactions sent within a time period is another effective method that can be used to gauge network activity. Determining the daily transaction volume of a cryptocurrency provides insight into the number of transactions made on a network and their average cost.
The number of active addresses on a blockchain network is a powerful way to determine exactly how many people are using a cryptocurrency or network in a given period. There are multiple ways to calculate active addresses, but the simplest approach is to count the total senders and receivers of every transaction sent within a specific time frame.
Determining the fees paid for transactions on a blockchain network can provide unique insight into the microeconomic relationship between transaction senders and miners, who process transactions for fees.
Cryptocurrency users seeking to send transactions, in most cases, are able to define the fee they’d like to pay to have a transaction completed. Getting a faster completion time usually requires a higher fee. A transaction with a higher fee is more likely to be included in the next block by a miner.
Miners are typically rewarded with two incentives to complete a transaction — a transaction fee and, in the case of Proof of Work blockchains, a block reward. Blockchain networks that periodically decrease block rewards, such as Bitcoin’s block reward halving, must balance the decrease in block rewards with an increase in transaction fees in order to incentivise miner participation in the network.
Observing transaction fee trends over time allows can indicate a number of valuable insights. For instance, you can view macro trends in transaction fee pricing and predict future miner participation in a blockchain network. A blockchain that fails to sufficiently incentivise miner participation may lose miners as they migrate to other more cost-efficient blockchains to mine. This can then compromise the security of a chain and increase susceptibility to 51 percent attacks.
Blockchain networks use a variety of consensus methods. These consensus methods dictate how a blockchain is secured and how all network participants agree on the current state of the ledger. Consensus methods play a critical role in maintaining transaction throughput and securing blockchain networks and are therefore highly relevant to fundamental analysis.
The two most widely-used consensus methods are Proof of Work (PoW) and Proof of Stake (PoS). Proof of Work leverages decentralized computing power to secure a blockchain network and disincentivize bad actors through the high energy costs associated with mining. This means miners compete to solve complex equations in order to create a new block.
Proof of Stake, on the other hand, forces miners to stake — or “lock-up” — a specific amount of cryptocurrency in order to participate in the mining process.
Did you know?
Staking coins not only helps secure the network, but it will also earn you staking rewards, thus providing you with passive income.
Hash rate is typically used as a key network health metric for Proof of Work blockchains. The collective amount of computing power directed toward solving blocks on a PoW blockchain such as Bitcoin is calculated in hashes per second.
In simple terms, a high hash rate on a PoW blockchain is associated with higher network security and higher interest from miners, indicating a healthy, growing network. Inversely, a drop in hash rate can represent falling interest from miners due to cost inefficiencies in the economic model that incentivises them.
Staking volume can be considered as roughly equivalent to hash rate when applied to Proof of Stake networks within the same context. The total amount of cryptocurrency staked by miners in a PoS network is indicative of total interest in the network, or the overall security of a network. This is often referred to as total value locked (TVL).
Project metrics focus on qualitative factors such as the team behind a project, the level of engagement within the developer community that drives a project, documentation such as whitepapers, competitors, use cases, and roadmap milestones.
The most important factor to consider when assessing the documentation of a blockchain project is the whitepaper. A whitepaper is a document that should provide a deep dive into the technology that drives a project, the problems it solves, and various other factors. A blockchain project whitepaper should provide details on:
Blockchain and cryptocurrency projects should provide detail on the individuals working to bring them to fruition. The expertise, history, and track record of individuals within a team can provide insight into whether or not a project will be successful.
When assessing the team behind a project, it’s important to check whether or not critical or leading team members have executed successful ventures within industries relevant to the project before. Team members should possess sufficient expertise to achieve project goals.
In addition to core team members, it’s best to check the activity and engagement of the developer community that supports a project. If a blockchain project has a GitHub, check the number of contributors and the regularity of contributions. A project with regular, productive activity on GitHub, for example, may be more reliable than a project that has remained stagnant for an extended period of time.
Successful blockchain or cryptocurrency ventures address a specific use case. The whitepaper of a project should provide a clearly defined use case for the project. Competitors should be clearly highlighted alongside an analysis of the infrastructure a blockchain project seeks to replace.
A project with realistic use cases, innovative and well-defined solutions, and a clearly defined market, for example, may present a stronger opportunity than a project with no obvious use cases or market research.
Blockchain projects may issue tokens as part of the launch process. Any project that issues blockchain tokens should be carefully assessed to determine that any issued tokens offer a utility that will be recognized by the wider market and therefore represent value.
Tokenomics is concerned with the supply and demand characteristics of a token or cryptocurrency. It’s important to consider the initial distribution of tokens issued by a project, such as via an initial coin offering (ICO) or an initial exchange offering (IEO). The whitepaper of a project should specify if or how many tokens are held in reserve for founders or team members, and how many tokens will be available for investors.
Assessing the token distribution model of a blockchain project can provide insight into the level of risk it presents. A project that reserves a large percentage of issued tokens for founders and team members, for example, may represent a high-risk investment due to market manipulation concerns.
Information on the current trading price of an asset, historical price data, trading volume, and liquidity are all metrics typically associated with technical analysis. There are, however, a number of general financial metrics that can be used to capture fundamental analysis insights into the economics of a cryptocurrency or blockchain project.
Market cap functions as a general representation of the total potential value of a project or blockchain. That said, it can misrepresent the amount of value committed by holders. It’s trivial for any developer to mint a new token with a supply of one hundred million units — if a single token trades at $1, the total market cap for this token would therefore be $100 million.
The market cap of a cryptocurrency or token is calculated by multiplying the current price of an asset by its total circulating supply. This value represents the cumulative cost of all units of a cryptocurrency token.
Market cap should be viewed in combination with a strong value proposition to ensure that the market at large would see value in a token. In the context of fundamental analysis, market capitalization can be used to gauge the growth potential of a project.
Keeping track of a coin’s market cap ranking can be a useful way to measure how valuable the market perceives that coin to be. For instance, if a coin is in the top 10 for five years straight, it is likely to be a stable project with lots of value and real-world utility, rather than just another flash in the pan.
Assessing the liquidity and trading volume of an asset can assist traders and investors in determining how easy an asset is to buy or sell. Liquidity refers to the ease with which an asset can be traded — a highly liquid asset can be purchased or sold easily.
Illiquid markets, however, make it difficult for market participants to either sell their assets at a price agreeable to them, or purchase assets at a competitive price. A cryptocurrency with a highly illiquid market may indicate a lack of interest from buyers or sellers.
The trading volume of an asset can be used to measure liquidity and typically represents the amount of value that has been traded in an asset in a specific time period. Both liquidity and trading volume function as indicators of market interest in an asset.
The maximum supply, circulating supply, and inflation or deflation rates of an asset can significantly influence investment or trading strategies. Some assets, such as Bitcoin, operate with a hard limit on the total number of units that will ever be issued. Other assets reduce, or “burn” tokens in order to decrease supply.
Did you know?
There will only ever be 21,000,000 Bitcoin in existence, with the last coin predicted to be mined around 2140.
The way a blockchain project handles supply can alter the way users and network participants handle them. Assets with a hard cap on issuance, for example, may disincentivise holders from using them as originally intended due to hoarding, reducing market liquidity. Limiting the number of assets issued by a project, however, can have a significant impact on scarcity and asset price.
Now that you understand the difference between metrics and indicators, let’s look at how we can combine metrics to create powerful fundamental analysis indicators. There are shortcomings with most metrics and looking at them by themselves may result in missing crucial information. Combining metrics provides us with the most complete picture of an asset.
There are lots of indicators and metrics available to choose from. If you’re just starting out, it’s a good idea to start with the most popular ones, first. But remember, each indicator only tells part of the story, so be sure to use a variety of them in your analysis.
The Network Value to Transaction ratio (NVT), also referred to as the network transaction value indicator, shows the correlation between market cap and transfer volumes. It is similar to the P/E ratio (price to earnings) used in the stock markets.
When NVT is high, this indicates that the network value is higher than the actual value being transferred. This could represent organic growth or a potential price bubble. If the NVT is low, it means that the network value is lower than the value being transferred on the network, which could represent negative market sentiment.
The Market Value to Realised Value ratio (MVRV) compares an asset’s market cap (total supply x current price) to its realized capitalization (market cap minus lost or inaccessible coins).
MVRV can be used to determine whether the price is above or below the “fair value”, which can be useful in spotting market tops or bottoms.
The Stock to Flow ratio (S/F) is a model based on the assumption that scarcity drives value. The model views each cryptocurrency as a fixed, scarce resource. As a result of the limited supply, investors feel confident that they can use these assets as a store of value.
Bitcoin’s value has historically followed the S/F Ratio, making it a popular model among traders and investors for predicting future price movements.
There are a number of tools that can be used to streamline the fundamental analysis process. Capturing transaction data from blockchain networks by downloading a client and operating a node, for example, can be time-consuming. The following tools provide highly relevant data and insights when performing fundamental analysis.
Fundamental analysis provides investors and traders with detailed, actionable insights into the level of interest, activity, and viability of blockchain projects. FA focuses on the key value propositions of a project, the level of activity, and the parties responsible for its development and growth. While there are many insights that can only be accessed via TA or fundamental analysis alone, many traders and investors choose to incorporate both methods for the most comprehensive analysis possible. Check out the Swyftx Learn platform to learn more about technical analysis or any of the other specific terms used in this article.
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