For cryptocurrencies and securities, in general, there are three types of analyses you could carry out to evaluate your investments. These are fundamental analysis, technical analysis, and sentiment analysis. Today, we dive into the fundamental analysis.
What is Fundamental Analysis?
Fundamental analysis typically precedes the other two analyses, since these are focused on assessing market fluctuations and trends. Through fundamental analysis, you could figure out which cryptocurrency projects are worth your buck. It's all about forming an educated opinion about the coins and tokens that you believe will reign supreme in the years to come.
Regardless of your experience level, it is wise to conduct fundamental analysis both as a starting point and as a recurring task. On the Cryptohopper platform, it could help you to determine the input to your automated trading bot, as you make the coin selection and decide on a trading strategy.
Coins vs. Tokens - Is there a difference, and, should you care?
When scanning the cryptocurrency space, it is essential to understand what kind of investments you could make. So, as a starting point of your fundamental analysis, you should be able to identify the differences between “coins” and how these differ from “tokens”. This will give you some idea of what the technology looks like and how it was developed.
Currencies are generally defined as a medium of exchange, a medium for value storage and as a unit of account. Unlike Bitcoin, many offerings in the market today do not fulfill these characteristics. Making it somewhat misleading to assign them the currency label. Most of the coins that are currently in the circulation are in fact variants of Bitcoin, meaning that they have tweaked Bitcoin’s original open-source protocol. The resulting new coins have unique features and run on a distributed ledger derived from the Blockchain. On these distributed ledgers, transactions are recorded in terms of their corresponding coin. Alternatively, other coins run on their own native blockchain, meaning their distributed ledger has been built from scratch. You might want to research this to better understand the development of a project or if you think that the shortcomings of Bitcoin’s blockchain may expose it to future disruption.
For people new to the crypto investing, there tends to be some confusion about the difference between coins and tokens. Coins are usually only used to transfer funds and operate independently. Tokens, on the other hand, are built on existing blockchains and given out to the public through Initial Coin Offerings (ICO). They can be used for transactions within a project’s ecosystem, to facilitate the interaction between decentralized applications or to perform other specific purposes in the system. Tokens are far easier to create than coins since you do not have to develop a new distributed ledger. However, they do bear a considerable risk. Before investing in a token, you should be sure that the application on which it is used, will be adopted for the intended purpose.
The analysis process
Doing due diligence is very important for cryptocurrencies, mainly because they do not represent equity in a company. Their value is not based on business performance but rather on community engagement, which can be very unpredictable. In order to find out if your investment is valuable, you need to first categorize the coin or token, by finding out how it was developed, whether it fulfills essential functions to be competitive in the marketplace and/or creates unique value. Investigate the coin’s adoption and ecosystem, whether the technology is well-developed enough to handle fast-paced expansion in the future and if the company has a realistic plan to manage this expansion. Finally, look into the company, its resources, roadmap and (marketing) strategy for gaining users. Try to find out if the company is currently on track with its roadmap.
To give a more in-depth view, we will discuss primary considerations for assessing a coin’s quality that a lot of other traders use:
In almost all cases, traders will look if a cryptocurrency facilitates trust-less decentralization. This means that there is a way of sending transactions to anyone in the world without having a centralized party involved. As Bitcoin has enabled this since 2009, it is basically a prerequisite for cryptocurrencies. Traders, therefore, look for new projects offering in-demand functionalities on top of trustless decentralization.
Long-term scalability and performance
If a traders invests in a coin because he/she believes it will become more widely used. It has to be scalable to handle the surging transaction volumes of its growing user-base. So unless a project can be scaled without jeopardizing any of its core attributes (e.g., decentralization, transaction speed, fees, security), it might not be a viable option for the future.
Traders want to keep an eye on some of the exciting recent developments in the space related to how companies attempt to steer clear of scalability issues. Other related metrics are “hash rate” and “mining-difficulty”.
The “mining-difficulty” concerns how complicated or costly it is for miners to find a new block. The “hash rate” gives you an indication of how much mining is going on. When this rate is high, you can generally assume that the network is more secure. If the rate is decreasing, this might lead to longer confirmation times and higher transaction fees in the system. Lastly, keep in mind that some select currencies are pre-mined, meaning no more new coins will be issued. For such coins, these metrics are not applicable.
Adoption and Expansion
The wide adoption is paramount for cryptocurrencies as currencies are subject to strong network effects. This means the utility users can enjoy, grows with the number of others users and the number of compatible applications available in the market. More users equal more trading partners, and more applications equal more ways to trade goods and services.
Without such network effects, a currency is effectively worthless, unless it can distinguish itself from a more established counterpart through radical innovation. So, the added-value holders of a currency can receive in a small network through new and disruptive features, has to be so substantial that they are willing to give up the greater network effects of a bigger network. It may, therefore, make sense to begin by building your portfolio with some of the more widely traded coins.
The best way to check this is to track a coin’s market capitalization and study its rate of expansion using the trading volume metric. Additionally, traders look into the number of unique addresses utilizing the coin per day. If this value grows, it can be a reliable figure for measuring adoption.
Company Resources and Team
One of the goals of fundamental analysis is to avoid scammers and con-artists from getting their hands on your money. In many cases, you can quickly do this by checking out the team behind the coin. The crypto market is becoming more mature and competitive, so traders are asking themselves if they think a company expresses the expertise, brain power, resources and trustworthiness necessary to deliver a working product.
Where can I find this information?
If you just started out, you may be sitting there wondering where you can get these insights. So, here some tips for finding reliable sources:
- White papers are a great place to start. They are usually drafted by the development team to outline who and what is behind the technology. It may also be helpful to compare white paper of competitors to understand technologies, teams, and roadmaps.
- You can get involved in the community through social channels. This tends to be the official communication channel of the core development team. Join to receive answers to your questions.
- If you are looking unsolicited or less biased points of view, a good medium is discussion forums. They can simplify the research process and make you aware of red flags directly from other users.
Here is a list of websites you might find handy for your fundamental analysis:
In the beginning, it might make sense to do research regarding what differentiates the top cryptocurrencies so that you can properly follow our proposed steps. It will also teach you to think more critically about cryptocurrencies, for instance concerning the importance of scalability, mining, price stability, and transaction speeds.
Although this article may help you in deciding what you think makes a certain cryptocurrency worthy of your investment, it is still advised to proceed with caution. 2018 has shown that the market is still maturing and many companies have had to close shop. Your analysis should aim at identifying projects that have long-term potential, as it is likely that many coins will not be around in the future.
We hope you have learned how you can form a more personal opinion about your potential crypto investments. And as always: Happy Hopping!