The Basics of Fundamental Analysis
Before entering the digital asset market, investors may consider digging into methods of pricing crypto currencies: technical, fundamental and quantamental analysis. Today, in this note, we will explore how fundamental analysis is applied in the context of digital assets pricing.
On top of the technical analysis described in our last paper, investors may also look at the global picture to understand the underlying factors driving the price and volumes of crypto assets. Fundamental analysis is used by investors to establish the "intrinsic value" of an asset or business. By looking at a number of internal and external factors, they will determine whether an asset or business is overvalued or undervalued.
Traditional fundamental analysis focuses on business metrics such as earnings per share or the price to book ratio (how investors value the company versus its book value). Cryptocurrency ecosystems on the other end cannot be assessed the same way, as they do not behave the same way.
Fundamental Analysis on digital assets focus on three different categories: on-chain metrics, project metrics and financial metrics. In each of these categories, investors look at some of the specific metrics described below.
- On-chain metrics
On-chain metrics are those that can be observed by looking at data provided by the blockchain. You can do it yourself by running a node on the network or pull the information from the websites or APIs for a more straightforward solution. As an example, click here to get bitcoin on-chain metrics.
You will follow the transaction count, transaction value, active addresses, security / hacking history and consumer protection, potential roadblocks.
- Project metrics
Project metrics involve a qualitative approach and will dig into many factors including the track record of the team, the whitepaper (overview of the cryptocurrency project) and the upcoming roadmap.
External factors that help to assess a project are the token economics (known as tokenomics) which consist in assessing whether the token issued has a real utility. Some new ecosystems in a blockchain environment are ingenious and disruptive whereas others can be dangerous and unstable.
Finally, competition analysis is as important as for traditional finance to assess the position of an asset compared to the market, analyse the new protocols, innovations and follow the regulation.
- Financial metrics
Financial metrics include all the information about trading and liquidity: market capitalisation, liquidity and trading volume, supply mechanism.
Market capitalisation is used extensively to figure out the potential growth of networks.
Circulating supply refers to the number of cryptocurrency coins or tokens that are publicly available and circulating in the market. Total supply refers to the number of coins or tokens that currently exists and are either in circulation or locked somehow.
Analysing those metrics individually can be misleading. Ideally you will combine some of these metrics and identify strong ones to better understand the financial health of the assets you would like to trade.
Some examples of popular pricing models
The Marginal Cost of Production model plays an important role in explaining bitcoin prices, challenging allegations that bitcoins are essentially worthless. According to microeconomic theory, under conditions of competition, the marginal product should equate with its marginal cost, which should also equal its selling price.
NVT ratio: the Network Value-to-Transaction ratio involves dividing the market capitalization (network value) with the amount transacted (typically on a daily chart). Coined by analyst Willy Woo, the NVT ratio has been called the "price-to-earnings ratio of the crypto world."
Metcalfe’s Law states that the value of a network is proportional to the square of the number of participants in the network. This rule has been widely accepted in the valuations of Facebook, Tencent, and can calculate a cryptocurrency’s value.
Trading assets as volatile as cryptocurrencies requires mastering technical, fundamental and quantamental analysis. If you decide to be less price sensitive, you might opt for a diversified index, where movements are smoothened by the various assets in the index. At Trakx.io, we offer Crypto Traded Indices (CTIs) to get an easy exposure to thematic strategies similar to ETFs in traditional finance. Investors need to select the thematic that meets their investment objective and match it with one of our various products, such as Top10 DeFi, Lending, Diversifier, Digital Inflation hedge, Vol controls, Decentralised and/or Centralised exchanges.
This paper will be followed next week with another method of Crypto Asset Valuation, the Quantamental Analysis.
Please contact Laurent at Trakx for additional questions.
Email [email protected]