Fundamental Analysis: What Is It And Why Is It Important?
With a fundamental analysis (FA), it is possible to measure the intrinsic value of an asset or a business. This can range from stocks or forex to cryptocurrency trading. The fundamental analysis for stocks and forex is quite different from doing a FA for cryptocurrency projects. A legacy financial market comes closest in comparison to a FA for crypto. The result of fundamental analysis is the same, though, assessing whether an asset is over-or undervalued. In general, traders use fundamental analysis for the long-term perspective.
A technical analysis (TA) is another approach to predicting an asset’s price movement. This is based on historical volume data and price action. Technical analysts strictly busy themselves with the numbers and figures on their charts and are not concerned about external factors. Technical indicators used for technical analysis are, for instance, Bollinger Bands, RSI, MACD, or Fibonacci retracement. Traders use technical analysis, typically for short-term predictions but can also be used for macro-level predictions too.
However, both methods deliver data that are relevant to trading. This may bring up whether either one of the methods is better. It may be best to find a middle ground to answer this question. A combination of both methods may bring the best results.
Since we are crypto traders and investors, we concentrate on fundamental analysis techniques for crypto trading.
What is fundamental analysis?
With fundamental analysis, traders and investors can determine the intrinsic value of an asset.
Objectively, it is possible to measure how much an asset is worth. With all the collected information about an asset, the evaluation will show if the said asset is over-or undervalued.
Shortly after the Great Depression, in 1934, Benjamin Graham and David Dodd published a book titled ‘Security Analysis.’ To this date, traders still use the idea described in this book to consider each and every of an asset’s factors to be of importance. It is also referred to as the bible for securities valuation. Although the authors wrote this book with stocks and bonds in mind only, the idea soon spread to all kinds of different investment decisions. The ‘Oracle of Omaha,’ Warren Buffet’s nickname, is a perfect sample of a believer in fundamental analysis. He used FA very successfully in trading stocks.
In general, if fundamental analysis considers an asset as undervalued, the recommendation is to invest in this asset and to stay away from an overvalued asset.
Fundamental analysis and the crypto market
The cryptocurrency market is not subject to international regulation, the same way that the traditional financial markets are. As a result, quite a few traditional business metrics are of no use in the crypto market. However, the crypto market can still apply similar concepts used in traditional stock trading. Crypto trading most certainly has enough similarities to justify this.
Short-term investments may reap good profits in the crypto market, but the crypto market is also volatile. As a result, a crypto project that performs well can quickly become a lot less profitable. Therefore, it is essential not to only look at a cryptocurrencies performance or market value but rather try to find its real value. This is very similar to traditional trading activity, and this is precisely where FA comes in.
Investors use similar techniques compared to FA in traditional finance when evaluating crypto assets. For example, an investor likes to know if an asset is over-or undervalued to decide if it is worth investing in or if it’s better to stay away from it. With over 15,000 cryptocurrencies already on the market and well over 1,000 having failed, conducting fundamental analysis should be an integral part of anyone’s trading strategy.
The fundamental analysis of digital assets requires some unique factors to consider. There are also different specifics to look out for, and an investor needs to consider many factors. Some of them are qualitative, and others are quantitative. Numbers and characteristics that are measurable make up the quantitative aspects. The qualitative metrics are harder to pinpoint because they are not final facts.
To understand the many aspects that come into play with crypto fundamental analysis, they become more accessible if we split them up into three parts—projects, financial, and blockchain metrics.
What are the project metrics in fundamental analysis?
The project metrics are part of the qualitative metrics in evaluating how a cryptocurrency performs. These metrics look into how a project works or who is behind it. It investigates the development side of a project.
The teams of most cryptocurrency projects can be easily found. Now it is possible to see their experience and success rate in similar projects or with blockchain technology. Thoroughly checking out their profiles can help determine if they can follow and achieve the roadmap on time. The advisors of a project can also be essential to decide on how credible a project is.
The white paper
The white paper is a critical aspect of the project metrics. Occasionally, a white paper can become very technical, and the team can also decide to publish a lightpaper. The lightpaper is less technical and easier to understand. The crypto white paper outlines various aspects of the project. It should at least support the technical aspects, the tokenomics, information about the team, what problem this project will solve, and any planned features with potential upgrades.
A white paper should be informative, clear, honest, and realistic. It doesn’t hurt to be skeptical about a project’s goals or to look for other people’s reviews of the white paper.
Is this project unique in what they are trying to achieve, or are there competitors with a similar or the same idea? There’s nothing wrong with good competition, but a few questions should be asked. How strong is this project compared with other similar projects? Will this project be able to outperform the competition? What does the overall ecosystem of this project look like?
The tokenomics explain the economic factors of this project, the supply, and demand. Cryptocurrencies can start in different ways, with an ICO, IDO, or IGO. How much of the initial token supply is going to the team? Is there a potential for a rug pull if that percentage is high? Is there a token release schedule? It is also essential to check the use cases of a token.
The roadmap should outline the team’s goals during various project development phases. Is there a testnet? When is the mainnet scheduled to go live, when are new features planned? Is the team up to follow this roadmap, and is the roadmap realistic?
What are the financial metrics in fundamental analysis?
The financial metrics are more quantitative and, therefore, most likely easier to find. Understanding the financial aspects involves trading conditions like liquidity, other surrounding factors, and market reactions.
The market capitalization of an asset is one of the most important factors to investigate because it represents a network’s value. The market cap can be easily calculated by multiplying the total number of coins in circulation by the current price of the coin or token. In general, low market caps have an opportunity to grow, and high market caps tend to be more stable. However, liquidity is also of importance. Nonetheless, a market cap gives a reasonable estimate of a network’s value. It will never be an exact or precise number since there is always an unknown quantity of coins because of lost wallets or keys or coins that owners forget about.
Liquidity is how easy it is to buy or sell the cryptocurrency of a project. If selling and buying a cryptocurrency can be done quickly and easily without changing its market price, the liquidity is strong. The bid-ask spread is a good indicator of an assets’ liquidity. If a cryptocurrency is liquid, it should have a well-filled order book with many buyers and sellers.
The trading volume tells a lot about the ability of a cryptocurrency to support momentum. First, it reveals how many times a cryptocurrency, or parts of it, has changed hands over a fixed period.
Combined with an upward movement, a high trading volume generally indicates a profitable trend. On the other hand, price swings with hardly any trading volume are relatively insignificant.
The circulating supply tells how many coins are accessible on exchanges to the public. Cryptocurrencies can be inflationary or deflationary. In contrast to the maximum and total supply, which are fixed, the circulating supply can change. This can be due to a release schedule of the token, a coin or token can be mined, or because tokens can be burned.
What are the blockchain metrics in fundamental analysis?
The blockchain metrics can provide lots of valuable information since this is where all cryptocurrencies live. Although the blockchain or on-chain metrics can be challenging to find at first glance, with a bit of digging, they reveal a lot of information about important factors of a cryptocurrency.
The hash rate can only be found on a Proof of Work (PoW) blockchain, like Bitcoin and Ethereum. That is, for the latter, until they change to Proof of Stake (PoS). The blockchain helps in securing each network, and with the hash rate for a PoW mechanism, it is possible to find out how fast miners can mine a new block. The higher the number, the more likely a miner can receive a reward, and it is less likely there will be a hack, like a 51% attack. The hash rate shows how healthy a PoW blockchain is. If the hash rates drop enough, miners may not be interested anymore in that specific currency because it is not profitable anymore.
Check all the sending and receiving addresses within a given timeframe and compare growth or decline in transactions. It will provide information about how much interest there is for a specific coin or token.
The transaction value metric will tell how much value has been moving around for a specific coin or token on a blockchain during a predetermined timeframe. A high value for an extended period of time means a steady circulation. It may be an indicator for future movements in a market.
The higher the gas fees, the more motivated miners are to approve transactions. It also indicates demand on a blockchain; more demand means a more secure blockchain. Not all blockchains work in this way, however.
What other metrics do exist?
Categorizing all metrics in the three primary metrics discussed above is not possible. Some metrics fall outside of the three metrics mentioned.
This sociopolitical environment may be hard to gauge, but it seems every time that China puts another ban on crypto, the market suffers. The Covid-19 pandemic is another example of how a market reacts to news that impacts the whole world. The stock markets and the crypto market suffered from this. Between 7-13 March 2020, Bitcoin’s price crashed no less than 58%.
With governments printing fiat currencies out of thin air, the inflation may drive investors back to the crypto markets, though. As a result, 2021 saw a couple of ATH (all-time highs) for BTC and massive overall growth.
External events can have an impact on user behavior. A tweet by Elon Musk can have meme coins shoot to the moon or see Bitcoin drop by a fairly high percentage. To put a finger on user behavior is like predicting the weather; it isn’t easy. Marketing and social media can have an impact and favor coins or influence investors.
Fundamental analysis for cryptocurrencies works differently compared to FA in traditional markets. This is because different dynamics are at play, which asks for a slightly different approach.
The three main factors to look for are project, financial, and blockchain metrics. Nonetheless, having a sound understanding of technical analysis will only complement any fundamental analysis. The best results in finding a sound investment strategy will come from using the best of both worlds. Combing fundamental and technical analysis will give any investor a cutting edge on this competitive and volatile market.
Nothing is ever guaranteed, but with the right tools and attitude of doing due diligence, combined with thorough research and FA/TA, some will be able to profit from the insights it will bring them.