Fundamental analysis as a decision to select cryptocurrency investment targets
Preface
No matter what kind of transaction, there are risks. I believe everyone has heard that "one day in the cryptocurrency world is ten years in the real world". The reason is that the stock market in the traditional financial market has a limit on the rise and fall. Once the price change exceeds the range, it will trigger a trading halt to prevent excessive profits or expanded losses. In the emerging financial market of cryptocurrency, there are no price and time limits. People in the cryptocurrency world never rest. It is always a trading day, and there is no day when the market is suspended. While bringing unlimited possibilities, risks also come with it. Under the rule of high rewards and high risks, what good methods can help investors make the best cryptocurrency investment decisions?
What is fundamental analysis?
In the traditional financial trading market, investors will make corresponding decisions based on the changes in the stock market, and appropriate decisions require appropriate analysis methods. The analysis methods can be roughly divided into three types: fundamentals, technical analysis, and chip analysis. The fundamental analysis of the traditional financial stock market uses three major financial reports and four important indicators to understand the financial status of the listed company, and based on the company's profitability, determine whether it can be used as a long-term investment target.
The above three financial reports include the comprehensive income statement to determine whether the company has a net profit, the balance sheet to view the company's assets and liabilities, and the cash flow statement to examine how much highly liquid cash the company actually has.
The four important indicators are as follows: Earnings Per Share (EP) which shows how much each share earns, Price-Earnings Ratio (PE) which predicts how long it will take for the stock to recoup its investment, and Operating Gross Profit Margin which examines the profits of the company's products and Price-Book Ratio (PB) which determines whether the current stock price is reasonable.
Whether it is the traditional stock market or the emerging cryptocurrency market, in short, fundamental analysis is the most important indicator used by investors in the financial market to assess whether the value of an asset is overvalued or undervalued.
Cryptocurrency and fundamental analysis
Cryptocurrency is different from the stock market of traditional finance. Project owners and currencies do not provide standardized quarterly financial reports released by listed companies for review. The three major financial reports and four important indicators are meaningless here. Therefore, the traditional financial market fundamental analysis method is not applicable to the emerging financial market of cryptocurrency.
Cryptocurrency, due to its decentralized nature, does not necessarily have a universal measurement standard. Sometimes there is too much noise in the market, and the rumors circulating in the cryptocurrency circle are both true and false. After hearing the news, it is necessary to exclude some artificially manipulated news and use appropriate indicators to check the reliability of the source. For example, Twitter or Telegram that you follow may publish false news, or a sudden increase in the number of active addresses on the blockchain may also be a false impression of water injection.
What are the suitable indicators and tools in the cryptocurrency world that can be combined with news to form the best fundamental analysis decisions?
The following article will discuss the three most basic metrics, three key indicators, analysis tools and news for cryptocurrency fundamental analysis.
Three basic metrics
1. On-chain metrics
On-chain metrics refer to the data that can be observed on the blockchain and used as an indicator for judgment. However, collecting data from each single node alone is time-consuming and labor-intensive. You can refer to the information provided by websites designed specifically for investment decisions, or obtain the required information from APIs (Application Programming Interfaces).
Number of transactions
It can be used as a simple measure to detect network activity. By observing transaction activities over a period of time, the number of transactions on the chain can be seen. However, it should be noted that there is no guarantee whether there is any artificial increase in the transaction records on the chain. It is just transferring assets between many wallets, and the probability of fraud and water injection needs to be considered.
Transaction Value
Different from the number of transactions above, transaction value refers to the total value of transactions in a period of time. The total transaction value on the chain needs to be calculated by multiplying the number of transactions by the transaction amount.
Active Addresses
Refers to the blockchain addresses that are active within a fixed period of time. There are countless ways to detect it, but a common method is to observe the number of senders and receivers of each transaction on the chain over a period of time, and check the accumulation of the number of addresses every once in a while to track the total number.
Paid handling fee
Through the demand for blockchain, if the blockchain is congested and the transaction takes a long time, the on-chain transaction fee can be increased to speed up the transaction schedule; if the blockchain is smooth and the transaction schedule does not take too long, the transaction fee can be reduced, that is, the transaction schedule can be increased to save transaction fees. The fee can intuitively know the degree of demand for this blockchain for the market audience. The higher the demand and the more crowded it is, the higher the fee.
Hash rate (computing power) and stake amount
In the distributed ledger system of blockchain, some mechanism is needed to determine the order of operation of each network node. This design that relies on the node calculation mechanism is called a consensus algorithm, which is very important for maintaining the stability of the blockchain and ensuring the security of the system.
One of the most common and original consensus algorithms for cryptocurrency is Proof of Work (PoW). For example, Bitcoin actually operates based on hash rate, or computing power - the total computing power for mining and processing transactions on the blockchain. Transactions on the chain are cumulative and cannot be tampered with. The typical 51% attack problem - if a hacker wants to successfully tamper with or forge blockchain data, he must control more than 51% of the nodes in the entire network. Therefore, the higher the hash rate, the more difficult it is to cause a 51% attack.
Another common method is Proof of Staking (PoS), the basic principle of which is that investors participate in block verification by staking assets. The market preference can be determined by examining the amount of staking.
2. Project Metrics
Project indicators examine the operational performance of the team behind the project and the results of project development in various ways.
white paper
White papers are like stock prospectuses in traditional financial markets, but they tend to provide technical information related to the project, which can help you understand the project's operating principles. They also state the project's future vision and initial resource allocation. The details are summarized as follows:
Technical aspects
Related applications
Roadmap for upgrades or new features
Token supply mechanism and issuance related
team
Since most cryptocurrency project owners put team member information on GitHub, it is very convenient to obtain team member information. Relevant information can be obtained by using GitHub, an open source development platform commonly used by programmers. Users of this platform can upload files and data to their accounts and allow everyone to view them. It is a very convenient low-cost open source code platform. Therefore, you can use the past experience and related information of the project team members to find out whether the team has the skills required to implement the project, or check whether the team has a bad record in the past.
Competitors
After doing the white paper and the team's research, you can compare it with competitors of similar applications. Use multiple indicators to compare and examine the competing products and the projects you are interested in, and evaluate whether this project is substitutable.
Token Economics and Initial Distribution
It is necessary to examine whether the tokens issued by the project have practical uses, the financial operation model behind them, etc. The tokens will only have real value after they have real utility and are recognized by the market.
Another important factor to consider here is how the initial funds are allocated. If it is through an Initial Coin Offering (ICO) or Initial Exchange Offering (IEO), the white paper should state the proportion of funds spent and retained by the founders and team, including the amount of funds available to investors. If it is earned by users through mining (Initial Model Offering, IMO), you can check the evidence of mining on the network that was previously announced.
Project measurement sometimes needs to consider the principle of trust. Investors can only make judgments based on the information disclosed by the team. Therefore, there are potential risks if there is hidden information or false disclosure.
3. Financial metrics
Unlike traditional financial fundamental analysis tools that evaluate public information such as trading conditions, prices, and liquidity, cryptocurrency financial indicators take a different approach and start from protocols or incentives.
Market Cap (Network Price)
The calculation method is to multiply the currency circulation by the price. The basic principle of market capitalization refers to the hypothetical cost per unit of buying cryptocurrency (excluding slippage). For example, if one million tokens are issued and the transaction price is $1, the total market capitalization is $1 million. The market creates $1 million out of thin air. The market capitalization is obviously distorted. In the long run, when the heat fades and the demand side decreases, the token will be worthless.
In addition to price uncertainty, there is also uncertainty in quantity. It is impossible to accurately assess how many units of cryptocurrency or tokens are circulating in the market because it is necessary to consider that tokens may be destroyed, lost in transmission, or keys may be lost. However, market capitalization is still widely used to estimate the potential for network growth. Some cryptocurrency investors believe that small coins have more room for growth than Bitcoin, Ethereum, etc.
Bitcoin market value example: BTC price is $20,669 USD, circulation is 19,087,475
The total circulating market value is approximately US$394.5 billion ($20,669 x 19,087,475 BTC = 394,536,772,126)
By CoinMarketCap
Liquidity and Volume
Liquidity refers to the speed of money circulation. If liquidity is high, buying or selling in the market is easy, convenient and fast, and assets can be traded at fair prices. On the contrary, if liquidity is insufficient, transactions cannot be made at prices that are consistent with an efficient market.
Trading volume is an indicator that can help determine liquidity. After measurement, the chart will record the trading volume and trading value within a time period. Examining liquidity can observe market preferences as an indicator of market preferences.
Markets List & Trading Pairs - By Volume | Coinranking
Supply Mechanism
The currency supply mechanism behind token economics is particularly important. The maximum supply, market circulation and inflation rate will indirectly affect the price of the currency. That is, if there are more and more tokens and the demand remains unchanged, the transaction price will become lower and lower.
After a period of time, some tokens will reduce the number of new coins produced and reduce the supply to maintain the price. Therefore, the supply can be used as a criterion to check whether it is unlimited. If so, it will bring about inflationary low prices and disrupt the market.
Three key indicators
1. Market Capitalization (MC) and Fully Diluted Valuation (FDV)
(The following assumes that the current market price of Token A is $1, the circulating supply is 1,000, and the maximum supply is 10,000)
Full Flow Value (FDV)
FDV = Maximum supply of tokens X Current market price of tokens = 10,000 X 1 = 10,000
Also known as fully diluted valuation, it is an indicator that can be used to estimate the future market value of a project. That is, if the project party unlocks all tokens and circulates them, FDV represents the future value of the project calculated at the current price.
Market capitalization (MC)
MC = Market circulation supply of tokens (circulating supply) X current market price of tokens = 1,000 X 1 = 1,000
Represents the current market value of the blockchain project. You can multiply the market circulation by the current market price of the token, and does not include the value of tokens that have not yet been unlocked.
The most obvious difference between FDV and MC is that FDV includes unlocked tokens in its calculation. MC can be used as an indicator to measure market purchasing demand. Compared to FDV, which is more like a supply indicator, the increase in market demand for unlocked tokens will also increase prices, causing FDV to increase proportionally.
For example, 5 million FDV is used to raise 250,000, and 5% of the tokens are sold after listing. Assuming the circulation volume is 1%, and the market value is 1 million, but in fact the FDV has reached 100 million, and the initial investors have received a 20-fold return. Once the tokens are unlocked, there will be considerable selling pressure. In other words, if the FDV is greater than the MC when unlocking, it is unreasonable, which is likely to cause a large amount of selling and a price crash. This also explains the sharp correction of DeFi in the past year, which is far better than the overall market, because most DeFi is through financing, and the unlocking price collapses.
2. Total Value Locked (TVL)
TVL refers to the liquidity assets of the DeFi protocol, which is an indicator of the total amount of tokens locked in the fund pool. If the TVL of the DeFi protocol is higher, it means that the capital investment raised by this protocol is also higher, and the project is more potential and more promising. You can use the DeFi Llama platform to observe the changes in the locked amount of DeFi protocols or public chain protocols, as well as the recent inflows and outflows.
by: defillama
The following three are the most commonly used TVL judgment bases:
Total locked value (TVL): The higher the TVL value, the better the DeFi protocol
Market capitalization (Mcap) / total locked value (TVL): The lower the ratio, the more potential the market has
Trading volume (VOL) / total locked value (TVL): The higher the ratio, the better the return on funds
3. Agreement income (profitability)
Revenue refers to the total amount of fees paid by users. Protocol revenue refers to the share of the amount paid to the protocol by users that is paid to token holders. Protocol revenue needs to be determined based on the business strategies of different projects. The following two profit models take NFT (Non-Fungible Token) as an example:
Play to Earn：Axie Infinity
Axie Infinity, the recently popular Ethereum NFT chain game, is a turn-based Pokémon game on the chain. It was launched by Vietnamese developer Sky Mavis in 2018. Users can obtain governance tokens by fighting other players and completing specific tasks. This game has led to the Play to Earn craze. According to data from NFT analysis website CryptoSlam, Axie Infinity's historical sales have exceeded US$1 billion, making it the first NFT chain game to exceed US$1 billion in sales, and the high NFT sales revenue is also the mainstay of the market.
100% of Axie Infinity protocol revenue flows to token holders, and in principle, protocol revenue and token value will change in equal proportion. When comparing protocol revenue or P/E ratios, you should understand how the project operates.
By token terminal
This play-and-earn protocol model is currently popular in NFT games, where players collect rewards in the form of NFTs in the game and then convert them into real fiat cash.
Move to Earn：STEPN
The design of STEPN's game mechanism draws on Axie Infinity's dual token + NFT model, which has dual currency mechanisms, reproduction systems, and energy systems such as game tokens GST (Green Satoshi Token), governance tokens GMT (Green Metaverse Token), and NFT running shoe assets.
STEPN is more about combining Web3 with the real world, allowing people to make money by running with virtual shoes.
The two team founders sketched out the prototype and concept of the project in one night. In this model, holding virtual running shoes in the form of NFTs to complete running tasks and then get token rewards is novel and unique. More than a month after its establishment, it won the fourth place in the Solana Hackathon Chain Game section, and just after it went online in December 2021, it received a $5 million seed round of financing led by Sequoia.
In early April, STEPN announced that it had made a profit of $26 million in the first quarter, with a global app download volume of over one million and an estimated market value of $1 billion. It also received investment from Binance. According to Dune on-chain data, 4,000 to 5,000 pairs of shoe NFTs were created almost every day in the last week of April.
As of May 2022, STEPN has 800,000 daily active users (DAU) and 3 million monthly active users (MAU). According to a report by the technology blog TechCrunch, STEPN's daily platform fee revenue is $3 million to $5 million, and its monthly revenue can be as high as $100 million.
Judging from the above data, this is a considerable protocol revenue, far exceeding other DeFi, GameFi, and even Web3 unicorn companies. The initial performance of the GMT token was also very good, from $0.1 on March 10 to the highest point of $4 on April 30, a 40-fold increase in 50 days. The protocol fundamentals performed well, the market was still a bull market, and investor sentiment was high, which further pushed up the price of the currency. It is a case worth reviewing. However, after the Federal Reserve announced an interest rate hike, the overall hot money flowed out, the market trend changed, the relevant monthly activity data declined, and the GMT price fell.
Looking at the fundamentals alone, it is indeed a good opportunity, but the timing of selling is still difficult to grasp. In addition to fundamental analysis, it is also very important to cooperate with appropriate entry and exit strategies and trading discipline.
Fundamental Analysis Tools Examples
Etherscan
The blockchain provides public information, and the flow of each transaction can be clearly checked. There are various types of blockchain browsers, and here we take the founding leader Ethereum as an example. The flow of each transaction on the chain is open and transparent, and you can see the wallet address where the funds go. Therefore, you can observe the flow of market funds here, and it provides the function of tracking and recording the movement of funds, that is, you can obtain detailed information on the distribution of chips on the chain.
Taking the SHIBA currency as an example, you can see the proportion of fund allocation and the transparent wallet address of the holder, the total supply of the currency, and the total number of holders.
By Etherscan
Token Terminal
Token Terminal standardizes cryptocurrency data with reference to traditional financial stock market indicators, allowing investors to easily examine the value of different blockchains and decentralized applications. The indicator parameters included in Token Terminal are: total market value, circulating market value, price-to-sales ratio, price-to-earnings ratio, token trading volume, total locked value, total commodity volume, revenue, protocol (token holder) revenue, costs and expenses, income, etc. It also provides the original data download of the project, and through the filtering and multiple display functions, the data can be analyzed quickly and accurately.
Taking Axie Infinity mentioned above as an example, you can see various data indicators such as total market value, circulating market value, price-earnings ratio, token trading volume, etc. Users can conduct competition analysis, data analysis, and comprehensive comparison of multiple indicators for similar projects.
By token terminal
Dune Analytics
Dune Analytics is a free and powerful blockchain analysis website. Users can use SQL syntax (database programming language related) on the web interface to extract data from the Ethereum blockchain, copy other people's SQL syntax or directly search for project currencies and make visual charts. It simplifies the process of writing special command programs for searching data, is easy to operate, and the visualization effect can present a more intuitive comparison.
Let's take STEPN mentioned above as an example. For example, the number of users added by STEPN every day and the price trend chart for a fixed time period can all be queried and plotted into a chart using Dune.
By Dune
Market News
Economic Market
It refers to various news factors that affect bad news and good news. In the real economic market, the overall environment not only affects the stock market, but also affects cryptocurrencies due to the interflow of money. The economic market factors affecting the currency circle include major upgrades, listing on exchanges, contract loopholes, etc. The most important thing in the currency circle is the four-year halving cycle of Bitcoin. Each halving will bring a new cycle of bottoming out and reversing, so it can be used as a reference for the news that dominates the entire currency circle.
【Four-year halving cycle market】
Bitcoin launch: January 3, 2009 Block reward: 50 BTC
First halving: November 28, 2012 Block reward: 25 BTC
Second halving: July 9, 2016 Block reward: 12.5 BTC
The third halving: May 12, 2020 Block reward: 6.25 BTC
Fourth halving: expected in 2024 Block reward: 3.125 BTC
By Trading View
Spot inventory in the exchange
If the economy is booming and in a bull market, there will generally not be a large sell-off, and whale investors who hold a large amount of funds will mostly store their currencies in cold wallets to ensure safety. When a bear market comes, in order to avoid losing money due to price drops, whale investors may sell a large amount of their currencies at any time. At this time, if the exchange inventory increases, it may also be a warning that a sell-off will occur and cause the price to fall.
The movement of whale wallets
Related to the above, a more direct way of observation is a data collection and analysis website called Whale Alert, which can check the flow of whale wallets of various currencies. It can find out which currencies are being traded in large quantities. However, this is only a signal for prediction and cannot be directly used as a basis for investment advice.
By Whale Alert twitter
Advantages and Disadvantages of Fundamental Analysis of Cryptocurrencies
advantage
Seize the opportunity and discover the turning point of trend change
The flow is clear and transparent, and real-time information and changes are clearly visible
Find suitable investment targets
Avoid irrational selling caused by panic
shortcoming
Data can still be falsified
There is no comprehensive and standardized public description, and the information is complicated
Some of the information is provided by the project team, which may still be hidden or untrue.
Collecting and analyzing data is time-consuming and labor-intensive
Summarize
Cryptocurrency is an emerging market. Traditional financial market fundamental analysis tools are no longer applicable, so various auxiliary analysis tools have emerged. However, due to the public nature of blockchain, all information is recorded on the blockchain. However, it still relies on various programs to collect data for analysis.
The data sources of all analysis software are not necessarily completely correct and accurate, and news is even easier to forge. Especially now that most cryptocurrencies are invested by investors from all over the world, it is almost a no-man's land. Even if there are disputes and lawsuits are filed, it is extremely difficult to wait for the day when justice is served.
At present, the fundamental analysis of cryptocurrency still cannot have very complete data models and judgment standards like traditional finance, and it is more difficult to accurately value and define it, and there is still considerable room for development. However, this is also an opportunity for investors. If you can dig into the fundamentals of the project, use better analysis models and judgment standards, and effectively make investment decisions with a higher chance of success, it is still a good way to evaluate.
Cryptocurrency projects have only started to flourish since 2020, with more diverse and innovative application scenarios emerging. The cryptocurrency market is highly volatile, with risks and opportunities coexisting. Establishing your own fundamental analysis can help you make investment decisions with a better framework. The cryptocurrency market has the characteristics of high risk and high reward, and a well-prepared fundamental analysis can take your investment strategy to the next level.
