Even though the learning curve may be steep for first-time crypto investors, cryptocurrency trading is not a rocket science, nor is it much different from trading traditional stock markets securities. Both cases involve making buying or selling decisions of financial assets based on estimated future price movements. Such a prediction employs methods of technical or fundamental analysis or a mix of both.
While technical analysis is widely used by both professional and amateur crypto traders, and the number of readily available tutorials and how-tos on this topic is truly astounding, the fundamental analysis gets considerably less attention. Many even believe that the very nature of crypto — unregulated and decentralized — renders fundamental analysis virtually worthless.
The truth is that fundamental analysis in crypto isn’t useless — it’s just different from the one used to analyze conventional assets like stocks and bonds. While technical analysis in crypto inherited many tools and indicators from legacy financial markets, crypto projects' FA metrics are very different from those used to evaluate publicly traded companies.
Fundamental analysis in crypto
Unlike technical analysis, which relies on historical market data to predict future price movements, the fundamental analysis evaluates business fundamentals to determine the asset’s fair price. The main goal of fundamental analysis is to determine whether the company (or a project in crypto) is undervalued or overvalued — and leverage this knowledge to take an ideal entry or exit position.
In traditional finance, the fundamental analysis generally refers to evaluating the company’s business metrics like earnings per share (EPS), price-to-earning ratio (P/E), free cash flow (FCF), return on equity (ROE), and many others. By analyzing these indicators, investors can spot undervalued companies whose shares trade below their fair value and exit overvalued and overhyped stocks.
However, most crypto projects — given their decentralized nature and general nascence of the industry — can't be really assessed through traditional FA indicators. Indeed, there’s no such thing as a “financial statement of a cryptocurrency,” since cryptos aren’t issued by corporations. But does it mean you can’t employ fundamental analysis to crypto trading?
Obviously, you can! However, first, we should identify key FA metrics that we can apply to analyze crypto projects. Below, you will find some useful indicators you should pay attention to when making an investment decision.
When Satoshi Nakamoto released the Bitcoin whitepaper in October 2008, it became a gold standard for all subsequent crypto projects. The whitepaper, which is often regarded as an equivalent of a company's prospectus in the crypto industry, provides investors with detailed information about the project’s underlying technology, specific use cases, roadmap, founding team, and initial token distribution.
In most cases, the whitepaper serves as the primary source of information about the specific cryptocurrency, so it would be a good practice to start your research from it. Some crypto projects also release a yellow paper, which is usually a more technical and scientific version of a whitepaper. It may be unhelpful if you want to take a deep dive into the project’s technology, but requires more domain-specific knowledge about cryptography and blockchains.
To make an informed investment decision, it’s also crucial to evaluate the whitepaper for the presence of any far-reaching statements that may draw unwanted attention from regulatory agencies. This is particularly relevant in light of recent restrictions imposed by regulators globally on how cryptocurrencies can be bought, sold, and used.
If project founders have voluntarily doxxed themselves, the whitepaper would likely list their names. This provides you with an opportunity to gain insight into their track record and decide whether the project is worth investing in. How long have the founders been in the industry? Have they previously participated in any successful ventures? Can their expertise be trusted? Any questionable endorsements or rug pulls in the past?
However, since the core values of the crypto community — privacy, decentralization, and self-sovereignty — explicitly encourage anonymity, many crypto projects choose not to disclose the real-life identities of their founders. In this case, you can gain some insights from exploring the project’s GitHub and joining its Discord/Telegram. Are team members open to critical feedback? What is their manner of communication? How many active contributors are there? These and many other questions would help you spot the early red flags that can signal a potential scam.
Road map in crypto
Most crypto whitepapers also include a roadmap that sets out the timeline and milestones for project development. A good roadmap sets concrete, measurable, and realistic goals, so if your project of choice promises “expansion of the platform to global markets” by Q1 2023 and the “launch of version 2.0 with AI-powered analytics and reporting capabilities” by Q3, it may be a good time to rethink your investment decisions.
After you’ve got a grasp of the project’s objectives and use cases, it’s time to identify its main competitors. You may want to ask yourself what legacy infrastructure the project is trying to replace and whether their solution is better than the already existing ones. Out of the market context, its offering may look appealing at first but may look much less inventive when compared to its competitors.
This indicator is closely related to the previous one, as the demand for a certain technology or service most likely is already supplied by other competing crypto projects. In this case, it’s important to identify whether the size of the target market is enough to sustain another project with a similar offering. What need or a use case it tries to address? Does it introduce an improvement to the existing solution that would make it stand out from the competition?
Tokenomics in crypto projects
One of the metrics crypto investors should pay particular attention to is its tokenomics. This is an important indicator of the project’s potential for success, as it provides insight into how the project is funded and how tokens will be used within the network.
The first factor to consider when evaluating the project’s model is whether there’s a need for token at all. What is its utility? Does it have the potential to appeal to the greater public? If the token has no role in securing the network and its only utility is staking, then the project’s tokenomics is most likely unsustainable and designed to extract maximum value for early adopters.
And be wary of unreasonably generous staking rewards with no strong use case or growing demand in sight. This is a huge red flag that signals either a failed tokenomics or an exit scam.
Another important thing to take into account is the initial distribution of tokens. In most cases, the pie chart showing how tokens are allocated in the ecosystem can be found in the whitepaper or blog. In case of an ICO (initial coin offering) or IEO (initial exchange offering), quality projects often impose a vesting period on tokens reserved for VCs, advisors, and founding team, so they don’t sell too early and are committed to the long-term success of the project. Too big allocations to a single entity should alert you: this increases the risks of a rug pull.
On-chain data analysis
Along with project metrics like a whitepaper, roadmap, and token allocation, there are also on-chain metrics that can provide valuable insights into the crypto project. These metrics include the number of active wallets, daily and monthly transaction volume, the number of transactions per day, and hashrate/the amount staked for the PoW and PoS networks, respectively.
Obviously, analyzing raw on-chain data may be quite challenging even for seasoned crypto investors, so it’s always more convenient to use already existing tools that pull the information from the blockchain and present it in a more digestible, applicable form. So, what are the best websites and services for crypto fundamental analysis?
Tools for fundamental analysis in crypto
CoinMarketCap is one of the most popular crypto price-tracking websites that provides up-to-date on-chain data that includes market capitalization, trading volume, best exchanges, and price. It has also proven itself as a helpful tool for discovering altcoins with the most potential to moon, so you should definitely give it a try.
TradingView is a powerful crypto screener and charting platform that allows investors to access real-time financial information and market data. Although it's more suitable for technical analysis, its sentiment indicators and social network for traders may help you find your next alpha!
CoinGecko is another cryptocurrency ranking website that aggregates detailed information about coins, NFTs, and exchanges. Along with on-chain metrics, CoinGecko also tracks community growth, open-source code development, and major events in the crypto industry.
Etherscan is a leading blockchain explorer, API, and analytics platform for Ethereum that allows users to view and analyze all wallets, transactions, and smart contracts on the network. Etherscan also has a “gas price tracker”, which is helpful for those who want to avoid its often unsustainable fees.
Crunchbase is a reliable platform for finding business information about private and public companies that provides detailed information about their backers, seed rounds, founders, and products. It can be extremely useful for the research on crypto startups and the overall state of VC funding in the industry.
Final thoughts on cryptocurrency fundamental analysis
If done correctly, fundamental analysis in crypto may be a powerful addition to your investing toolbox. However, relying on FA only won’t provide you with a full picture of the market, so it’s highly recommended that you pair it with technical analysis to ensure appropriate investment timing.
Hopefully, you found this article helpful and now feel equipped with knowledge on evaluating key metrics of fundamental analysis in crypto. At Coinpaper, we are committed to the sole mission of helping you master the necessary skills to confidently navigate the crypto market. Make sure you check our other educational materials on stablecoins, different types of crypto tokens, and Ethereum scaling solutions.