Navigating the newly-born cryptocurrency market could be a tricky thing for investors, and fundamental analysis could be the tool to traditional investors to search for potential investment opportunities in the volatile market.
In the previous section, 2 of the 5 important elements in cryptocurrency fundamental analysis were briefly discussed (crypto market trends and individual cryptocurrency’s fundamentals). Here is a look at the remaining 3 factors in crypto fundamental analysis.
A catalyst is often referred to as an incident that pushes a financial instrument’s price to rise or fall drastically. The same applies for the crypto market. A catalyst in the crypto market could be an update on government regulation of cryptocurrencies, or a tweet from Tesla CEO Elon Musk.
One of the examples is Musk’s tweet regarding Dogecoin and Bitcoin. On a couple of occasions Musk posed tweets related to cryptocurrencies, leading to a surge in both currencies. Another good case in point would be the latest bipartisan infrastructure bill which outlines regulations on cryptocurrency including crypto reporting provision. While the regulation’s impact on cryptocurrency (where decentralization is one of its highlights) is uncertain at the time of writing, investors might want to pay close attention to future price development for privacy coins like Monero and Zcash.
In addition to the examples mentioned above, updates on the roadmap or technical upgrade on both specific cryptocurrencies and the general technologies could both serve as catalysts, resulting in a surge for the corresponding financial assets.
While valuation techniques (such as the use of accounting ratios or Gordon growth model) are well-known and used widely for traditional financial instruments due to prominence of value investors such as Warren Buffett, similar tools for crypto market are relatively under the radar due to the volatile nature of the market and also the complicating nature of individual cryptocurrency.
However, valuation techniques could still be of use to crypto investors who want to determine the relative value of the assets. Here is a list of examples of cryptocurrency performance metrics.
1. Growth/Change in TVL (Total Value Locked)
2. MCap/TVL (Market Capitalization/Total Value Locked ratio)
3. Relative MCap (Market share of centralized solution)
4. P/S Ratio (Price/Sales ratio)
Potential investors should be cautious when choosing one (or more) performance metric(s) as indicator(s). Some metrics are only suitable for specific sectors of cryptocurrency. One example is P/E ratio could be applied for decentralized finance (DeFi) assets but not Bitcoin as Bitcoin does not directly provide earnings for its holders. The Stock-to-flow Model, which uses Bitcoin’s value with scarcity might be more suitable for Bitcoin.
Using performance metrics appropriately and building a profitable investment strategy based on that requires investors’ understanding of the specified crypto assets. We will cover that in future articles.
One important aspect of investment (no matter in traditional assets or crypto assets) is risk. The risks associated with crypto investments share a certain degree of similarity with that of traditional investments. Regulatory risk and liquidity risk are two types of risk that is frequently mentioned. The bipartisan infrastructure bill mentioned above is an example for regulatory risk with uncertain impact on the crypto market.
However, there are risks more specifically related to crypto investments. One of them is the risk of rug pull, which means the original developers of a crypto project taking investors’ money and abandon the project, in other words a scam. Squid crypto token is one of examples. Its developers have taken away an estimated $3.38m after the crypto surged to $2,856 in a week’s time. Currently the cryptocurrency is trading at around $0.29 at the time of writing.
Due diligence is important to avoid risks. Paying attention to the tokenomics and see if any unusual mechanics and the degree of holder centralization. For instance, Squid Game is an obvious scam which does not allow investors to sell them even if there is no rug pull. Another way would be checking whether the crypto assets’ whitepaper contains abnormal amount of mistakes (such as grammatical one), buzz words, to see if the project is a hoax.
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