Investors accustomed to traditional financial markets can find it difficult to use familiar methods of financial analysis to evaluate cryptocurrencies. For example, a traditional investor may look at the fundamentals of a stock or security to decide if they should invest.
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Fundamental analysis is a method of determining the value of a security in order to understand if it’s a good buy compared to current market prices. Investors will look at certain factors like price-to-earnings (PE), price-to-book (PB), earnings per share (EPS) and free cash flow (FCF), among many others, in order to arrive at a conclusion.
But you can’t listen to a quarterly earnings call for a token because they don’t exist. There’s no company revenue, profit or expenses to look at for, say, bitcoin (BTC) – there’s no Bitcoin “company” running the show – the decentralized nature of Bitcoin is an essential, founding part of the project.
So what can analysts and investors use instead to make decisions? And what else do they have to keep in mind?
Tokenomics is a popular and important way to analyze a cryptocurrency project. Tokenomics is the system of incentives and mathematics that govern a crypto project. A token with a sound plan for why people will buy and hold tokens over time has a good chance to succeed, while a project with poor tokenomics is doomed to fail. Understanding the tokenomics of a project is vital in order to make a wise decision.
Token distribution is a large part of tokenomics – this means understanding who holds the tokens and how they were given out. Another thing to consider is if the supply is limited or unlimited, and how new tokens enter the ecosystem. For instance, Bitcoin limits the supply at 21 million coins; new coins enter the ecosystem through proof-of-work, while Cardano (ADA) is a proof-of-stake blockchain with a maximum supply of 45 billion.
Other things to consider include:
Taking these things into consideration can give investors signals of the long-term viability and expected growth of a cryptocurrency. For example, if a token is highly inflationary, that may signal to the investor that the future value of the token will be challenged.
Read More: What Is Tokenomics and Why Is It Important?
There are many other factors that go into understanding the complete tokenomics of a project. In order to find the tokenomics and other important information, analysts will usually refer to the project’s whitepaper.
In order to understand the full scope of a cryptocurrency, reading the white paper is an essential place to start.
White papers are documents specific to a crypto project. The white paper is published by the creator(s) of a coin or token before the inception of the project. The white paper is a document that outlines the project’s purpose, statistics of the project, formulas found in the project’s code and the tokenomics of the project.
By reading the white paper, investors will have a clear understanding of the goals and desires of the developers. They will understand the market the coin is competing in and the future plans of the project. They can then use this information to begin formulating an investment thesis around the project. If you can’t understand the “why” or the goal of the project after reading the white paper, that’s a bad sign. The Bitcoin white paper can be found here and clearly outlines the problem it is trying to solve and how it will accomplish that goal.
The white paper is also a place to look for red flags and check the backgrounds of the founders. A white paper filled with spelling errors, plagiarized sections, promises of returns that sound too good to be true or founders that have been linked to failed projects or rug pulls should warn investors away from the project.
Read More: 4 Ways to Stay Safe in Crypto
Once an investor understands the tokenomics and has a thorough understanding of the project’s goals and intentions, they can begin to analyze the token’s blockchain.
One of the most interesting things you find in crypto that you don’t find in traditional finance is the availability of blockchain data that is publicly available for all to dig into – transactions and wallet balances are there for all to see “on chain,” 24 hours a day, seven days a week.
On-chain analytics is the term given to the process of using information found on a blockchain ledger to formulate an opinion on market sentiment. Analysts will look at certain metrics found on blockchain ledgers, such as wallet balances, transaction data, gas fees, transaction volume, active addresses, etc., with the goal of understanding market sentiment and whether it’s a good investment or if it's sending sell signals.
For example, if a project has many active transactions and active addresses, you may assume the coin is popular. On the other hand, if wallet balances are decreasing and transaction volume is decreasing, this would indicate that the project is losing users and might be struggling or being outcompeted by another coin. There are many resources an investor can use for on-chain analytics, such as EtherScan or Glassnode.
In traditional finance, markets have operating hours. The U.S. stock market is open from 9:30 a.m. to 4:00 p.m. ET, Monday through Friday. Markets are closed on major holidays and weekends. In particularly volatile markets, investors may pay attention to after-hours trading and there are derivatives that trade outside of market hours, but nearly all of the trading volume occurs during the main daytime trading window.
On the other hand, crypto markets never shut down. Investors in the U.S. need to understand that trading in European and Asian markets will move the price of crypto assets overnight, and events in other parts of the world may cause a coin’s price to move at any time of the day. Because of this, certain macroeconomic events in foreign countries may cause price swings in crypto in domestic markets. Investors must understand the 24/7 nature of these markets and have a plan to embrace these challenges, as they are significantly different from traditional markets.
As investors learn to navigate the crypto markets and research specific coins and tokens, it is important to understand that some traditional methods of analysis don’t work in crypto, but there are other new tools to add to their analysis arsenal. It’s essential to understand the new paradigm of analysis and leverage crypto's unique attributes of openness and transparency to formulate their opinion.