The Role of Fundamental Analysis

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The Role of Fundamental Analysis

Like any other financial asset, trading cryptocurrencies require a well-defined strategy. This strategy will require a never-ending learning process. The three major analyses you’ll need to conduct are fundamental analysis, technical analysis, and a third but relatively unknown one, Sentimental analysis.

The sentimental analysis is a measure of people’s sentiment towards an investment class. It’s a measure of fear vs. greed towards a particular token. The technical analysis requires using indicators usually used in forex markets and commodities trading to predict market behavior towards a particular token. The main aim of technical analysis is to try to predict future results from past performances.

Lastly, the fundamental analysis, which this article will look at in detail, is a value-based approach to analyzing and trading a token. It leverages so much information about the internal and external factors surrounding a token before choosing an entry or exit point. Let’s see what a fundamental analysis entails.

Main Components of Fundamental Analysis

We’ll take a quick look at three major components of fundamental analysis. With this list, we should have a decent understanding of what to do when performing an analysis using value metrics.

On-chain Metrics

On-chain metrics can be defined as blockchain metrics. They refer to the analysis of data seen on the blockchain. Instead of running a node and extracting the data,  we can easily get blockchain data on specific data websites. For example, CoinMarketCap, Coinmetrics, or Binance Research project reports are three major data platforms for cryptocurrencies. Some of the on-chain metrics you should look out for include;

Transaction Count

Transaction count is used to note the buying and selling activity on a network. It requires some technical analysis like moving averages to make sense of it, or if you are not familiar with that, you can plot the number for a specific time on a graph. You’ll notice the activity changes on the network. Although this metric is simple, it is not really effective as we are not sure of the parties involved in the transfers. One investor might be transferring funds across his wallet to bloat the on-chain activity.

Transaction Value

The transaction value is slightly different from the transaction count. The latter tells us the number of transactions performed, while the former gives us the worth of the transactions.

For example, twenty Solana transactions worth $30 each were performed on a Sunday; the transaction count is twenty while the transaction value is $600 (transaction count × value of each transaction)

Active Addresses

Active addresses refer to the number of blockchain addresses involved in any transaction on the network over a given period. It can either be calculated by checking the sender and receivers of each transaction or by examining the number of unique addresses cumulatively. Again, it would be extremely time and energy demanding if you try to get this yourself. You can leverage on APIs or dedicated data websites.

Transaction Fees

Although it doesn’t work for all crypto assets, fees are a good way of showing us the demand for a token. The Higher the transaction fees, the faster the transaction will be executed. This is a good metric for Proof of Work (PoW) blockchains. 

Financial Metrics

The financial metrics refer to the data on the economics and incentives of the token’s protocol. Some of them include:

Market Capitalization

Market capitalization is the total value of a token or a network. It is calculated by multiplying the circulating supply with the token’s current price.

Unlike traditional Investments, knowing a token’s market cap is dicey. Tokens can be burned, and some coins are irrecoverably lost. We can only have estimated to show the coins in circulation.

Either way, market capitalization is a generally accepted metric used to know a token’s worth and growth prospects. If a token has a low small-cap, sentiments towards it are somewhat bullish compared to a large market cap that is often viewed as established, reliable, and stable alternatives. 

Liquidity and Volume

Liquidity refers to the ease of buying or selling cryptocurrency assets. When an asset is liquid, it can be bought or sold easily. An illiquid asset is the one that is difficult to buy or sell. When there are many buyers, It is believed that the project is valuable and vice versa.

To understand the amount of liquidity on a token, we look to the trading volume. Volume refers to the cumulative measure of value exchange within a specified period. When the volume is higher than it averagely is, there has been a lot of interest (either buying or selling) in the token.

Supply Mechanisms

One of the most important metrics from a financial standpoint is the supply mechanism. There are a few models (we’ll be seeing them in detail in a moment) used to inform investors about the prospects of a token.

Maximum supply, circulating supply, and rate of burn are a few supply metrics that show if the demand will match or outweigh the supply of a token in the coming months or years. Projects with unlimited supply are naturally seen as not viable, and they are commonly seen amongst meme coins.  

There’s another school of thought in the crypto world that is not impressed with a fixed supply. They believe it only benefits early investors disproportionately as the latecomers get the tokens at a higher price.

Project Metrics

Project metrics look at a token from the mindset of quality and the vision involved.  The history of the founders, the project’s whitepaper, and the growth estimations are the three things checked on the project metrics. Let’s see these three in detail. 

The Whitepaper

Except you are gambling, it is important to understand the token you’re investing in. One of the early ways of seeing green lights and red flags is in the project’s whitepaper. Of course, they would try as much as possible to explain the project in a good way, but a good knowledge of the crypto market will help you notice inconsistencies. A whitepaper is a detailed technical document that shows the general overview and specifics of a project. It contains the goals, the use case, the project roadmap, and the supply methods.

Since you may miss a thing or two from the project’s whitepaper, it is important to cross-reference your findings with a community of traders interested in the same project. From there, you’ll see some red flags you missed and how achievable the project seems.  Social media has made this very achievable.

Credibility of The Founding Team

The team behind a cryptocurrency network is enough proof to show if the project will be achievable or not. What project(s) has the team undergone in times past? Which skills do they have that will be helpful to the project? Has any of them been linked to a scam project before? These and many other questions about the team will give you a broad overview of what you’re in. 

Yes, some projects indeed have anonymous teams. However, we advise you to be careful with these. If you must invest, check the developer community.  What does it look like? How’s their public GitHub? How many contributors do they have? How active is the platform? A token with more activity will be deemed more legitimate than that with erratic contributions. 

Competitors

After understanding what use case a crypto asset is about and its target audience, the next thing to do is identify its competitors both at the traditional and digitized token levels. What advantages does it have over its competitors, what infrastructure does it seek to displace? This exercise is time demanding, but the results are boundless. What seems like our token’s advantage may well and truly be a demerit when compared to similar assets performing the same function.

Tokenomics and Initial Distribution

Normally, projects and their tokens should exist to solve specific problems, but this rule has some exceptions.  The project might have some short-term prospects, but it may not be useful in the long term. One thing to check out before buying a token is if such a token has real utility. After this, you might want to ascertain if the utility is scalable and at what price.

It is equally important to consider the initial method of funds allocation. Was it via an ICO or airdrops, or was it by mining? More often than not, the token’s whitepaper would show the initial method of funds allocation, how many percentages the founders and team have, and how much will be available for public trading.

The reason we are focusing on the distribution is to eradicate the possibility of a rug pull. If most of the tokens were gotten by a few parties, it might be a risk not worth venturing into. A pro tip; the initial methods of funds allocation are also used for publicity of the new token, so if an initial fund allocation shows only a few people, you should be wary.

Valuation Methods For Fundamental Analysis

Network Value to Transactions Ratio (NVT)

Like the price-to-earnings ratio used in the stock market to analyze stocks, the network value to transaction ratio indicator is used to analyze a token’s value. It is done daily and would probably vary from day to day. The formula for calculating it is simply the token’s market capitalization divided by the daily transaction volume.

The Network Value to Transactions ratio is used to value a coin if it’s undervalued or overvalued. The concept works on the premise that the more the volume moving around the system, the more valuable the project is. An increasing token’s market cap without a corresponding daily transaction volume is proof the token is in bubble territory. When the reverse happens and prices are unchanged while the transaction volume is increasing, you may have a very good buying opportunity in your hands.

The summary of the NVT is this; the higher the value of the ratio (above 90-95), the more the probability of a bubble occurring. The reverse is also true.

Advantages of Network Value to Transaction Ratio

  1. With the NVT, you can compare the value of two similar tokens to know which is undervalued or overvalued based on their historical data.
  2. You can know the value of the most popularly traded coins using the NVT. Since their market cap exists for a long period, and so does the number of daily transactions, you can measure whether the NVT is increasing or reducing. 
  3. Although no one token can be used to understand the price movement of crypto, the NVT has been consistently noticed to precede many major market shifts in either direction.

Disadvantages of the Network Value to Transactions Ratio

  1. The Network Value to Transactions ratio is not a reliable metric for analyzing crypto on short-term timeframes.
  2. Historically, the rise and fall of tokens have been influenced by forces that a mathematical formula cannot calculate. News and sentiments are two things that cannot be calculated but have a huge effect on the token’s price.

Market Value to Realized Value Ratio (MVRV)

How does the Market Value differ from the Realized Value? Simple.  Market value is another name for market cap, it has been explained above, but to save you some stress, it is simply the multiplication of the total supply of coins by the market price. Realized value is quite different. It refers to the value of tokens in lost or inaccessible wallets.

An example of realized value is this, a wallet with 2 bitcoins lost in the early months of 2016 will only be valued at $800 ($400 per Bitcoin) rather than $120,000 (Current price).

Our Market Value to Realized Value Ratio is calculated by simply dividing the market cap by the realized cap. If the realized cap is way lesser than the market cap, our ratio will be relatively high as the coin will be deemed overvalued.  Historically, a high MVRV ratio always precedes a huge selloff, as seen in 2014 and 2018 with Bitcoin’s Market Value to Realized Value Ratio of 6 and 5, respectively.

A Market Value to Realized Value Ratio of under 1 is proof that the token is highly undervalued and presents itself as a good buying point.  The viable range is between 1 and 3.7.

Advantages of Market Value to Realized Value Ratio

  1. It is one of the most accurate ways to predict market tops or bottoms. Since we know the acceptable range, it is easy to predict buying and selling actions. An upward trend past the 3.7 mark might show a massive dump on the way, and a downwards trend towards the 1 mark may be proof of a good buying opportunity.
  2. Market Value to Realized Value Ratio tracks the interdependence of major players involved in the price movement of cryptocurrencies. It tracks the buyers and their volume, and also the sellers. It also considers holders and all these in relation to the lost or irretrievable tokens and wallets.

Disadvantages of Market Value to Realized Value Ratio

  1. The realized cap may reduce in a black swan event. Investors that long bitcoin may suddenly feel the urge to sell their huge tokens, causing disruption in the market.
  2. MVRV cannot be effective in short-term perspectives. It also isn’t relevant in the distribution or accumulation phase of a token.

Reliable Tools To Perform Fundamental Analysis

Having the right tools is what differentiates a professional trader from an amateur. Many of the tools you need for your fundamental analysis are free, and a few of them include:

CoinMarketCap

Coinmarketcap.com is the most-used site for checking live statistics about a company’s fundamentals. They are also useful if you want to use their API for your personal website.

Advantages

  1. It is free to use
  2. Information gotten on coinmarketcap are reliable
  3. There are thousands of tokens you can check from

OnchainFX

OnchainFX does everything Coinmarketcap does but has some unique statistics. On OnchainFX, a trader can see the market categorization of a token – whether as scams, top gainers, or top losers.

Advantages

  1. It is customizable
  2. More user-friendly interaction

Disadvantage

  1. Still largely unknown amongst many crypto circles.

CryptoCompare

If you’re looking for a match of reliability, learning, and portfolio tracking, CryptoCompare is your go-to platform. They have been around for a while and have earned the trust of traders for their reliability and promptness.

Advantages

  1. Highly reliable platform
  2. You can find informative articles if you’re willing to learn more about crypto.
  3. One of the best platforms for beginners

Sector Analysis

Unlike traditional stock investing, there are no industries in the crypto market. However, two ways to categorize tokens are

  1. Via their use cases.
  2. The protocol they are built on.

Tangible Example of Fundamental Analysis (Example – ETH)

Etherum has existed for many years and has been the building block for many blockchains and decentralized applications. Seeing how volatility can change our perception of different tokens, it is important to look beyond the charts and into the fundamental analysis behind the token, which is always tagged as the second-largest token in the cryptocurrency world.

What Makes Ether Valuable?

Much more than for another thing, Ether is the oil that keeps the Ethereum community running smoothly. Every transaction on the Ethereum platform is conducted using Ether. It is also used in the NFT marketplaces to price or buy digital assets. Yield Farming and staking are two additional use of the Ether.

Supply and Market Capitalization

Market capitalization shows the total value of the coin in dollar terms. It is very important to know how much value a coin has and its prospects for more upsides. Ethereum is tagged the second largest cryptocurrency after Bitcoin because of its market cap and total supply. Ethereum’s market cap is currently $529 billion, and the circulating supply stands at 118.23 million ETH.

Transactions Count

To learn how actively bought or sold a token is, the transaction count is a good place to look at.  With the current hype around Ethereum following all-time highs, a daily 1,328,883 transactions are performed on the network or about 55,370 per hour. 

Transaction Fee

Network congestion and huge fees during these congestion periods are two issues facing the Ethereum platform. The gas fees on the last bull run touched the $70 mark making Ethereum a highly illiquid token to own. To put in perspective, gas fees above $10 are still seen to be expensive.

Ethereum transaction fees are currently over 2,000% from its June price and sit above the $50 mark.

Average Time Between Transactions

The average time between transactions on the Ethereum blockchain isn’t remarkable. With the average time showing the time interval between the validation of one block and the next. A higher average transaction time can only infer that the network is congested. Because of the high volume and massive use case of the Ether.

The average time of 13 seconds is relatively low but can be greatly improved seeing the many use cases of the Ethereum network. We can only hope that the Ethereum 2.0, touted to improve network efficiency, will deliver as promised.

Social media has been a critical part of cryptocurrency projects. Communities have been (and are) useful in determining a coin’s popularity and relevance. The market moves on news and rumours, so nothing should be taken with a pinch of salt when it comes to cryptocurrencies.

The Ethereum community is a buzzing one. Twice this year (May and now), the online interaction of Ethereum peaked. It also affected sentiments in May as many people went all in and fell with the crash.

Conclusion of ETH FA

All eyes are on Ethereum’s upgraded version to roll out. It’s definitely going to be a major improvement to the current version. If issues surrounding scalability and congestion can be solved, it would affect the price positively, and we might be really headed for the moon. If not, the cryptocurrencies tagged as ‘Ethereum eaters’ may be here for a long time.

Bottom Line

Fundamental analysis plays a crucial role in understanding the credibility of a cryptocurrency. This knowledge is crucial for crypto traders and investors while making decisions involving vesting real money in the crypto market. We hope this article and the example gave you a clear understanding of the fundamental analysis basics.

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