A GUIDE TO CRYPTOCURRENCY FUNDAMENTAL ANALYSIS

Crypto fundamental analysis involves taking a deep dive into the available information
about a financial asset. For instance, you might look at its use cases, the amount of people
using it, or the team behind the project.

Your goal is to reach a conclusion on whether the asset is overvalued or undervalued. At

that stage, you can use your insights to inform your trading positions.

CONTENTS

Introduction
What is fundamental analysis (FA)?
The problem with crypto fundamental analysis
On-chain metrics

INTRODUCTION
Trading assets as volatile as cryptocurrencies requires some skill. Selecting a strategy,
understanding the vast world of trading, and mastering technical and fundamental analysis
are practices that come with a learning curve.

When it comes to technical analysis, some expertise can be inherited from the legacy
financial markets. Many crypto traders use the same technical indicators seen in Forex,
stock, and commodities trading. Tools like RSI, MACD, and Bollinger Bands seek to predict
market behavior irrespective of the asset being traded. As such, these technical analysis
tools are also extremely popular in the cryptocurrency space.

In cryptocurrency fundamental analysis, though the approach is similar to that used in

legacy markets, you can’t really use tried-and-tested tools to assess crypto assets. To
conduct proper FA in cryptocurrencies, we need to understand where they derive value f

What is Fundamental Analysis (FA)

Fundamental analysis (FA) is an approach used by investors to establish the "intrinsic value"
of an asset or business. By looking at a number of internal and external factors, their main
goal is to determine whether said asset or business is overvalued or undervalued. They can
then leverage that information to strategically enter or exit positions.

Technical analysis also yields valuable trading data, but it results in different insights. TA
users believe they can predict future price movements based on the past performance of
assets. This is achieved by identifying candlestick patterns and studying essential indicators.

Traditional fundamental analysts generally look to business metrics to figure out what they
view to be its real value. Indicators used include earnings per share (how much profit a
company makes for each outstanding share), or the price-to-book ratio (how investors value
the company versus its book value). They might do this for several businesses within a niche,
for example, to figure out how their prospective investment stands in relation to others.

For a more comprehensive introduction to fundamental analysis, see What is Fundamental

Analysis?

THE PROBLEM WITH CRYPTO FUNDAMENTAL ANALYSIS

Cryptocurrency networks can't really be assessed through the same lens as traditional
businesses. If anything, the more decentralized offerings like Bitcoin (BTC) are closer to
commodities. But even with the more centralized cryptocurrencies (such as those issued by
organizations), traditional FA indicators can't tell us much.

So, we need to turn our attention to different frameworks. The first step in that process is to
identify strong metrics. By strong, we mean ones that can't easily be gamed. Numbers of
Twitter followers or Telegram/Reddit users are probably not good metrics, for example, as
it's easy to create fake accounts or buy engagement on social media.

It's important to note that there's no single measure that can give us a full picture of the
network we're assessing. We could look at the number of active addresses on a blockchain
and see that it has been sharply increasing. But that doesn't tell us much by itself. For all we
know, that could be a standalone actor transferring money back and forth to themselves
with new addresses each time.

In the following sections, we'll take a look at three categories of crypto FA metrics: on-chain
metrics, project metrics, and financial metrics. This list will be non-exhaustive, but it should
provide us with a decent foundation for the subsequent creation of indicators.

ON-CHAIN METRICS
On-chain metrics are those that can be observed by looking at data provided by the
blockchain. We could do this ourselves by running a node for the desired network and then
exporting the data, but that can be time-consuming and expensive. Particularly if we're only
considering the investment, and don't want to waste time or resources on the endeavor.

A more straightforward solution would be to pull the information from websites or APIs
specifically designed for the purpose of informing investment decisions. For example,
CoinMarketCap's on-chain analysis of Bitcoin gives us a myriad of information. Additional
sources include Coinmetrics' Data Charts or Binance Research's project reports.

TRANSACTION COUNT
Transaction count is a good measure of activity taking place on a network. By plotting the
number for set periods (or by using moving averages), we can see how activity changes over
time.
Note that this metric should be treated with caution. As with active addresses, we can't be
sure that there isn't just one party transferring funds between their own wallets to inflate
the on-chain activity.

TRANSACTION VALUE
Not to be confused with the transaction count, the transaction value tells us how much
value has been transacted within a period. For instance, if a total of ten Ethereum
transactions, worth $50 each, were sent on the same day, we would say that the daily
transaction volume was $500. We could measure this in a fiat currency like USD, or we could
measure it in the protocol's native unit (ETH).

ACTIVE ADDRESSES
Active addresses are the blockchain addresses that are active in a given period. Approaches
to calculating this vary, but a popular method is to count both the sender and receivers of
each transaction over set periods (e.g., days, weeks, or months). Some also examine the
number of unique addresses cumulatively, meaning that they track the total over time.

FEES PAID
Perhaps more important for some crypto assets than others, the fees paid can tell us about
the demand for block space. We could think of them like bids at an auction: users compete
with each other to have their transactions included in a timely manner. Those bidding
higher will see their transactions confirmed (mined) sooner, while those bidding lower will
need to wait longer.

For cryptocurrencies with decreasing emission schedules, this is an interesting metric to

study. The major Proof of Work (PoW) blockchains provide a block reward. In some, it's
made up of a block subsidy and transaction fees. The block subsidy decreases periodically
(in events such as the Bitcoin halving).

Because the cost to mine tends to increase over time, but the block subsidy is slowly
reduced, it makes sense that transaction fees would need to rise. Otherwise, miners would
operate at a loss and begin to drop off the network. This has a knock-on effect on the
security of the chain.

HASH RATE AND THE AMOUNT STAKED

Blockchains today use many different consensus algorithms, each with its own mechanisms.
Given that these play such an integral role in securing the network, diving into the data
surrounding them could prove valuable for fundamental analysis.

Hash rate is often used as a measure of network health in Proof of Work cryptocurrencies.
The higher the hash rate, the more difficult it is to successfully mount a 51% attack. But an
increase over time can also point to growing interest in mining, likely as a result of cheap
overheads and higher profits. Conversely, a decrease in hash rate points to miners going
offline ("miner capitulation") as it's no longer profitable for them to secure the network.
Factors that can influence the overall costs of mining include the current price of the asset,
the number of transactions processed, and fees being paid, to name a few. Of course, the
direct costs of mining (electricity, computing power) are also important considerations.

STAKING (in Proof of Stake, for example) is another related concept with similar game
theory to PoW mining. Insofar as the mechanisms, though, it works differently. The basic
idea is that users stake their own holdings to participate in block validation. As such, we
could look to the amount staked at a given time to gauge interest (or lack of it).

PROJECT METRICS
Where on-chain metrics are concerned with observable blockchain data, project metrics
involve a qualitative approach which looks to factors like the performance of the team (if
any exists), the whitepaper, and the upcoming roadmap.

THE WHITEPAPER
It's highly recommended that you read the whitepaper of any project before investing. This
is a technical document that gives us an overview of the cryptocurrency project. A good
whitepaper should define the goals of the network, and ideally give us an insight into:

• The technology used (is it open source?)

• The use case(s) it aims to cater to

• The roadmap for upgrades and new features

• The supply and distribution scheme for coins or tokens

• It's wise to cross-reference this information with discussions of the project. What are
other people saying about it? Are there any red flags raised? Do the goals seem
realistic?

THE TEAM
If there's a specific team behind the cryptocurrency network, its members' track records can
reveal whether the team has the required skills to bring the project to fruition. Have
members undertaken successful ventures in this industry previously? Is their expertise
sufficient to reach their projected milestones? Have they been involved in any questionable
projects or scams?

If there is no team, what does the developer community look like? If the project has a public
GitHub, check to see how many contributors there are and how much activity there is. A
coin whose development has been constant may be more appealing than one whose
repository hasn't been updated in two years.
COMPETITORS
A strong whitepaper should give us an idea of the use case the crypto asset is targeting. At
this stage, it's important to identify the projects it's competing with, as well as the legacy
infrastructure it seeks to replace.

Ideally, fundamental analysis of these should be just as rigorous. An asset may look
appealing by itself, but the same indicators applied to similar crypto assets could reveal ours
to be weaker than the others.

TOKENOMICS AND INITIAL DISTRIBUTION

Some projects create tokens as a solution looking for a problem. Not to say that the project
itself isn't viable, but its associated token may not be particularly useful in this context. As
such, it's important to determine whether the token has real utility. And, by extension,
whether that utility is something that the wider market will recognize, and how much it
would likely value the utility at.

Another important factor to consider on this front is how the funds were initially distributed.
Was it via an ICO or IEO, or could users earn it by mining? In the case of the former, the
whitepaper should outline how much is kept for the founders and team, and how much will
be available to investors. In the case of the latter, we could look to evidence of the asset's
creator premining (mining on the network before it's announced).

Focusing on the distribution might give us an idea of any risk that exists. For instance, if the
vast majority of the supply was owned by only a few parties, we might reach the conclusion
that this is a risky investment, as those parties could eventually manipulate the market.

MARKET CAPITALIZATION
Market capitalization (or network value) is calculated by multiplying the circulating supply
with the current price. Essentially, it represents the hypothetical cost to buy every single
available unit of the crypto asset (assuming no slippage).

By itself, market capitalization can be misleading. In theory, it would be easy to issue a

useless token with a supply of ten million units. If just one of those tokens was traded for $1,
then the market cap would be $10 million. This valuation is obviously distorted – without a
strong value proposition, it's unlikely that the wider market would be interested in the
token.

On a related note, it's impossible to truly determine how many units are in circulation for a
given cryptocurrency or token. Coins can be burned, keys can be lost, and funds can simply
be forgotten about. What we see instead are approximations that attempt to filter out coins
that are no longer in circulation.

Nonetheless, market capitalization is used extensively to figure out the growth potential of
networks. Some crypto investors view "small-cap" coins to be more likely to grow compared
to "large-cap" ones. Others believe large-caps to have stronger network effects, and,
therefore, stand a better chance than unestablished small-caps.

LIQUIDITY AND VOLUME

Liquidity is a measure of how easily an asset can be bought or sold. A liquid asset is one that
we'd have no problem selling at its trading price. A related concept is that of a liquid market,
which is a competitive market flooded with asks and bids (leading to a tighter bid-ask
spread).

A problem we might encounter with an illiquid market is that we're unable to sell our assets
at a "fair" price. This tells us there are no buyers willing to make the trade, leaving us with
two options: lower the ask or wait for liquidity to increase.

Trading volume is an indicator that can help us determine liquidity. It can be measured in a
few ways and serves to show how much value has been traded within a given time period.
Typically, charts display the daily trading volume (denominated in native units or in dollars).

Being familiar with liquidity can be helpful in the context of fundamental analysis. Ultimately,
it acts as an indicator of the market's interest in a prospective investment.

SUPPLY MECHANISMS
To some, the supply mechanisms of a coin or token are some of the most interesting
properties from an investment standpoint. Indeed, models like the Stock-to-Flow (S2F) ratio
are growing in popularity amongst Bitcoin proponents.

Maximum supply, circulating supply, and rate of inflation can inform decisions. Some coins
reduce the number of new units they produce over time, making them attractive to
investors that believe the demand for new units will outstrip their availability.

On the other hand, different investors might see a rigidly-enforced cap as damaging in the
long run. Such concerns may be that it disincentivizes the use of the coins/tokens as users
opt instead to hoard them. Another criticism is that it disproportionately rewards early
adopters, whereas a steady inflationary policy would be fairer for newcomers.