For traditional investments in stocks or real estate, fundamental analysis entails evaluating the financial health and viability of a company according to its financial statements.
If the numbers look good, we can be confident that the company has good fundamentals and we can, therefore, invest in it. Performing fundamental analysis for cryptocurrencies, however, is radically different since there are no financial statements to analyze. Why? Because:
- Cryptocurrencies are not corporations but are rather digital currencies that represent value or assets within a network. It’s important to understand the differences between stocks and cryptocurrencies.
Its viability is not based on generating a revenue, but rather directly depends on the participation of the community (users using the service, miners securing the network and of course the developers). Each cryptocurrency is a manifestation of the different applications of Blockchain technology, and are usually decentralized;
- The crypto space is in its infancy stages, and almost all of the cryptocurrencies are in development stages. Which means that there are limited uses cases in the real world currently and therefore, a lack of track record to show for.
Thus, fundamental analysis on cryptocurrencies must be performed with a different methodology. Given the complex nature of cryptos and their underlying technology, it is even more important for us to engage in research to assess the viability and potential of the coins. This ensures that we make better investment decisions and are kept in the loop of things.
Factors affecting cryptocurrency value
A coin must have a strong function (or use-case) to incentivize people to hold the coins; a coin’s utility is strongly correlated with its value. Let’s use Ether (ETH) as a case study. In order for anyone to execute commands and develop applications in the Ethereum Blockchain one needs to have ETH, as it will be converted into gas and represents the ‘fuel’ for the Ethereum ecosystem. Therefore, ETH is used as a currency within its system to fuel transactions and development. The more people that execute transactions and develop apps, the greater the demand for ETH and will, therefore, push prices up.
Some utility includes voting rights, dividend payments or most commonly a medium of exchange within their respective ecosystem. A coin without a use is simply speculative in nature that’s substantiated without any fundamental value.
Scarcity refers to the finite nature of the coins. In economics, a fixed supply of a certain item would increase its value in the long term, assuming its demand increases. This creates scarcity, as there is only a limited supply of coins in circulation. For instance, Bitcoin’s maximum supply is fixed at 21 million coins. Especially for coins that have a great utility, demand will undeniably push its value up.
Some coins even employ a “burning” mechanism, which refers to the act of destroying a portion of the coin supply. This would increase the value of the coin as there is now a much lesser supply of coins.
A coin is only as valuable as what the markets deem it to be, and how a project is valued depends on factors that are core to the development of the project. Therefore, projects that persistently achieve their milestones that was set out in their white paper. Additionally, collaborations and partnerships with credible companies or other projects is a good sign of expansion. Other news that can enhance the perceived value in the eyes of the market includes a successful launch of their Minimum Viable Product (MVP) or the beta version of their protocol/software. These are positive indicators of good progress by the project and will enhance the value of their coin.
These are key elements of a coin that will affect its value and is vital for everyone wanting to invest in cryptocurrencies to understand. Here’s a more detailed guide to getting you started with doing your due diligence before investing in cryptocurrencies: A Guide To Fundamental Analysis For Cryptocurrencies.