Cryptocurrency projects have only been booming after 2020. Since then, more diverse and innovative application scenarios have emerged. However, the crypto market fluctuates greatly, with risks and opportunities coexisting. Designing your custom fundamental analysis model will help you to make investment decisions in a more disciplined way. Due to the high-risk and high-reward feature of crypto investment, a well-designed analysis model will make your investment strategy better. trading. You may have heard the words that "one day in crypto equals ten years in traditional financial markets". This is because the “limit up-limit down” rule in the stock market prevents both excessive profits and magnified losses. Once the price change exceeds the limit, it will trigger trading halts. However, in the emerging cryptocurrency market, there is no limit on price or trading time. You can trade crypto every minute. However, the huge potential of profiting is always accompanied by high risks. Under the law, are there optimal ways investors can utilize to make the best possible investment decisions?
In traditional financial markets, investors have to make decisions in response to market changes. Every appropriate decision is made with the adoption of suitable analysis methods. Basically, analysis methods can be divided into three types: fundamental, technical, and position cost analysis. Fundamental analysis in the traditional stock market is to understand a company's financial status and profitability through analysis of its three financial statements and four key indicators, thereby judging whether it deserves long-term investing.
The above-mentioned three financial statements include an income statement (to determine whether the company has a net profit), a balance sheet (to check the company's assets and liabilities), and a cash flow statement (to see how much highly liquid cash the company actually owns).
The four indicators consist of Earnings Per Share (EP) that shows the profits each share brings, Price-Earnings Ratio (PE) that predicts how long the stock will reach the break-even point, and the Price-Book Ratio (PB) that calculates the operating gross profit margin and judges whether the stock price is fair.
In a nutshell, fundamental analysis is the most important method investors use to assess whether an asset is overvalued or undervalued in both the traditional stock market and the emerging cryptocurrency market.
Different from the listed companies in the stock market, crypto projects do not provide quarterly financial statements for investors. Hence, the three major financial statements and four key indicators do not apply in the emerging crypto market.
Due to the decentralized nature of cryptocurrencies, there is no universal measure that can be applied to the whole crypto space. As the seemingly trusted hearsay might also be fake, investors must learn to identify the real information and determine whether the source is reliable. Either a Twitter account or Telegram group you follow may release unverified news, and the surge in the number of active addresses on the blockchain may also be fake data.
Then, what are the suitable indicators and tools that work best with market news to make the best possible fundamental analysis to facilitate decision-making in the crypto market?
Below is a detailed analysis of the three basic metrics, three key indicators, analytical tools and market news of cryptocurrency fundamental analysis.
On-chain metrics refer to data that can be used to observe the blockchain as an indicator for judging the market trend. However, collecting the data of a single node alone is time-consuming and labor-intensive. Investors may refer to information provided by websites exclusively designed for providing investment decisions, or retrieve the required information from APIs (Application Programming Interfaces).
Number of Transactions
It can be used as a simple measure to evaluate network activity. By observing the transaction activity for a period of time, we can see the changes of the number of transactions on the chain. However, this does not guarantee that all the data is authentic and not artificially increased by transferring assets between different wallets of the same investor. You should pay special attention to data fraud.
Unlike the number of transactions mentioned above, the transaction volume means the total value traded over a fixed period of time. The total on-chain transaction volume is equal to the number of transactions multiplied by the amount of each transaction.
It refers to the blockchain addresses that are active during a fixed period of time. Among the various methods to judge whether an address is active or not, we commonly trace total active addresses by observing the number of sending and receiving addresses of each on-chain transaction for a certain period of time and calculate the sum at regular intervals.
Transaction Fee Paid
If the blockchain is congested and it takes a longer time to complete a transaction, we can speed up the transaction by increasing the transaction fee; if the blockchain goes smoothly and it takes not too long to complete a transaction, we can lower down the transaction speed and save the transaction fee. From the transaction fee, we can directly see traders’ demand for a specific blockchain. The higher the demand, the more crowded the blockchain, and the higher the transaction fee.
Hash Rate (Computing Power) and Staking Amount
In the distributed ledger system of blockchain, a certain mechanism is needed to determine the order of operation of network nodes. This mechanism that is based on node computing is called consensus algorithms, which is very important for the stability and security of the blockchain.
One of the most common and primary consensus algorithms is Proof of Work (PoW). For Bitcoin, it uses hash rate, i.e. computing power - the total computing power of mining or processing transactions on the blockchain. The on-chain transactions are linked together and cannot be changed. Let’s take the typical 51% attack for example. If hackers want to tamper with or forge blockchain data, they must control more than 51% of the entire network nodes to make it possible. Therefore, the higher the hash rate, the higher the difficulty of a 51% attack.
Another common consensus algorithm is Proof of Staking (PoS). Basically, it takes staking assets to participate in block verification. We can tell market preferences by examining the number of staking.
2. Project Metrics
The project metric is used to assess the performance of a project team and the result of the project in various ways.
The whitepaper is like a stock’s prospectus, but focuses more on the research and technical information related to the project, providing a way for the public to understand how the project works as well as the envisions and initial resource allocation. Specifically, a whitepaper covers:
Roadmap for upgrades or new features
Token supply and issuance
As most cryptocurrency project teams would post information of their team members on GitHub, it is very convenient to obtain relevant information. GitHub is a most commonly used open-source platform for developers because of its low cost. Registered users of this platform can upload files and data to their accounts, making them publicly available for everyone. Therefore, it is possible to know whether the team has the skills required to realize the project, or to evaluate whether the team has a disgraceful history by assessing its members’ past experience revealed and reading relevant news.
Having made enough research on the whitepaper and the team, you can have comparative analysis of its counterparties of similar applications. By comparing it with competing products and projects you are interested in with multiple indicators, you can assess whether the project is easily replaceable.
Tokenomics and Initial Token Distribution
It is necessary to check whether the tokens have practical use cases, how the cash flow operates, etc. The real value exists only if the token has real usage and is recognized by the market.
We should consider another important factor - how the initial tokens would be allocated. If it is allocated through an Initial Coin Offering (ICO) or Initial Exchange Offering (IEO), the whitepaper should specify the percentage of tokens that the founder and the team spends and retains, including the amount of tokens available for investors. And it is through an Initial Model Offering (IMO), you can view the evidence of announcing to mine on the network you previously posted.
Sometimes, the trust principle should be taken for the project metric. As investors can only make judgments based on the information disclosed by the team, any hidden information or false disclosure will trigger potential risks.
3. Financial Metrics
Different from the fundamental analysis tools in traditional finance that evaluate public information such as trading volume, prices and liquidity, the financial metrics in crypto focuses on agreements or incentive measures.
Market Cap (Network Value)
Market cap is equal to the token in circulation multiplied by the token price. Market cap refers to the hypothetical cost (excluding slippage) per unit of buying a token. For example, if 1 million tokens are issued and the trading price is $1, then the total market cap is $1M, which is totally created out of nothing. The market cap is obviously distorted. The token will be worthless if the popularity recedes and demand subsides after a period of time.
In addition to price fluctuations, the number of tokens in circulation is also uncertain, as tokens may be destroyed or lost in transferring or because of losing keys. Despite that, market cap is still commonly used to estimate the potential for network growth. Some crypto investors believe that coins with small market caps have higher potential for growth than mainstream coins like Bitcoin and Ethereum.
Example of Bitcoin market capitalization: The BTC price is $20,669 and the circulating supply is 19,087,475
The total market capitalization in circulation is about $394.5 billion ($20,669 x 19,087,475 BTC = 394,536,772,126)
Liquidity and Trading Volume
Liquidity refers to the velocity of money. In a market with high liquidities, it is easy and fast to buy or sell assets at a fair price; while with insufficient liquidities, an asset cannot be traded at a price that conforms to an efficient market.
Trading volume is an indicator that helps determine liquidity. Charts will record the trading volume and trading value during a specified time period. Liquidity can help determine market preferences.
The currency supply mechanism behind tokenomics is rather important. The maximum supply, market circulation and inflation rate will impose an indirect impact on the price. This means that if the number of tokens increase and the demand remains the same, the trading price will be falling.
After a period of time, some tokens will reduce the number of new coins created and reduce the total supply to maintain the price. Therefore, the supply can be seen as a criterion for checking whether there is an unlimited additional issue. If so, it will cause inflation and low prices and further damage the market.
1. Market Capitalization (MC) and Fully Diluted Valuation (FDV)
(In the following example, let’s assume that the current market price of A token is $1, the circulating supply is 1,000, and the maximum supply is 10,000.)
Full Diluted Valuation (FDV)
FDV = maximum supply of the token X current market price of the token = 10,000 X 1 = 10,000
FDV is an indicator that can be used to estimate the future market value of a project. That is, if the team unlocks all the tokens and put them into the market, FDV represents the future value of the project at the current price.
Market Capitalization (MC)
MC = Token's market circulation (circulating supply) X token’s current market price = 1,000 X 1 = 1,000
MC represents the current market value of a blockchain project. It is calculated by multiplying a token's market circulation by its current market price, which does not include the value of locked tokens.
The most obvious difference between FDV and MC is that FDV includes only the value of locked tokens. MC can be used as an indicator to measure market demand. It is more like a supply metric, as an increase in market demand for more unlocked tokens will also raise the price, increasing FDV proportionally.
For example, raise 250,000 with 5 million FDV, and sell 5% FDV after listing. Assuming that 1% is in the circulation, and the market cap is 1 million, but actually the FDV has reached 100 million. As initial investors have got 20 times of returns, there will be considerable selling pressure if those initial investors unlock the tokens. That is to say, it is unreasonable if the FDV is larger than the MC at the time of unlocking, as it may cause a large number of selling and the drastic fall in prices. This explains the sharp correction of DeFi in the past year, far worse than performance of the whole crypto market, as most DeFi projects are established through financing and the price will fall once the token is unlocked.
2. Total Value Locked (TVL)
TVL refers to the liquid assets of DeFi protocols, which indicates the total amount of tokens locked in the capital pool. The higher the TVL, the more the funds raised, the greater the potential of the project will be. We can grasp information like changes in TVL and recent inflows and outflows of locked tokens of DeFi protocols on DeFi Llama.
Three commonly used TVL indicators:
Total Locked Value (TVL): The higher the TVL, the better the DeFi protocol
Market Cap (Mcap) / TVL: The lower the ratio, the greater potential the market has
Trading Volume (VOL) / TVL: The higher the ratio, the better the returns
3. Protocol Revenue (Profitability)
Revenues refer to the total fees paid by users, while protocol revenue is the portion paid to token holders of the total amount that users pay to the protocol. When calculating the protocol revenue, we should consider different business strategies of projects. To further explain, we will take NFTs (non-fungible tokens) as an example:
Play to Earn: Axie Infinity
The recently popular Ethereum-powered NFT-based game Axie Infinity is a blockchain turn-based game launched by Vietnamese studio Sky Mavis in 2018. Users earn governance tokens by fighting other players and completing tasks. This game hits the Play-to-Earn (P2E) craze. According to CryptoSlam, an NFT analytics website, Axie Infinity’s sales have exceeded $1 billion, making itself the first NFT-based blockchain game to exceed 1 billion sales. The high NFT sales revenue of the project is also the mainstay of the market.
100% of Axie Infinity protocol revenue goes to token holders. Technically, protocol revenue and token value will change in equal proportions. When comparing protocol revenue or PE ratios, it is necessary to understand how projects work.
The P2E model exploded in popularity in NFT-based games, where players collect NFT rewards and could cash out the assets in the real world.
Move to Earn: STEPN
The design of the STEPN game draws on the dual-token + NFT model of Axie Infinity. It has a dual-token mechanism, a reproduction system and an energy system, including the game token GST (Green Satoshi Token), the governance token GMT (Green Metaverse Token) and NFT sneakers.
STEPN connects Web3 with the real world and provides users with a platform to make money by running with virtual shoes.
The two founders outlined the prototype and concept of the project overnight. In this unique model, virtual sneaker NFT holders can earn token rewards by completing running tasks. Over a month after its establishment, STEPN came in fourth in the Solana Ignition Hackathon Gaming Track, and received a $5M seed round funding led by Sequoia soon after its launch in December 2021.
In early April, STEPN reported $26M revenues in the first quarter. It has over 1 million app downloads globally and an estimated market cap of $1 billion, and has secured investments from Binance. According to on-chain data on Dune, about 4,000~5,000 pairs of sneaker NFTs came into being almost every day in the week in late April.
As of May 2022, STEPN has seen 800,000 daily active users (DAU) and 3 million monthly active users (MAU). According to TechCrunch, an online newspaper focusing on high tech and startup companies, STEPN’s daily platform income is about $3M to $5M, with a monthly income reaching up to $10M.
The data shows a considerable protocol revenue of STEPN, far exceeding that of other unicorn companies in DeFi, GameFi, and even Web3 sectors. In the initial stage, GMT has also shown excellent performance, witnessing a 40 times increase within 50 days, from $0.1 on Mar. 10 when it was first launched to $4 that it peaked at on Apr. 30. The fundamental data of the protocol is sound and the investors are highly enthusiastic in this bull market, both of which are leveling up the token price. It is definitely a good example for us to learn. However, as a result of the Fed announcing a rate hike, hot money flowed out, market trend changed, MAU declined, and the GMT price fell.
If we simply look at the fundamentals, it is indeed a good buying opportunity, but the selling point is difficult to decide. In addition to fundamental analysis, it is also very important to employ appropriate entry and exit strategies as well as trading discipline.
Transaction details are accessible for anyone to check on blockchains. Among a diversity of blockchain browsers, we here take the leading Ethereum blockchain explorer Etherscan as an example, where the fund flow of each transaction on the chain is transparent and traceable.
Taking the SHIBA INU token as an example. We can see from below the token allocation and the holders' wallet addresses, as well as the total token supply and total number of holders.
Token Terminal standardizes cryptocurrency data referring to traditional financial stock market indicators, allowing investors to easily review the value of different blockchains and decentralized applications. Metrics currently available on Token Terminal include: total market cap, circulating market cap, price-to-sales ratio, price-to-earnings ratio, token’s trading volume, total value locked, total commodity volume, income, protocol (token holder) revenue, cost and expense, total revenue, etc. It provides original, downloadable project data, making it possible for all to conduct data analysis quickly and accurately with the help of the filter and multiple display functions.
In the Axie Infinity example mentioned above, you can see various metrics available, including total market cap, circulating market cap, price-to-earnings ratio, and token’s trading volume, for users to conduct competitive analysis, data analysis, and multi-metrics analysis of similar projects.
Dune Analytics is a free and powerful blockchain analytics website, where you can extract data from the Ethereum blockchain with SQL (a database programming language) or just copy SQL programs from others or search a token directly. With the data you can create visual charts. It simplifies the process of data searching, is easy to operate, and presents a more visualized result.
In the following example, we can use Dune to query and draw a chart showing how many new users STEPN has every day, and the price trend chart for a fixed period of time, etc.
It refers to various news that affect the market negatively or positively. In the real economic market, the overall environment will not only affect the stock market, but also cryptocurrency due to the exchange of financial flows. Factors that influence the economic market in crypto include major upgrades, listing on an exchange, contract loopholes, etc. The most eye-catching moment in crypto would be the four-year Bitcoin Halving Cycle. Each halving will bring a new period of bottom reversal, so it can be used as a news reference for the whole market.
[Four-year Bitcoin Halving Cycle]
Bitcoin launch: January 3, 2009 Block reward: 50 BTC
The first halving: November 28, 2012 Block reward: 25 BTC
The second halving: July 9, 2016 Block reward: 12.5 BTC
The third halving: May 12, 2020 Block reward: 6.25 BTC
The fourth halving: scheduled in 2024 Block reward: 3.125 BTC
Generally, large sell-offs are less likely to occur in a bull market. Most whale investors holding a large amount of funds will store the currency in cold wallets to ensure safety. While in a bear market, whale investors may sell their holdings in large quantities at any time in order not to lose money. At this time, if the exchange balance increases, it could be a warning of possible sell-off and may lead to a fall in price.
Whale Wallet Transaction History
A direct approach to query whale wallet transactions is through Whale Alert, a data collection and analytics website, where you can check whale wallet transactions of various coins and find out which coins are undergoing large transactions. However, this is only a signal of predicting the future trend and should not be used as investment advice directly.
1. Help to find the turning point when trend changes
2. Facilitate grasping real-time information and trend changes instantly
3. Help to identify suitable investment targets
4. Avoid irrational selloff caused by panic
1. The data may be falsified
2. No standardized, comprehensive introduction and information publicly available, making it difficult to identify the real ones.
3. Some information provided by the project team might also be hidden or false.
4. Data collection and analysis is time-consuming and labor-intensive
The fundamental analysis tools designed for traditional financial markets are no longer applicable for the emerging crypto market. In response to this, various auxiliary analysis tools are created. All information is recorded and made public on the blockchain due to its open nature. However, the use of these auxiliary tools still relies on various applications to collect data.
The data sources of all analytics platforms could not be completely accurate, and the news might be forged easily, especially as most of the crypto investors are scattered all over the world, making it a regulatory blind spot. Even if there is a dispute, it is extremely difficult to have it solved through a lawsuit.
Currently, we have no sophisticated data models and evaluating criteria for the fundamental analysis of cryptocurrencies as for traditional finance. There is still considerable room for improvement of the tools. However, if investors are able to make effective investment decisions with a higher probability of profiting by exploring fundamentals of a project and using better analysis models and evaluation criteria, fundamental analysis is still a good method for evaluation.
Cryptocurrency projects have only been booming after 2020. Since then, more diverse and innovative application scenarios have emerged. However, the crypto market fluctuates greatly, with risks and opportunities coexisting. Designing your custom fundamental analysis model will help you to make investment decisions in a more disciplined way. Due to the high-risk and high-reward feature of crypto investment, a well-designed analysis model will make your investment strategy better.