What is fundamental analysis (FA)?
A one-size-fits-all approach does not work when trading the stock market or cryptocurrencies. Instead, many different approaches to trading and investing exist. These methods can be generally put into two categories: fundamental analysis (FA) and technical analysis(TA).
This article will define and explore different types of fundamental analysis within the world of cryptocurrency.
What is fundamental analysis?
Fundamental analysis is a method where investors and traders try to find the true value of cryptocurrencies. They do this by looking at internal and external factors to see if the asset or business is overpriced. Their findings can help them create a plan.
For example, if you’re interested in investing in cryptocurrency, you might first study things like the number of active addresses, the team’s experience, its business model, the company’s financial health and its Network value-to-transactions (NVT) ratio to get a feel for how strong it is.
Stepping back from the company, you would inspect the market or industry it is a part of.
- Who are the competitors and what are they doing?
- Is the market trending and what are the industry trends?
A bottom-up approach starts with a company you’re interested in and then understands its place in the broader economy. Conversely, you could use a top-down approach which narrows your picks by first examining the bigger picture.
After you carefully analyze the data, you can then decide whether it would be beneficial to invest in that crypto or not.
Fundamental analysis and cryptocurrencies
In the next section, we will explore a few indicators commonly used by cryptocurrency traders and investors.
Active addresses
The number of active addresses on a network is not always accurate, but it can give you some information about the activity going on and future growth. You should take this into account when trying to find the true value of a digital asset.
Whitepaper, team, and roadmap
One of the most well-known approaches to determine the value of cryptocurrencies and tokens is by investigating the project. By reading a whitepaper, you can comprehend a project’s aspirations, its use cases, and its tech. The records of team members give you an understanding of their aptitude to construct and enlarge the product. Lastly, a roadmap lets you know if the project is on schedule. It can be backed up with extra research to calculate the probability of the project achieving its objectives.
Network value-to-transactions (NVT) ratio
The NVT ratio is becoming increasingly popular in cryptocurrency fundamental analysis, as it can be seen as the Price–earnings (P/E) ratio equivalent of the crypto markets. It is calculated by taking the following:
- Network value / daily transaction volume
NVT attempts to assess a network’s worth based on the value of the transactions. Imagine two coins, both with a market capitalization of $2,000,000. However, Coin A has a daily transaction volume worth $100,000 while Coin B’s is only valued at $20,000.
The ratio of Network Value to Transactions (NVT) for Coin A is 20, and the NVT for Coin B is 100. In general, assets with a lower NVT ratio are seen as undervalued compared to those with higher ratios. If we’re taking these merits into account, it suggests that Coin A is underpriced compared to Coin B.
Price-to-mining-breakeven ratio
The price-to-mining-breakeven ratio is a metric for valuing Proof of Work coins. It considers the costs associated with mining costs, such as electricity and hardware expenditure.
- coin market price/cost to mine a coin
The price-to-mining ratio can give a lot of insight into the current state of a blockchain network. Breakeven is defined as the cost to mine one coin – for example, if it’s $2,000 per coin, miners would typically spend that much to generate each new unit.
Suppose that Coin A trades at $1,000 and Coin B at $5,000. If both coins have a breakeven point of $2,000, then Coin A’s ratio will be 0.5 ($1,000/$2,000), while Coin B’s ratio will be 2.5 ($5,000/$2,500). SinceCoin A’s ratio is greater than or equal to 1, it means that miners would actually make money if they mined this coin. Mining Coin B would be profitable as every miner who spends $2000 mining the coin, can expect to make $2500.
Given enough time, you would expect the ratio to trend toward 1 because of the incentives in place. If Coin A’s current market price doesn’t increase soon, miners will be discouraged from staying on and mining it at a loss. On the other hand, since Coin B has a much higher reward, more miners are incentivized to join until it becomes unprofitable.
Though there is some disagreement over how effective this indicator is, it can still give you a sense of the mining economics involved in a digital asset. You can then use this information to help you make an overall assessment of the asset.
Summary
Many thriving traders credit their success to refining a fundamental analysis strategy. This practice allows investors not only to assess the value of cryptocurrencies but also to comprehend industries on a broader scale.
To attain a comprehensive understanding of which assets and businesses would be most profitable, many traders and investors rely on both technical analysis (TA) and fundamental analysis (FA). This approach is popular in both traditional markets as well as cryptocurrency markets.
