August 28, 2024 When analyzing a cryptocurrency to invest in or searching for new trading ideas, traders have two main paths.
The first is technical analysis. Similar to what we’ve covered in past articles, this analysis method is focused on charts and candlestick patterns. Specifically, it’s designed to identify repetitive chart patterns and optimal ways to capitalize on them.
The second analysis method is fundamental analysis, and we’ll focus on it in our blog post today.
We’ll elaborate extensively on this topic soon, but for now, think about fundamental analysis as a sort of due diligence, similar to the one you’re supposed to do before making any financial decision. Like checking the engine, mileage, and paperwork of a car before buying it, there are specific criteria traders are recommended to examine before investing in or trading a cryptocurrency. Regarding financials, this type of due diligence is called fundamental analysis.
In fundamental analysis, we wish to examine the foundations and features of a cryptocurrency, like the underlying technology of crypto, news and developments, real-life use cases, tokenomics, on-chain analysis, and more. Don’t worry if you are unfamiliar with these concepts. We’ll provide in-depth explanations to ensure your full grasp of the subject.
In line with our recent series covering technical analysis, this topic is also highly vast and, therefore, will be split into multiple parts. In this blog post of the series, we’ll take our first steps into fundamental analysis: what it is, who it is suitable for, and some of the basic concepts and metrics that make up the fundamentals of this type of analysis.
Before we move forward, a quick reminder that all the information presented in this blog post is intended solely for educational purposes and should not be considered a call for action or any kind of financial advice. Traders must consider their financial status, trading goals, and risk tolerance before employing any crypto trading strategy. Cryptocurrency trading involves inherited risks; consulting with a qualified financial advisor before making decisions is highly recommended.
A trader might first ask why he needs fundamental analysis if the setup for his strategies and bots solely relies on technical analysis.
First, traders need to understand that technical and fundamental analysis are not competitors, and it’s better to consider them complementary methods, not rivals. As we’ll demonstrate later on, fundamental and technical analysis are heavily dependent on one another, and adopting both of them as part of your research is likely to improve the accuracy of your trading strategies, as they rely on much more inclusive data.
Another way of looking at it is that, in many cases, fundamentals can explain what we’re seeing on the charts. While in some cases, dramatic up or down swings can happen spontaneously, often, these price movements can be explained by what we find in fundamental analysis. Furthermore, market dynamics supported by fundamental and technical indicators are more reliable than just technical analysis alone.
Furthermore, many experts suggest that traders should focus mainly on trading projects with solid fundamentals, and there are a few reasons for this claim. Projects with good foundations tend to be more established in general and are less likely to be scams or any kind of tool to draw funds from traders through market manipulation. On top of that, crypto projects with strong fundamentals are more likely to perform better over long timeframes, making them better candidates for trading strategies focused on slow and steady price appreciation, like DCA trading.
Additionally, since every trade comes with inherited risks, you want to stay with something valuable in your hand. In other words, trading more resilient cryptos can mitigate some of the risks of holding onto an asset for a substantial amount of time by minimizing the likelihood of your investment completely evaporating (a thing that’s happened more than once with pump-and-dump schemes.) This, in turn, can enable traders to take more risks in their trading strategies, as the downturn risk is somewhat limited.
To sum up, while trading meme coins could be very profitable with accurate timing and the right amount of luck, most experts would agree that for traders who wish to achieve more consistent results with more favorable risk-reward ratios, it’s better to trade projects you are familiar with, and believe in their long-term prospects.
After grasping the basics of fundamental analysis and its importance for daily crypto traders, we’ll delve into what kind of data we seek, why we want it, and where to find it.
Generally, all information about crypto is unrelated to its performance in the various crypto exchanges (chart patterns, trading volumes, etc.) and can be considered fundamental data. That said, it’s also important not to be overwhelmed with endless data and to know how to differentiate between primary and bland.
For these reasons, most advocates for fundamental analysis suggest that crypto traders should focus their research on four main characteristics. Let’s review them together.
We’ll start with the most obvious. Active crypto traders should always watch what’s happening in the crypto world. From exciting news like new developments and system upgrades to less exciting news like malfunctions and black swan events, traders should know what’s happening with their favorite crypto projects.
As the world of cryptos becomes more mainstream, it will also be more affected by the fiat ecosystem and traditional markets. We advise traders to focus on crypto news, macroeconomics, and global financial markets.
By monitoring crypto and fiat economies, traders can better understand what’s happening in the market and gain insight into what will likely happen.
When choosing reliable news sources, it’s best to diversify and get updates from multiple sources. Also, it is crucial to make sure that your news source does not speak out of position, presenting you only data that supports their subjective outlook and not the whole picture.
Most experts agree that for a crypto project to be successful in the long term, it has to have some added value to the actual world and not just rely on hype.
As cryptos and blockchains are designed to upgrade and replace many of our current financial systems, plenty of projects in the crypto world offer actual contributions to our daily lives and how we conduct our business.
Traders can explore many different crypto categories while searching for real-life cases. The most famous is a simple store of value (a.k.a digital gold), like Bitcoin (BTC). Another dominant category is Web3, where L1 crypto projects like Ethereum (ETH), Solana (SOL), and Cardano (CAD), along with complimentary L2 layers like Polygon (MATIC) and Optimism (OP), are trying to design a new updated version to the internet we all know. Another intriguing category of cryptos that traders can explore is the ISO20022 group, with crypto projects like Ripple (XRP) and Stellar (XLM) attempting to take over the world of traditional finance by replacing the outdated SWIFT system for round-the-globe money transfers.
Remember that this is a very partial list of categories at best, and the projects mentioned here are just examples for educational purposes (not a recommendation). Traders are advised to research, explore the vastness of available crypto categories, and decide where they find the most potential.
Besides the news, another good resource for gathering this type of information is through the crypto project itself. Established crypto projects have some online presence on their website or social media platforms, and you can follow and read their goals and roadmaps for getting there. Projects without a real online presence should raise a red flag for you, as they often tend to be less reliable candidates for investment.
Another method of determining the success of a crypto project in the real world is through on-chain analysis. In this method, you gather and analyze the data recorded on the blockchain, like the number of developers and daily active users, to evaluate current and future market sentiment. We’ll elaborate more on on-chain analysis in our next blog post.
Decentralization is arguably the most essential term when analyzing cryptos fundamentally. At its core, decentralization is a concept aimed at evaluating the strength, security, and efficiency of cryptos and their underlying technology, the blockchain.
From a theoretical perspective, cryptos were designed to create a fairer alternative to the fiat ecosystem, where no figures like governments and central banks have complete control over their currencies. Cryptos represent freedom and emancipation from centralized control and not about replacing one form of authority with another.
From a technical standpoint, blockchains heavily depend on decentralization for their operations. For example, a blockchain that relies only on a small number of validators (miners) is more susceptible to malfunctions than a blockchain where its hash power is evenly distributed among a more significant number of validators.
With no definitive definition, we’ll refer to decentralization as a measurement of how well control over the blockchain’s infrastructure is divided among its participants. Besides the number of validators, a partial list includes the number of servers a blockchain uses (such as Amazon’s AWS), mining pools and nodes, supportive wallets, crypto exchanges listed, and more.
To simplify things, a popular way of measuring a specific blockchain’s level of decentralization is through a metric called the Nakamoto Coefficient. It measures how many entities and subsystems one needs to dominate to gain complete control over the entire blockchain and ecosystem. Intuitively, the greater the number of subsystems needed to be in control to reach full dominance, the higher the decentralization of the crypto.
Tokenomics is yet another widely used term in the world of cryptos, with many different meanings, depending on who you ask. For further reference, we consider tokenomics a whole data set related to the currency’s distribution. This can range from its initial coin offering to its max cap, circulation supply, inflation rate, number of active wallets, and more.
This topic is related to the on-chain analysis we’ve mentioned before. We will delve into this topic at length in our next blog post, which is dedicated solely to tokenomics and on-chain analysis.
We’ve covered a lot of ground today! We’ve gained an understanding of fundamental analysis and why it’s essential for everyone, including active daily traders. Then, we went through the most useful data and metrics a trader should use to determine the quality of a specific crypto project through fundamental analysis and some guidelines on where to retrieve the data needed for this kind of analysis.
Fundamental analysis is a vast subject, so feeling overwhelmed is okay. This is also why we’ve separated the topic into several blog posts. We promise that by the end of our series, and after some practice, you can be a master of crypto fundamental analysis.
