When you start trading crypto, there are a bunch of things to figure out. One challenge is what information you will use to develop a trading thesis and guide your trading.
You will typically hear about technical analysis as a tool for trading crypto. This makes sense given crypto’s relative newness and rapid evolution. We’ve talked about some technical analysis basics here to get you started.
But fundamental analysis is a little tougher to rely on in the crypto space. Crypto has numerous unique nuances, and it’s constantly evolving.
The recent expansion of products and services across smart contract platforms means new data points. And because these are so new, it isn’t always clear what the best data points to focus on are.
And it depends on what part of the crypto market you are operating in whether it may be relevant at all.
Fundamental analysis is a valuable practice for some traders on its own. But for many, certain fundamentals will be a value add to their existing approach.
What are fundamentals?
Fundamental analysts are the number crunchers and data hounds. They prefer models and deep research to charts and technical indicators.
But the name of the game is to make money, so it doesn’t matter what method you use. Ideally, you should incorporate the best of both methods.
The idea behind fundamental analysis is to determine the value of an asset. Fundamentals are the specific variables that can help determine that price or value.
That valuation can be compared to the current market price. This is what it means when you hear a given asset is over or under-valued.
You can compare the valuation on a relative basis to other assets in the same class or sector.
These variables and valuations can also influence the current and future prices of an asset. They do this by shaping the expectations and reactions of investors and traders that use them.
Some fundamentals for traditional assets
Different assets have different fundamentals.
For gold, you might keep an eye on production numbers, the monsoon season in India, and jewelry demand.
You might follow the inflows and outflows of capital through the GLD ETF. You could look at the commitment of traders’ reports. Or production in key mining areas around the world.
For stocks, you have earnings, cash flows, market conditions, and competitive analysis. Then there are interest rates, bull/bear sentiment, fund flows and things like index inclusion. Short interest and margin rates are also important fundamentals, as demonstrated by the WallStreet Bets crowd.
Fundamentals might include the management team, regulation, taxes, and things like seasonality.
Currencies draw on elements like GDP, monetary and fiscal policy, political stability, and various perception factors. You would also want to understand capital flows in and out of that economy.
There is also data from derivative financial products that can be used as well.
Crypto is now much more than just some tokens
Crypto has evolved substantially in the last several years.
What started as Bitcoin has evolved into more than 10,000 token, altcoin and cryptocurrency projects. DeFi, NFTs, and stablecoins are developing rapidly, aided by numerous smart contract platforms.
Crypto fundamental analysis was initially laser-focused on a limited number of data points. These included analyzing transactions and details from mining operations on hash rates, transaction speeds and rates.
There was also an emphasis on tracking large movements of coins on the blockchain and the number of Bitcoin ATMs and businesses that accepted crypto.
All of which remain part of a fundamental matrix.
Today, the breadth of products and services means a wider range of data inputs. And these all lead back to the first key fundamental document, the whitepaper.
The crypto whitepaper
The whitepaper is an important document in the crypto space. Before moving into any project, especially if it’s new, the whitepaper is a great place to start.
This is important, especially when it comes to infrastructure projects like different smart contract platforms. You will want to understand what they do and how they differ from competitors.
As a trader, you might get some insight into red flags, new concepts and other key information.
The whitepaper is going to help you understand things like the coin or token limit. The issuance and projected inflation as well as the consensus mechanism. They will outline the vision.
And they will tell you all the ways they are improving on what has come before it.
After you’ve read the whitepaper, published interviews with the founders can provide valuable insights. These are widely available and show you the project’s origin, thinking, and vision in ways the whitepaper cannot do.
Crypto project teams are important
At the start of most crypto projects, the team is going to be important. Teams with well-known crypto operators will tend to attract investment, press and strong followings.
For example, you will see Cardano’s Hoskinson is from Ethereum. Or Polkadot’s Gavin Wood is also a co-founder of Ethereum and author of the Ethereum Yellow Paper. You might recognize Stellar Lumens’ McCaleb as the co-founder of XRP and previously Mt Gox.
Other teams have reputations and followings that can translate into strong support, community and governance. All of these are crucial to the success of the platform or project over time.
Governance as a fundamental
The whitepaper will outline the consensus mechanism. Consensus is part of a broader incentive and disincentive structure that determines the viability of a project.
One of the most powerful elements of a project is the community. And the governance that guides that and how it’s implemented is a key part of it.
For example, there are numerous proof-of-stake protocols with different governance approaches.
Governance shapes how the community can interact, guide and influence the direction of the protocol. It also outlines specific incentives and disincentives to guide behaviour for the good of the project.
Knowing how these work in each project is an important piece of fundamental information.
How many coins or tokens are in circulation?
An obvious fundamental would be the total number of tokens in circulation. Specifically, you might want to know the free float or amount of free trading coins out there.
Tightly held coins with a smaller float can be more illiquid and hence more volatile.
You might want to know if the project has a coin limit or an inflation rate.
How do they achieve that?
How much did the founders take and how much was distributed, and to whom?
These are all key pieces of information.
The number of transactions and overall trading volume could also be a helpful metric. This could include the activity across different DeFi products and services. It might also include options and futures activity which are part of the price discovery mechanism.
Another crypto fundamental could be the number of entities that accept a given cryptocurrency. How much activity do they generate?
You could also look at the number of active wallets on a given cryptocurrency and the trend in those numbers. Are they rising or falling?
You might also track the transaction times and fees. And mining activity is a potentially useful metric in proof-of-work consensus projects like Bitcoin.
Yield farming, lending and staking
With the explosion of DeFi, numerous other elements provide data for fundamental analysts. Yield farming can give some insight into arbitrage opportunities and evolving market conditions.
It’s still a bit of a wild west, but there are different ways that you might be able to use this data.
The amount of assets locked into these various platforms via staking is a useful metric.
What is the trend in asset accumulation?
This can tell you something about the current trust in and economics of the protocol.
Assets locked can tell you a bit about the perception of the values or mission of the protocol itself.
Institutional endorsement of crypto projects
The announcement by MicroStrategy in late 2020 was a significant endorsement of crypto. Musks’ subsequent involvement is another key endorsement. The announcements of stodgy old insurance firms getting into Bitcoin was another.
Institutional involvement is a key fundamental. This can be evaluated by looking at the investor documents of major corporations.
Greyscale’s funds reflect institutional demand for specific crypto products.
Different ETF products and funds and the trends in their AUM might be another useful fundamental data point.
Institutions also play heavily in derivatives products. So looking again at crypto futures and options, where available, will provide some clues on activity.
You could also look at the evolving short interest on MicroStrategy’s stock due to their outsized Bitcoin position. This might give you some insight into the expectations of institutional traders hedging or executing a directional position related to Bitcoin. Or as an expression of the crypto market as a whole until correlations uncouple.
Correlation between different cryptocurrencies, altcoins and tokens
Bitcoin has long been the north star in terms of price movement for the entire space. Where Bitcoin went, almost all others followed.
But this correlation is evolving.
The big move in 2020 demonstrated a delay between the moves in Bitcoin and Ethereum. There are now thousands of different crypto communities, consensus, liquidity profiles and visions.
Correlations will continue to evolve and change. This is a fundamental to watch, especially in times of stress.
Under stress, the correlations across traditional assets often go to 1. That means they can all go down together, at least temporarily.
So watching crypto assets during important market events can be an important piece of information. Which ones stick together, and which ones buck the trend? This can be a valuable piece of trading information.
Sovereign government actions are a fundamental
While crypto may be anti-establishment, the government plays a substantial role in every tradable asset. Government decisions, actions and regulatory behaviour drive fundamentals across asset classes in some interesting ways.
For example, several assets have a sort of seasonality based in many cases around regulation. Tax-loss selling, earnings seasons, options expiries and fiscal year-end are all regulatory events.
Government can limit access to certain products. The UK’s FCA limited the general public’s access to speculative crypto futures products, for example.
Crypto is unique to the extent that regulation is currently limited in most jurisdictions.
However, regulation remains a significant wild card as nations compete for digital supremacy without ceding sovereignty. Any announcement by a major economy about crypto or blockchain has market impact.
So government and regulation have important and largely unknown fundamental influences on crypto markets. These characteristics make them important catalysts.
Crypto fundamentals plus crypto technicals for the win
The challenge with fundamentals is that they require assumptions about what is more important than others. Crypto is an evolving environment for fundamental analysis.
Crypto isn’t just Bitcoin. It’s now a growing and diverse ecosystem of products and services.
As a result, fundamental analysis will grow in significance.
It means you will have an endless slew of crypto fundamental rabbit holes to go down.
As a trader, the fundamentals you choose will depend on where you are operating.
It will depend on your trading style and objectives.
The fundamentals for Bitcoin are different from those for a smart contract pure-play like Ethereum, Cardano or Polkadot. And the way you evaluate them is different from a decentralized oracle platform like Chainlink.
Governance tokens are different from the sub-tokens on some platforms. On others, one token represents everything from payments to governance and rewards.
As a trader, being aware of these various elements can be useful. And when you combine fundamentals with technical analysis, you can formulate better trading plans.
These insights can help you manage your risk better.
And you can potentially make more coin.
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