How to Evaluate a Cryptocurrency before Purchase

A guide for beginners and the crypto-curious.

The optimal moment to purchase an asset is when it is undervalued. This principle applies across all investment classes, including the burgeoning field of cryptocurrencies. The crypto industry, despite its rapid growth, remains in its nascent stages, making it challenging to separate worthwhile projects from those inflated by hype. Employing fundamental analysis allows investors to conduct initial due diligence, potentially identifying undervalued crypto projects worthy of investment.

Relevance of Fundamental Analysis in Crypto
Although it began with stocks, fundamental analysis has proven effective for other asset classes, including cryptocurrencies. Given the volatility and hype in the crypto market, fundamental analysis helps investors evaluate the intrinsic value and risks associated with various crypto assets.

As the crypto space has evolved, so have the tools for fundamental analysis. Modern techniques now include evaluating project teams, tokenomics, partnerships, utility, network metrics, and security audit statuses to assess the intrinsic value and growth potential of crypto assets.

Fundamental vs. Technical Analysis
Before diving deeper, it’s crucial to distinguish between fundamental and technical analysis. Fundamental analysis evaluates a crypto project’s intrinsic value using qualitative and quantitative information. In contrast, technical analysis predicts future price movements based on historical price data.

Imagine buying real estate. Fundamental analysis would involve inspecting the property and evaluating the neighborhood’s growth potential (e.g., local schools, hospitals, transport links). Technical analysis would only consider historical price trends of properties in the area before deciding whether the property is a good investment.

Key Aspects of Crypto Fundamental Analysis
Several data points inform a project’s intrinsic value. Here, some essential aspects:

1. Development Team
   Evaluate the project’s team based on their educational background, relevant work experience, past successes, and prior collaborations. Teams with identifiable individuals, reputable expertise and a strong track record are more likely to develop successful projects.
2. Technology and Blockchain
   Blockchain technology underpins a crypto asset, much like power lines deliver electricity. A robust blockchain infrastructure is essential for a token’s utility and can influence its market price. For example, Ethereum enables thousands of decentralized applications (dApps) and requires Ether for transaction fees. Solana offers fast micro-transactions, while Avalanche combines scalability and security for smart contracts. Assess scalability, security, transaction fees, and transparency.
3. Token Utility, Use Cases and Roadmap
   Following the 2017 ICO bubble, it is crucial to consider a token’s use case and utility. A practical use case increases the likelihood of long-term success, driving demand and influencing price action. A project’s whitepaper and technical documents provide insight into its utility and technology. Assess the project’s purpose, technology, use cases, token utility, and tokenomics. Understanding the value proposition is crucial for making informed investment decisions and ask yourself if a token is needed for this projects value accrual. Also make sure that the project has a roadmap — how is value created in the long-term?
4. Tokenomics and Distribution
   Tokenomics and distribution plans significantly impact a digital asset’s valuation and price action. Bitcoin’s deflationary model, with its halving events and finite supply, creates scarcity, driving demand. Conversely, Ethereum’s controlled issuance rate, coupled with a fee-burning mechanism, manages its supply. New token launches should have a clear distribution plan. Evaluate how tokens are allocated, the vesting schedule for team tokens, network taxes, and the overall distribution timeline. A balanced supply and distribution scheme builds trust and can create scarcity, boosting prices.
5. Partnerships, Adoption, and Ecosystem (Marketing)
   Partnerships indicate a project’s potential and readiness to deliver on promises. Strategic alliances enhance the project’s ecosystem and credibility. In addition, marketing such as X Spaces (AMAs), articles and thought leadership are also important to look out for.
6. Code Audit and Security
   A thorough code audit identifies vulnerabilities in a project’s smart contracts and technology. Reputable third-party audits demonstrate a commitment to security. Look for projects with established security protocols and bug bounty programs.
7. Regulatory Compliance
   Regulatory compliance is vital for a crypto’s long-term value. Ensure the project adheres to relevant regulations and industry best practices to avoid legal pitfalls.
8. Evaluating Market Metrics
   Market metrics provide valuable insights into a cryptocurrency’s valuation and potential risks. Key metrics include market capitalization, trading volume, and supply.

ATH = all time high, ATL = all time low

Market Capitalization: Calculated by multiplying the cryptocurrency’s price by the total number of coins in circulation, market cap helps gauge a project’s market standing. While a high market cap (over $1 billion) suggests stability, it is not a fail-safe indicator. Also look at the IMC (Initial Market Cap) when a project launches to understand price potential. The IMC is determined by multiplying the initial circulating supply of tokens by their launch price. This figure acts as a benchmark to assess a project’s early potential for growth and success. When you are looking at buying from Launchpads* this is instrumental.

(*Launchpads are platforms that help new cryptocurrencies enter the market. They provide a platform for new projects to raise funds, build communities, and establish partnerships, thereby playing a vital role in shaping the initial market cap of a cryptocurrency.)

Trading Volume: This metric shows the trading activity of a cryptocurrency within a specific timeframe. High trading volume indicates liquidity and price stability, while low volume can signal low investor interest and potential price volatility.

Supply Metrics: Understanding the difference between maximum supply, circulating supply, and total supply helps assess a coin’s scarcity and potential price impact. Total supply refers to the entire amount of tokens that have been created. This differs from the circulating supply, which only includes the tokens currently available for trading or held by users, and from the maximum supply, which represents the maximum number of coins or tokens that will ever be created.

Price History: Analyzing a cryptocurrency’s price history provides insights into its volatility and long-term trends. Look for a gradual price increase over time and avoid coins with exaggerated highs followed by sudden drops, indicating potential pump-and-dump schemes.

Example: Analyzing Ethereum (ETH)
Ethereum is a prime example of a fundamentally strong cryptocurrency. Its robust blockchain supports a wide range of dApps, smart contracts, and NFTs, creating significant demand for Ether. Ethereum’s updates, like the EIP-1559 fee-burning mechanism, aim to control its supply, potentially making it a deflationary asset. Please see here for a detailed analysis of Ethereum: https://simpleswap.io/learn/analytics/projects/eth-fundamental-analysis

With a high market cap, substantial trading volume, and practical use cases, Ethereum demonstrates the principles of fundamental analysis. Its strategic partnerships, comprehensive whitepapers, and commitment to security further reinforce its value proposition.

To conclude, identifying undervalued assets in the crypto market requires thorough fundamental analysis. By evaluating development teams, technology, token utility, tokenomics, partnerships, documentation, security, regulatory compliance, and market metrics, investors can make informed decisions. Understanding these elements helps distinguish valuable projects from the hype, ensuring sound investment choices in the dynamic crypto landscape.

Sources:
1. https://bullperks.com/understanding-initial-market-cap-in-cryptocurrencies-how-is-it-calculated/
2. https://onetrading.com/blogs/fundamental-analysis-in-crypto-investing
3. https://www.investopedia.com/analyze-crypto-6456223
4. https://www.fidelity.com/learning-center/trading-investing/crypto/evaluate-cryptocurrencies
5. https://coindcx.com/blog/cryptocurrency/how-to-do-fundamental-analysis-in-crypto/?__cf_chl_tk=b4eCaYnM5K6GF_.I4HfQnhrYgSQ7R_59mysh.lkZwiM-1719178957-0.0.1.1-4394