Cryptocurrencies were non existent about a decade ago, and they have certainly come a long way since then. In this article we try to understand how cryptocurrencies are valued, so as to give the investors a better understanding of what they are getting into.
In this article
Before we Begin
- Fundamental analysis forms the backbone of any type of valuation.
- Performing fundamental analysis for cryptocurrencies is different due to the absence of financial statements to analyze.
- We have to understand that cryptocurrencies are not companies but currencies, i.e. their viability is not based on generating revenue.
- It directly depends on the participation of the community, i.e.,
- There is a lack of track record which hampers our ability to assess the viability and potential of the coins.
Factors that Affect Crypto Value
- A coin must incentivize people to hold the coins.
- The more the people that execute transactions, the greater the demand for coins will be and will, therefore, push prices up.
- Utility also include voting rights, dividend payments or being a medium of exchange.
- The finite nature of the coins.
- Demand will push its value up, especially for coins with great utility.
- What the markets deem their value to be.
- Collaborations and partnerships with credible companies enhance the perceived value of a coin.
What is needed for a good understanding of a coin’s fundamentals?
The Right Sources of Information
Coin’s White Paper
- A detailed proposal by the development team which outlines the purpose and mechanics of the coin.
- Represents the main source for evaluating the fundamentals of the coin.
- The drawback is that it can get very technical – concepts that are hard for an average person to comprehend.
Coin’s Slack Channel or Blog
- Official channel of communication of the core development team.
- Joining their slack channel, asking questions to get more information on the coin, viewing the interaction of the development team with the community helps a lot.
- A great way to understand the coins as well as sentiments surrounding the coin.
- Simple definitions of certain concepts, easy-to-understand analysis of coins from forums can be found as the community is well-informed.
- It allows one to grasp the mechanics of the coin far better, especially if he/she not technically-inclined.
Cryptocurrency Fundamental Analysis
- Purpose of Coin?
- Does it Solve a Real Problem?
- Does the Coin Possess Any Utility?
- Is the White Paper a Marketing stunt filled with jargons?
- Is the Project Funded/Backed by Prominent Investors?
- Governance Structure-Centralized or Decentralized?
- Development Roadmap? (clear timeline for the development – indicator of the development team’s commitment)
- Running “Proof” of the Coin
- Money Have They Raised? How have they spent it?
- First mover advantage
- Difference from the nearest Competitor?
- The Target Market
- Significant Legal Barriers?
- Founding Team Members & Advisors
- Response through their official channels and forums
- Supply Structure of the Coin (finite coin supply = stronger value)
- Market Capitalization of the Coin
- Allocation of Coins to the Founders (high percentage of Coins to the founders = not a healthy indicator)
- Is the Distribution of Coins Even? (could result in price manipulation)
- Cryptocurrencies should be backed by Blockchain technology, not an MLM structure
- Warnings Relating to the Coin pertaining to scam
There’s no way to determine the inherent value of a cryptocurrency, as there is no asset backing it, but certain calculations can give us a reasonable estimate for the value of cryptocurrencies based on certain assumptions.
Quantity Theory of Money
MV = PT
- M is the money supply
- V is the velocity of money in a given time period
- P is the price level
- T is the transaction volume in a given time period
- the equation as valid over the long-term
- a large portion of this velocity is just trading volume, not spending volume.
- criminal activity, since that’s one of Bitcoin’s biggest applications that affects the actual value of goods traded
National Currency Comparisons
- Cryptocurrency adoption compared to fiat currencies.
- How much economic activity – the equivalent of GDP, that actually occurs in a cryptocurrency from the active users.
- Examining active user base of the cryptocurrency, since the ledger is public.
A reasonable forward-looking valuation estimate for a given cryptocurrency:
- Understand the numbers and growth rates of units existent in a cryptocurrency.
- Estimate the economic activity to occur in total blockchain cryptocurrencies in long term.
- How will a given cryptocurrency change its market share.
- Compare spending patterns to other monetary bases
- Take into account velocity of money.
Disclaimer: the views expressed here are of the author and do not reflect those of Groww.