Analysing a Cryptocurrency for Investing
Similar to a stock investing, analyzing cryptocurrency for investment requires a mix of fundamental analysis (evaluating a project’s intrinsic value) and technical analysis (studying price and market data).
Table of Contents
Fundamental Analysis (FA)
Fundamental analysis focuses on the underlying value and potential of a project. It includes the understanding of project related details of the cryptocurrency.
White Paper and Project Goals: Crypto project’s white paper helps to understand its purpose, technology, and roadmap. A clear use case and specific, achievable goals are positive signs, vague promises can be a red flag.
Team and Developers: Research the experience and track record of the founders and development team. Transparency (public identities) and a history of success can be indicators of a trustworthy project.
Roadmap and Milestones: Evaluate the project’s roadmap and check if it has consistently met its past milestones. A realistic and well-defined plan for future development indicates a committed team.
Tokenomics: Understand the economic principles governing the token’s supply and distribution. Key metrics include:
- Token Utility: Understand the token’s purpose within its ecosystem (e.g., paying transaction fees, governance rights, staking for rewards). The token should have a genuine, practical use case beyond speculation.
- Circulating Supply: The number of coins currently available to the public.
- Total and Maximum Supply: The total number that will ever exist, which can affect scarcity and potential future dilution.
- Distribution and Vesting: Examine how the initial supply was distributed among founders, early investors, and the public. Look for fair distribution and transparent vesting schedules that prevent a few large holders (e.g., founders) from “dumping” tokens on the market.
On-Chain Data: Analyze on-chain metrics directly from the blockchain to gauge real-world usage:
- Active Addresses: The number of unique wallets involved in transactions over a period. It quantifies the extent of user engagement.
- Transaction Volume: Shows how much value is being transacted on the network, suggesting demand and liquidity.
- Hash Rate: For proof-of-work chains, a rising hash rate indicates a more secure network and growing miner confidence.
Community and Adoption: A strong, active community and real-world adoption indicate genuine interest and utility. Check engagement levels on social media platforms like X (formerly Twitter) and Reddit. Strong partnerships with established companies or projects are also signs of credibility and potential for growth.
Competitive Advantage: Assess the target market and the project’s competitors. Find out if it offers a unique value proposition or technological advantage over existing solutions.
Technical Analysis (TA)
Technical analysis involves studying historical price data and trading volume to predict future movements, often using charting tools.
Price Charts and Patterns: Analyze candlestick charts and price patterns to identify trends and potential reversals, such as support and resistance levels.
Trading Volume: High trading volume generally indicates high liquidity and stability, while low volume can signal a lack of interest or potential for price manipulation.
Technical Indicators: Various mathematical indicators can be used to gain insights, including:
- Relative Strength Index (RSI): It measures if an asset is overbought or oversold.
- Moving Averages (MA): Smooth out price data to help identify trends (e.g., a “golden cross” or “death cross” signal).
- Bollinger Bands: Show volatility and potential price ranges.
Sentiment Analysis
The crypto market is heavily influenced by hype and emotion, so gauging overall market mood (sentiment) is also important. This can be done by monitoring social media discussions and news headlines.
Third Party Audits
Cryptocurrency projects typically undergo several types of audits to ensure security, financial accuracy, and regulatory compliance. These include technical audits focused on the underlying code and financial/legal audits focused on operations.
Technical and Security Audits
These audits focus on the integrity and resilience of the project’s code and infrastructure against cyber threats.
Smart Contract Audits: It reviews the source code of a project’s smart contracts to identify vulnerabilities, logic errors, and security risks (like reentrancy attacks or integer overflows) before deployment.
Blockchain Protocol Audits: These examine the underlying infrastructure of the blockchain network itself, including the consensus mechanism, transaction history, and overall architecture, to prevent issues like double spending or loss of consensus.
Security Audits/Penetration Testing: A broader security review that may include testing external API endpoints or internal systems for weaknesses. It may include evaluating key management and access controls to ensure private keys are secure.
dApp and Protocol-Specific Audits: Specialized audits exist for specific applications and functionalities built on the blockchain, such as decentralized exchanges (DEXs), NFT marketplaces, lending platforms, or cross-chain bridges, each with unique potential vulnerabilities.
Financial and Operational Audits
These audits focus on the business and financial aspects of the project, building transparency and trust.
Financial Audits: A systematic examination of the project’s financial records and infrastructure to verify asset ownership (e.g., control of reported wallets), ensure accurate transaction recording, and confirm that financial statements align with accounting standards (like GAAP).
Compliance Audits: These evaluate the project’s adherence to relevant laws and regulations across different jurisdictions, including anti-money laundering (AML), know-your-customer (KYC), and tax reporting requirements.
Legal Audits: A review of the project’s legal structure, contracts, intellectual property, and privacy policies to ensure legal compliance and mitigate regulatory risks.
Operational Audits: These review the internal processes and controls of the project to ensure they are operating in an efficient and secure manner, which includes aspects like disaster recovery plans and employee access levels.
Investors should look for projects that undergo rigorous timely audits. Third-party audits from reputed firms indicates a commitment to security, transparency, and risk management.
Best Practices
Only Invest What You Can Afford to Lose: Cryptocurrency is highly volatile, and you could lose your entire investment.
Diversify: Don’t put all your capital into a single crypto asset. Diversify your holdings across different cryptocurrencies or asset classes to manage risk.
Use Cost Averaging: Invest a fixed amount of money at regular intervals to reduce the impact of price volatility over time. Staggered buying helps in averaging your purchase price.
Secure Your Assets: If you have significant holdings then store the crypto in a secure hardware wallet (cold storage) rather than leaving them on an exchange. Especially if you are planning to hold the investment for the long-term.
Avoid Emotional Decisions: Stick to your predefined strategy and avoid making hasty choices based on fear of missing out (FOMO) or panic selling.
Like any other investment asset class, crypto investing also requires due diligence. By combining these analytical methods and following sound investment principles, you can make more informed decisions when investing in cryptocurrency.
