Valuation Methods

In this section, I will show you some basic methods on how to make a fundamental analysis of a cryptocurrency. In terms of fundamental analysis, the valuation of a coin differs from the valuation of a stock for example. Other than the share of a company, a coin does not have an intrinsic value in the sense that it produces something or has real assets like real estate, patents or commodities to be processed. Instead, the price of a coin is purely caused by supply and demand. This makes it hard to do a fundamental analysis because there is no fundamental data that would explain an increase or decrease in the value of a coin. Of course, this is only the case for coins, that are decentralized and don't underly a company.

Nevertheless, there are a few metrics to look out for, to get a better idea of the factors that could have an impact on the future price of a coin. Five of these metrics are presented below. The analysis of the metrics for each coin will not give clear decision advice on whether to buy or not to buy a specific coin. It does give a better understanding of factors, that could have a significant price impact on a coin in the future. Depending on the personal strategy, this information can be used to make a buy or sell decision.

Key takeaways

A fundamental analysis on a coin like on a stock is not possible because the price of a coin is purely coused by the supply and demand, with no fundamental data that would explain a price movement. Nevertheless, there are indicators, that could have an impact on the future price movement. These are:

Market Capitalization (high market cap -> lower risk)
Circulation / Total Supply (circulation low & total supply high -> high volatility)
Historical price development (overall acceptance in the market -> steady growth)
Trading volume (steadily increasing trading volume -> bullish indicator)
Distribution (low distribution -> longterm bearish indicator)

Market Capitalization

The Market capitalization (market cap) gives the overall market value of a coin. It is calculated by the amount of circulating coins x the price of the coin.

market cap = circulating amount x price

So why is this information important? A high market cap can be an indicator, that the risk of a total loss of an investment is lower than the risk of a coin with a low market cap. This is because more money is already invested in the high market cap coin than in the low market cap coin and therefore it is more established in the market. A low market cap can be also an indicator of a higher upward potential in the value of a coin. A website that provides live data is: coinbase.com

Example: Below you will see a screenshot of the market capitalization of the 100 biggest coins with Bitcoin on top of the list.

If someone now predicts hypothetically that the price of SOL will rise from $100.48 to something around $3,000 the price of SOL would be in between the price of ETH and BTC. However, if you consider the market capitalization of SOL and BTC, you will notice, that the market cap of BTC (which is by far the biggest cryptocurrency) is around 20x the market cap of SOL. Therefore, the $3,000 price prediction would mean a higher market cap of SOL than for BTC which you wouldn't think of by only looking at the price per coin. Now it is very unlikely that an altcoin like SOL would pass BTC.

Circulation / Total Supply

The circulation tells the amount of coins that are circulating in the market. If for example 50% of the total coin supply is held by a single person and the other 50% are traded on the market, the circulation would be low. The total supply gives the total amount of a coin that was issued. With these two indicators, the supply and demand of a coin can be estimated. If the circulation is low and the total supply is high, it can be an indicator, that the coin has a higher chance of being more volatile. In that scenario, coins are already traded but a big amount of coins did not entered the market yet because they are held in the hands of investors. If the held back coins enter the market, chances are high for a price decline because a higher supply with a steady demand means falling prices.

Historical price development

It is not clear if the past price development of a coin can give information about future price movements of a coin so compared to the other metrics, this is a more vague one. Nonetheless, an overall acceptance in the market can be an indicator of future steady growth of the value. If there was no significant growth in the past, it might be coming in the future. As mentioned before, this metric is a very vague one and a buy or sell decision should not only be made on the analysis of this metric.

Trading Volume

A high trading volume implies a higher liquidity of a coin. Liquidity is an important factor because it can determine how fast you can enter and exit a position which means, how fast you can buy and sell a coin. If a coin is very liquid like Bitcoin, it is easy and cheap to buy and sell on an exchange, because supply and demand are always ensured. Therefore a relatively small commission is collected by the exchange to execute an order. A steadily increasing trading volume can be a bullish indicator because supply and demand are increasing and therefore the market is paying more attention to that coin and the acceptance also increases.

Distribution

The distribution factor is linked to the concentration and total supply factor. The higher the distribution of a coin, the lower the concentration of a big share of coins in the hands of few people. A high distribution means automatically a higher decentralization which is a factor itself. Bitcoin and most of the altcoins were established, to enable decentralization. If a coin enables decentralization based on the underlying technology but on the same time doesn't ensure it because of a low distribution, it should be a fundamentally negative factor for a coin that claims to enable decentralization.

Besides the fact that a low distribution acts against the philosophy of most of the coins, it also means a higher risk for a downwards trend. A low distribution means that a big share of coins is held by few people. Therefore, few people can lower the price of a coin if they decide to sell their share in a significant amount. The risk is even higher, if the people who are holding a big share of the coin supply are unknown to the public and therefore their future acting and interests can not me estimated.