“Beauty lies in the eyes of the beholder” is one of the most famous sayings among the fundamental analysts of financial markets. A plethora of factors have an effect on a company’s value. The value is resultant of various macro and microeconomic forces. For different entities, all these forces will have different impacts. Though fundamental analysis is subjective there is merit in trying to understand different projects with a broad framework. It allows us to compare projects of a like to like basis.
Fundamental analysis aims to arrive at the intrinsic or fair value of a stock, bond or any other asset. Traditionally, investors expect cash flows attached to assets, for example, dividends with stocks, coupon payments with bonds, and so on. The expectation of cash flows makes it easier for an analyst to calculate the present value of the future cash flows via various methods. However, with crypto assets, there are no expected future cash flows. And thus, the fundamental analysis gets a lot trickier.
The whole concept of fundamental analysis is based on understanding the difference between price and value. As one of the most successful investors of our time, Warren Buffet says “price is what you pay and value is what you get”. We won’t be stretching it if we say that the foundation of Buffet’s wealth creation philosophy is a clear understanding of how price and value differ. Though cryptoassets is an entirely new asset class, the fundamentals of investing do not change. We are cognizant of the fact that a lot of work has been done on the fundamental analysis in the traditional finance world and we have tried to modify these models to create the best for cryptoassets.
Evaluating a company depends on a lot of factors. Some of the most crucial factors are – a macroeconomic environment that may impact the company, moat of the company, management of the company and so on. We have tried to borrow these aspects to create a framework for analyzing cryptoassets. And while creating the framework we are mindful of the differences between cryptoassets and traditional financial assets.
One of the most prominent differences is the fact that the company’s growth does not mean the growth of the token. In the realm of equities, when the company does well, the intrinsic value of its stock increases. That is the value growth is directly proportional to the growth of the company. However, most of the cryptoassets do not represent a share in the company. The management has no obligation towards token holders whatsoever. For the management, ICO or IEO is a very good funding mechanism but it is incredibly difficult for them to pass on the value to token holders. As the total value created by the company remains constant, the value captured by shareholders and token holders is a zero-sum game. Therefore, the management has to strike a fine balance between passing value to token investors and equity investors. Recognizing how equity is different from tokens is vital for crypto token investments.
Bitcoin was a great investment and we believe it still is. However, we also know that along with bitcoin there are other pockets of possibly clever investments in cryptoassets. People made money through ICOs and they lost even bigger money through ICOs. We aren’t strangers to both. We have made mistakes in the past and we will make mistakes in the future. But we also have learned immensely from our mistakes. We want to share our learnings with the people so that they don’t end up making the same mistakes. Instead of only suggesting investments, we believe our job is to go beyond and flag bad investments for people. So that they can avoid losing money. After all, we hate losses more than we love profits, don’t we?
We have identified 25 different factors across eight categories for cryptoasset. Based on our knowledge we have assigned weights to these factors and we arrive at fundamental scores of various assets using our fundamental scorecard. The model we use is not set in stone. We understand that our industry is fast-paced and we embrace the fact that our model needs to change periodically if want to ensure that we keep pace with the rapidly changing industry dynamics. We intend to periodically backtest our models, adjust the weights and even add or remove the factors we look into.
Different categories we look into are – Security, Liquidity, Market Standing, Development, Reputation, Marketing, Team, Scarcity
Blockchains often claim to be decentralized and therefore security becomes crucial as there is no one liable for losses. Security is arguably the most important function of a blockchain used for value transfer.
The consensus mechanism is the heart of a blockchain. The way any blockchain arrives at consensus determines the security of the blockchain. Therefore, it becomes important to take a look at how the blockchain achieves consensus.
When tokens issued are not securities, the team doesn’t have any fiduciary duties towards the token holders. Therefore, the team should not have too much power to make changes to the protocol or otherwise without consulting token holders. The governance model should be such that token holders’ interests are looked after. Decentralization ensures that the fate of token holders is not at the mercy of team members.
Liquidity is the ease at which the underlying asset can be converted into a widely used form of money such as fiat currency. Therefore, while making an investment it is vital to ensure there is a market that allows buying and selling of the asset at stable and transparent prices.
Exchanges listed on shows the strength of the project and liquidity. If the project is listed on a top exchange it passed these exchanges in-depth analysis meaning it is a strong project. Additionally, top exchanges lead to extra liquidity meaning the token can be sold rapidly, with minimum loss of value, and at any time.
Fiat-to-Crypto Trading Pairs
Fiat on-ramps for tokens imply that these tokens do not have to rely on other tokens for liquidity. Liquidity is an important aspect for traders and having fiat pairs help the liquidity.
Percent of Total Supply Circulating
Often, token supply is released in tranches. Therefore, if more supply is anticipated to be released in the future, it can put downward pressure on the price. The more the percentage of circulating supply, the better it is.
Turn-Over Ratio (Trading Volume Versus Market Cap)
This helps in understanding how liquid the market is. Liquidity is important because illiquid markets are often volatile. The more the ratio of trading volume to market cap, the better it is.
Cryptoassets are a nascent asset class. There are no clear winners at the moment. For example, while Ethereum is migrating towards Eth2.0 with proof of stake consensus mechanism, there are other upcoming Dapp platforms such as Polkadot, Cosmos, Dfinity, and so on. Which one of them will be the distant leader in the future is difficult to determine right now. Therefore, we need to constantly evaluate their market standing based on different parameters.
Several projects often compete to capture a market for a similar use case. Therefore, capital allocation also gets divided. How a project differentiates itself from the rest of the competition becomes crucial to judge its value as an investment.
In 2017, many projects raised money by throwing around buzzwords like ‘XYZ on a blockchain, decentralizing ABC’, etc. It is crucial to understand whether the products built by companies are being put to use. Having customers or users contributes to the sustainability of the project.
One should invest in an asset only when they understand the utility of the asset. Therefore, it is important to examine the use of the asset before committing. Also, in terms of regulations, whether the token passes the Howey test of securities is important. If the token is not being issued as a security, it is important that it fulfills an important function within the platform to justify its existence.
Token Economic Incentives
Investors will hold tokens only when the token economic design incentivizes them to hold tokens. If the token is only a medium of exchange within a particular platform, there should be a mechanism, such as staking or distributing a part of fees to tokens holders, that helps value creation to incentivize users to hold tokens.
Leveraging different sources to track the development of projects is crucial. Right from whether a project has its own blockchain to whether the project attracts enough talented developers, the development puzzle needs to be should be put together carefully.
Number of Years Operational Before ICO/IEO
When companies raise funds through an ICO, founders are not legally obligated towards ICO buyers. Therefore, the number of years the company already worked before crowdfunding acts as a good proxy to judge the commitment of the company.
The validity of the FAT protocol thesis is debatable. But, empirical evidence suggests that protocols capture more value than applications. Though with interoperability protocols, it may not be the case in the future as there could be more vertical and horizontal value capture. However, the type of project could be a limiting factor as of now. Blockchains seem to have a higher potential to reach network effects as other projects can build on top of the platform and this leads to more use of the token. At the moment, projects that capture most of the value are protocols.
Availability of talented developers and competent leaders
This industry is nascent and nobody really knows what can work. Projects that manage to attract the talent pool are likely to succeed. Having experienced developers and leaders in the team could act as an important driver for the project. Experienced developers can suggest the direction in which projects should steer forward.
A dedicated team with capable members is the best asset for any project. The number of members, as well as the quality and experience of the members, count when it comes to evaluating the potential of the team.
Number of Team members
The number of team members needs to be in sync with the roadmap. We have often observed the Github having just one or two developers. This
Number of all-star team members
Based on the success of the projects in the past, we have decided on a set of criteria to qualify a member as an all-star member. There has been a direct relationship between the number of all-stars and the success of the project.
Number of community members
Community members are the potential users of the project. We track social media such as Reddit, Twitter, Telegram to understand how much traction the project has. The number and the quality of followers give us a good insight into how the project is being perceived by the people.
The company website serves as the primary source of information for any project. Any attempt to hide information is a red flag. Information such as the roadmap, team members, privacy policies and so on should be readily available on the website.
Site visits per month
Website visits are a good proxy to gauge the mind share of the project. Before investing anyone would visit the website to understand more about the project. Also, site visits are a way to determine customer awareness or popularity. It shows how well the project advertises and promotes what they are doing. More customer visits to the website increase familiarity with the project.
Mainstream media coverage
Mind share is one of the important attributes for buyers. If the token is getting covered by larger media, there is a greater chance that it will occupy the mind share of investors.
Reputation builds stories and stories are the life of any investment thesis. A good story tends to attract better numbers. You see there are so many loss-making companies but good business model stories make them attractive. The reputation of a company is of paramount importance to investors. It determines how people perceive the brand.
Public Videos of Team Members
Founders’ talks are a good source to learn more about projects. The way founders answer question determines how equipped they are to manifest the project into reality.
The reputation of early investors shows the strength of the project. Reputable investors only invest in projects they believe in and expect a good return on investment (ROI). These investors could also be crucial in the development of the project down the line. The early investors could help the project obtain partnerships to drive growth.
The validity of promises and thoroughness of the use-cases in the whitepaper and website
During the ICO mania, various projects promised the moon to all the ICO investors and did not deliver on their promises. We understand that we cannot have all three security, decentralization, and scalability at the same time. One suffers when we pick the other two. Projects that claim to be blockchains and promise all three better than bitcoin or ethereum are almost instantly worthy of branding as scams. Therefore, the way projects showcase information is crucial. It is essential that they understand the trade-offs to be made based on their application.
Litigations against the company or team members
If the company or a key member was involved in a scandal this could hurt the project’s long term potential. Alleged or actual unethical behavior will cause bad press involving the project. Users are less likely to want to be involved with a project that is known for unethical practices.
One of the characteristics that make bitcoin special is its scarcity. We are in an era of rampant money printing and therefore understand the importance of scarcity. If the supply is at the beck and call of a cabal, how long could the underlying retain the value? An asset that is scarce will have more chances of appreciation vis-a-vis an asset that has an infinite supply.
Nature of Supply
At its core, value is a function of demand and supply. Therefore, whether the supply is inflationary or deflationary is an important question to consider while evaluating a token fundamentally.
A token burn is a mechanism to create scarcity in the supply. This could be seen as an indirect way to redistribute profits or cash flows to the token holders. The scarcity puts upward pressure on utility token’s price.
As stated earlier, this model is fluid and it needs to be evolving. We will make constant upgrades to our model to ensure that it’s of value to our users. We will keep sharpening our edge to make sure that our model remains relevant.
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