How to Evaluate Any Cryptocurrency’s Investment Potential
Crypto-curious investors have changed the face of the cryptocurrency market over the past year.
For many such investors, bitcoin and ethereum have been the starting point. They are the most valuable and they have the longest track records to consider in terms of future potential. But what about investors who want to go further?
The deeper you get into cryptocurrency and less popular altcoins, the riskier you can expect your investments to get. With any cryptocurrency, experts say price and a handful of other key metrics can help investors make smarter decisions about what has high investing potential, and what’s more likely to flop. And along with quantitative factors like price, market cap, and trading volume, investors should also consider more qualitative factors like who created a given cryptocurrency, use cases, what’s in its white paper (if it has one), and more.
Before you look into the price action, you actually have to look at what we call the fundamental analysis, which is picking the right asset for the right goal,” says Kiana Danial, author of “Cryptocurrency Investing for Dummies” and founder of Invest Diva.
We’ve talked to dozens of experts about how to invest in crypto as smartly and safely as possible, and a few ground rules have emerged, whether you’re investing in bitcoin or a new token that was created yesterday. They are true of all cryptocurrency investments, and especially so for riskier and newer altcoins:
Keep crypto investments to 5% or less of your portfolio
Only invest in crypto what you’d be OK losing
Make sure you have an emergency fund, have paid off high-interest debt, and secured a traditional retirement plan before investing in crypto
Start with bitcoin and ethereum, the most popular and mainstream cryptos
Whether you’re just getting started, or interested in going beyond bitcoin and ethereum, here’s a rundown of how you can evaluate any cryptocurrency’s long-term potential:
Understanding Crypto Fundamentals
If you’re investing in crypto for the long haul, you should have a fundamental understanding of what you’re getting into before deeply looking at the technical factors that affect a cryptocurrency’s market value.
“Focus more on the project itself, on the problem it’s solving, and on where it is actually deriving its value,” says Danial.
When analyzing potential crypto investments, there are several qualitative factors experts recommend looking at when you’re doing your own research and deciding whether to invest in a potential coin:
Project Website and Social Media
Experts say it’s important to consider an initial high-level overview of the project. Check the crypto project’s website and social media channels to also get a sense of how socially active the project is and gain greater insight into the project, the team, and its community. The project website should be easy-to-navigate, functional, and openly share details about the project, the team behind it, and its white paper and roadmap.
The credibility and experience of the team behind a project can play a significant role in the success or failure of it. If the team is not openly disclosed, that’s a red flag (bitcoin is the exception). You’ll also want to look at the team’s prior experience in the crypto market and other projects they’ve worked on.
For example, you’ll want to know if this is their first project or if they have a solid history developing successful crypto projects. Additionally, look at the executives of the project team. Projects with reputable executives or partnerships with established firms are also a positive sign.
White Paper and Road Map
As an investor, a critical component of assessing a coin or token’s long-term value is the project’s white paper and road map. A solid crypto project will have a strong and well-defined white paper and roadmap. A white paper is a document produced and released by a crypto project that gives you technical information about its concept to help you determine whether it has any merit, whereas a road map helps set expectations on how a crypto project plans to grow and evolve with its hopeful success and adoption.
“I read the white paper, so I can understand where the value is coming from,” says Danial.
In a road map, you want to see a general timeline providing details of the project’s development. If the project doesn’t have a clear vision with a white paper and roadmap, you should question the future success and value of it.
Major Investors
Determine whether the project already has investors and if so, who they are. It’s a good sign if the project has already been invested in by well-known investment firms or big time investors. It means they’ve done their due diligence and believe in the project’s long-term viability.
The Community
For many crypto projects, the community supporting the project can make or break a given crypto’s potential. The enthusiasm and size of the community play a large role in the initial and continued success of the project, though you should be careful with this factor when assessing a coin or token.
Sometimes, hype can exceed and even mask a project’s actual utility or value, which is why you shouldn’t invest in a coin or token solely based on hype and should take the time to become familiar with all the factors above before putting too much stock in its community.
“It can be a very confusing environment to figure out what’s what and who is who, especially when you have a lot of people really pumping it or being very zealous about it,” Doug Boneparth, a financial advisor and president of Bone Fide Wealth in New York, told NextAdvisor.
Though subjective, your goal is to reach a perspective on whether the asset is overvalued or undervalued. Having these things in mind will guide your selection of potential coins to invest in. Once you’ve nailed down the fundamentals, you can use more technical indicators and metrics as a supplement to help inform your investment decisions.
Beginner’s Guide to Analyzing Crypto Pricing Data
Once you’ve done the initial general vetting of a potential crypto investment, it’s time to focus on more of the technical aspects of the crypto you want to invest in.
I look at the charts to see if I want to buy more, when would be an optimal price to buy,” says Danial. “This is after I have selected an asset that matches my risk tolerance and my financial goals.”
Experts say technical analysis is a little trickier in crypto compared to the stock market, but there are some key indicators and metrics you can use to help inform your investment decisions:
Trading History
Start by taking a look at the daily, weekly, monthly, and yearly trading history, so you can get a high-level overview of the price and performance of the project. There may be price trends that stick out to you that you can explore more. A steady increase over longer periods of time is typically a positive sign for a crypto’s long-term potential.
Market Capitalization
Experts recommend paying attention to market capitalization as well, which is the total value of a cryptocurrency. Crypto market capitalization is calculated by multiplying the price of the cryptocurrency with the number of coins in circulation.
In general, the higher the value of the market cap the safer the investment, though that’s not always the case with crypto, according to Danial. “You don’t want to go and invest in something that has a really low market cap, because it’s probably super new and is high risk,” she says.
Also, market capitalization gives a clearer picture about the growth potential of a crypto asset. Cryptocurrencies with lower market caps have more tendency to grow than those with larger, more established market caps.
“In the crypto universe, market cap is of mixed value,” says Avik Roy, managing partner at Roy Capital Advisors and author of “Bitcoin and the U.S. Fiscal Reckoning.” “Market cap by itself, particularly for thinly-traded crypto tokens, is not a very good marker of a token’s value. But in the case of bitcoin and ethereum, which are the most widely traded, most widely accepted, most valuable assets, the market cap is a reasonable indicator and certainly one common benchmark year.”
It’s also important to remember that because crypto prices fluctuate so dramatically, market capitalization is constantly changing. This fluctuation — along with the potential for the market to drop out entirely — is also why experts recommend only investing what you’re OK with losing.
Trading Volume
You’ll also want to glance at the trading volume. A low trading volume can be a red flag as it is a measure of how easily a crypto asset can be bought or sold. Usually, the higher the volume of cryptocurrency transactions, the more liquid the market for that particular coin or token will be.
If a project has a low trading volume, especially a medium or large-cap project, it may have been abandoned, lacks real-world use-case, or there are other serious concerns with the project. While trading volume can help a crypto investor in their decision to either buy or sell, experts say it shouldn’t play as big of a role in the decision-making process for long-term investors who are betting on value growth over time rather than the ability to trade for a profit in the short-term.
“Trading volume is a little bit more difficult to measure in crypto relative to the stock market,” says Roy. “The Nasdaq records every single trade, so you have very precise measures as to how many shares were traded that day because it’s regulated. With bitcoin or ether, it’s not like that. Crypto is the most unregulated market globally.”
In fact, you should be wary of spoofing in crypto markets, he says. That’s when people or institutions create fake buy and sell orders in an attempt to create a false sense of supply and demand. Some cryptocurrency exchanges have been accused of faking their volume numbers to raise the visibility of their businesses and bring in more customers. That’s easy to do in the cryptocurrency space because it’s immature with limited regulations and vulnerable to market manipulations.
Circulating, Total, and Max Supply
It is also important to look at a crypto project’s circulating supply and total supply in relation to max supply. Circulating supply is the number of coins or tokens that are circulating the market, while the total supply is the total number of coins or tokens that have been created. Total supply does not account for coins or tokens that have been burned or destroyed. Max supply refers to all the coins that will ever come into existence. Depending on the coin, max supply can be fixed or infinite.
“The most important thing to understand about bitcoin, and this is true of crypto in general, is the monetary policy of the token. In other words, what are the rules of current and future supply of the token?” says Roy. “From an investment standpoint, one thing that investors in the conventional markets care about a lot is predictability of supply.”
Bitcoin offers a good reference point — for bitcoin, there are only 21 million in total supply while there are about 19 million currently in circulation. When compared to a project like ethereum, which has an infinite total supply and a circulating supply of over 120 million, the scarcity of bitcoin can easily be seen. Experts say investors tend to place a higher value on investments that are scarce than on investments that are abundant, though that’s trickier to define in crypto as developers sometimes design the crypto ecosystems in the way that a particular coin or token is actually never truly unlimited. For example, ethereum technically has an unlimited supply, but the issuance is capped at 18 million Ether per year.
Keep in mind that like trading volume, circulating supply and total supply can sometimes be unreliable metrics. That’s because many coins and tokens are considered “in circulation,” even if they’ve been lost or stolen. For example, bitcoin investors have misplaced about 20% of all existing tokens, and unlike fiat currency which can potentially be recovered, it’s highly unlikely that these tokens will be returned to circulation. Also, in cases where the total supply is larger, a large influx in the circulating supply can quickly lower the price.
While these metrics are all good to keep in the back of your pocket as a crypto investor, it’s very important to recognize that cryptocurrency is new and highly volatile — and the market is still developing. Above all, It’s important to note the crypto market is completely different from the stock market, and therefore the rules and metrics that stock markets go by don’t always apply to crypto markets.