(This is a six-minute read)
Knowledge Creates Wealth
Cryptocurrencies produce high returns because they are not well understood.
One of the biggest criticisms of cryptocurrency is the fact that the industry is ‘speculative.’ Skeptics say that crypto investors are only here to make money. And sure, many crypto bulls don’t really understand what they’re investing in.
It’s fair to call those people speculators.
But the more you can educate yourself on crypto and verify the facts for yourself, the more you understand the intrinsic value behind a cryptocurrency and how it’s used, the less risky investing in it becomes.
If you’re aping money into cryptocurrencies without researching them, you’re virtually gambling. But if you’re investing into cryptocurrencies and have put in the time to understand them, your risk is mitigated.
By understanding the fundamentals of a given crypto, as circumstances and markets change, you can evaluate whether those changes affect the odds of that crypto being successful. Simultaneously, you can evaluate opportunities and pick investments that are likely to go up based on those foundational changes.
The Universal Laws of Crypto
People who simply knew of and understood crypto in its early days have now been rewarded with hundreds of billions of dollars of wealth. And while crypto price action has been volatile, the industry has been consistent in two things since its inception:
- Those who understand cryptocurrencies have been financially rewarded.
- Those who invest in cryptocurrencies without understanding have been financially punished.
If everyone understood how crypto worked and its world-changing potential, it would be a lot harder to make money. The market would be more efficient.
Thankfully for us, we’re early to the party. If we put in the work to learn and understand cryptocurrency, we can create incredible opportunities for life-changing financial reward.
The Three Rules for Altcoin Analysis
If knowledge inefficiency allows us to create outsized returns for our portfolio, then the way to create reliable alpha (excess ROI) is to set up a repeatable process where we can research and understand cryptocurrencies.
Fundamental analysis is difficult, but it does not require special education, exclusive information, or super-genius level brains.
In today’s market conditions, any halfway-clever investor can perform research that will allow them to generate better-than-average returns on their cryptocurrency portfolios.
In my time as as an Altcoin Research Analyst, I’ve established a simple fundamental framework I go through to perform basic prospecting on all of the cryptocurrencies I research.
While this framework isn’t comprehensive, it is a starting point that will give you a solid foundation for better understanding cryptocurrencies, and thus, make better investing decisions. I’ve broken it down into three rules: three questions to which you must have answers.
If you have a strong grasp on how these three rules apply to the altcoin you’re researching, you are well on your way to making a good, informed investing decision for the given cryptocurrency.
The single most important thing to understand in a cryptocurrency is how it provides value for its users. This can often be distilled down to just a few words or sentences, but it sometimes can be tricky to wrap your head around.
We’ll take a look at a few of the biggest cryptos for inspiration:
- Bitcoin: “a decentralized digital currency, without a central bank or single administrator, that can be sent from user to user on a peer-to-peer network without the need for intermediaries.”
- Ethereum: “a decentralized, open-source blockchain with smart contract functionality.”
- Polkadot: “a blockchain network that connects, builds, and hosts blockchains.”
Conversely, many cryptos thought to be poor investments have flimsy (or sometimes no) value propositions
- Bitconnect: Crypto’s most famous scam intended to “build trust and reputation in bitcoin and cryptocurrency ecosystem with Open-source platform.” (What does that even mean?)
- Safemoon: When you start diving into Safemoon’s documentation, you find a lot more related to their tokenomics (burning and redistributing sold Safemoon) than the value it hopes to add to the world.
If you couldn’t explain to your Mom/Dad/Relative how this might add value to the world, it’s a signal you need do more research and reading. White papers, the foundational documents of cryptos, are pretty helpful in this respect, (look up “target cryptocurrency” + white paper to find it) although they can be quite dense. Project roadmaps, often hosted on the crypto’s official website are helpful as well.
Explore your curiosity and dive into what you don’t understand. This is not the time to be shy or embarrassed about what you don’t get, you’re going to be putting your hard-earned money on the line: Twitter, Reddit, and Discord are all your friends.
Understanding how a crypto creates value allows you to:
- Establish a thesis for why the crypto will rise in value
- Determine when that thesis has been invalidated
This value proposition will serve as the foundation for the rest of your research.
It’s not enough that a cryptocurrency simply adds value to the world: it must have incentives built in to facilitate increasing demand that outpaces supply.
Bitcoin and Ethereum are both successful examples of cryptocurrencies that have created markets where demand eclipses supply, which causes price to appreciate. Bitcoin has accomplished the feat by creating a solid monetary policy base (slowly decreasing mining rewards and a capped supply).
Ethereum has started to burn Eth tokens since the EIP-1559 hard fork was activated, creating a deflationary supply while network activity continues to increase, driving demand. Before the EIP-1559, Eth’s supply still outpaced demand thanks to high network activity across DeFi platforms, NFT minting, peer-to-peer transactions, and other tokens that existed on the network. Exchange token FTX uses network proceeds to buy back and burn tokens, creating deflationary pressure that in theory causes the price to rise.
There are plenty examples of misaligned supply/demand pressures as well. Yield Farm/DeFi platform Iron Finance had a ‘bank run’ style collapse on on June 16th, 2021. The cause of the collapse? Poor management of supply and demand. Too much of the native farm token (TITAN) flooded the market as TITAN holders were not sufficiently incentivized to hold.
Since it was used as collateral for the yield farms, the entire ecosystem fell apart. To avoid a fate like that of Iron Finance investors, make sure you understand exactly why investors may choose to buy, hold, and sell a token.
White Papers are one way to understand these dynamics, while simply taking part in the ecosystem helps you get an intimate understanding of the incentives that affect market participants.
You can also take a look at CoinGecko and CoinMarketCap to see how much of a given coin has been mined (and thus how much it will be diluted). Total Value Locked (TVL) shows you how many dollars of a given asset is secured inside of a protocol, hypothetically showing you how much that protocol might generate in revenue and how confident players are in the protocols permanence.
Why is Ethereum such a strong investment? It’s constantly being criticized for its slow transactions, its high fees, and it’s develop first, fix later approach, it’s managed to attract thousands of the most talented developers, marketers, artists, and community builders in the world. Nonetheless, it’s the king of altcoins.
Every individual working on Ethereum or on any project around Ethereum is creating value for Ethereum holders. Lending platforms like AAVE, NFT platforms like OpenSea, and Level Two (L2) ecosystems like $MATIC are all built on top of Ethereum.
People building on Ethereum creates network effects that make other people want to build their platforms on Ethereum, which brings more smart, talented people ad infinitum. The lesson? Work to understand who is working on a platform and why they are there.
Does the core team have a strong background in blockchain tech? Can you watch interviews or check their social media to get a feel for them? Are they transparent and accessible or mysterious and elusive? All of these can help us get a better feel for the project.
We also must understand the stakeholders’ incentives. Some projects (Decentraland is one that comes to mind) have gotten criticism recently, as vesting has ended and now the founders now have access to all of the tokens that were once locked up. Because the founders won’t be rewarded with any meaningful quantity of new tokens, and the project’s market cap is around $1 billion, there’s not as much incentive for the founders to be working hard on development.
Finally, we should look at whale wallets: who are the biggest holders? Why do they hold so much of the currency? Is their stake large enough to manipulate the supply?
Dogecoin gets a lot of this criticism: thanks to the miracle of public ledgers, we can see how much of a given currency the biggest whales own. The top 11 Dogecoin whales own around 47% of the total supply, meaning they could easily influence the price of the currency should they choose. The top Ethereum wallet, in comparison, owns a mere 1.65% of the total Ethereum supply. It’s easy to understand which coin is less likely to be manipulated.
Team info can be found by poking around Twitter and the team pages of official project sites. Info on incentives is often found on Medium, while whale wallet data can be found by poking around on blockchain explorers and on-chain analytics platforms.
This framework is not a silver bullet, but it is a simple, replicable process for understanding cryptocurrencies that can be applied at any point in a market cycle to drastically decrease your probability of picking duds while simultaneously increasing your probability of picking the rare 1000x investment when it does come along.