An Introduction to Fundamental and Technical Analysis of Bitcoin and Cryptocurrencies

Disclaimer: This is not financial advice.

Introduction

Fundamental analysis and technical analysis are two of the leading methods for analyzing the value of financial assets. I first learned about these methods when I was studying stock investing in college. Fundamental and technical analysis are not the only methods for valuing an asset. However, these two analysis methods can appeal to individual investors because you are able to perform these types of analysis on your own. All you need is market research and data. You do not need of state-of-the-art algorithms or discounted cash flows to use these methods of analysis and determine if the price of an asset will go up or down. Fundamental and technical analysis can be applied to cryptocurrency investing and trading.

Fundamental Analysis Basics

Fundamental analysis focuses on determining the usefulness of an asset in the real world. Sure, a specific cryptocurrency might sound great on paper, with promises of artificial intelligence and machine learning capabilities, but fundamental analysis goes deeper than how the asset is described on paper. Here are some questions you may research when performing fundamental analysis of a cryptocurrency:

  1. Will anyone actually use this digital currency? Or is this a product that sounds great but nobody actually wants?
  2. What value does this asset provide that similar assets do not?
  3. Can this asset be easily replicated by a competitor asset?
  4. Is there any reason to expect increased or decreased consumer demand for this asset in the near / long term future?
  5. Is this cryptocurrency actually worth a damn, or is it a scam?
  6. Is the team behind this product on track to be successful? Do they have a successful track record? Is the team mainly interested in a pump-and-dump project, where they can take profit in the short term and neglect the long term development of the product?

Below I will perform a brief fundamental analysis of the current state of bitcoin, by answering the questions above. Please be aware that the questions above are not an exhaustive list for performing fundamental analysis. These questions are only the basics. Often, fundamental analysis requires the analyst to learn everything and anything about the cryptocurrency/stock/asset in order to have the best possible grasp on its current and predicted future value.

  1. Will anyone actually use this digital currency? Or is this a product that sounds great but nobody actually wants?

From my research, the most valuable use case for bitcoin is that it is a form of sound money. This means bitcoin has a fixed amount on the number of bitcoins that will ever be created. There will never be more than 21 million bitcoins in existence. It really comes down to purchasing power and being a “store of value.” Is 1 bitcoin more valuable if there are one thousand or one hundred million in existence? Well, if there were one thousand bitcoins in existence, then 1 bitcoin represents 1/1000 of the total purchasing power of the market. Meanwhile, if one hundred million bitcoins existed, then 1 bitcoin represents 1/100,000,000 of the purchasing power. In this scenario, as more bitcoins are created, each existing bitcoin incrementally loses its purchasing power. Loss of purchasing power means you essentially are able to buy less goods for the same amount of money, or in other words, you become poorer. Sound money is a valuable characteristic when compared to other currency competitors. Some people believe that currencies/assets with the sound money characteristic, such as gold, can be used as a hedge against economic crashes, as well. For more information on the concept of store of value and sound money, list to my podcast on the topic here:

What The – Fintech? podcast episode Store of Value

Another valuable use case for bitcoin is users can send the digital currency to anyone, anywhere in the world, in a matter of minutes, with small fees. Payments and remittances are a massive market in all economies. This use case adds to the fundamental value of bitcoin.

There are other fundamental value propositions of bitcoin, but the above two use cases seem to be the most compelling reasons why anyone would want to buy or use a bitcoin.

  1. What value does this asset provide that similar alternative assets do not?

Bitcoin strives to be a form of currency. We all know that the most popular currency today is the US dollar. What does bitcoin provide that the dollar does not? The US dollar is not a form of sound money. This is because the US dollar have an ever-changing monetary policy, while bitcoin does not. The central bank and treasury of the United States determines how much dollars will be printed each day. There is not set schedule of production for how many dollars will be printed today, and printed tomorrow, and yesterday, and so on. You have no idea how many dollars are in existence and this befuddles the concept of purchasing power of the dollar. We are aware of the M2 money stock, which is more or less the total amount of US dollars in the economy, but future production rate of US dollars is unknown and seems to be ever-increasing, which only degrades the purchasing power of each dollar in existence.

M2 Money chart below:

M2 money supply chart from Federal Reserve data

Meanwhile, with bitcoin, the production rate is programmed into the blockchain protocol that underpins the currency. The blockchain protocol is the software that allows the cryptocurrency to run. The software code is open-source which means anyone and everyone is able to see the production rate of bitcoin, and know how many bitcoins were produced today, how many will be produced tomorrow, yesterday and so on. This level of transparency is one value proposition that bitcoin offers that its main competitor, the US dollar, does not.

Bitcoin production chart below:

BTC production supply chart. The
  1. Can this asset be easily replicated by a competitor asset?

Yes, bitcoin can be easily replicated. As mentioned earlier, bitcoin’s code is open-source, which means that anyone can  easily created a clone of bitcoin. This has already happened many times, with other Cryptocurrencies using the exact same code, but going by a different name. The fact that bitcoin can be replicated easily hurts the value of bitcoin. Why would I buy a bitcoin for $1,000 when I could buy an exact clone that is selling for $3.00?

However, there are certain important aspects of bitcoin that cannot be easily replicated. To explain this briefly, bitcoin is the most secure of all Cryptocurrencies. All digital currencies are susceptible to things such as hacking, but bitcoin’s massive network of nodes, miners and users allows bitcoin to be the most trustworthy cryptocurrency. Read more about this advantage of bitcoin here.

  1. Is there any reason to expect increased consumer demand for this asset in the near / long term future?

This is a complicated question to answer because it depends on the timeframe used for the analysis. Bitcoin’s price and trade volume (number of transactions in 24 hours) spiked in December 2017-January 2018. Then, the price and trade volume dropped dramatically, but it did not crash to zero. Fundamentally, this means that people are still buying and selling bitcoin, despite the massive drop in price from almost $20,000 per bitcoin to now $8,000. This shows that the product has a stable floor, currently, although analysis of volume is more on the technical analysis side, so I will hold further comment. The fact that bitcoin crashed 66% this year is terrible for those holding since January, but the fact it did not go to zero during the crash can be viewed as a positive for now.

  1. Is this cryptocurrency actually worth a damn, or is it a scam?

Everyone has a different opinion regarding if bitcoin is a scam. I am not here to change anyone’s mind. I believe bitcoin is as strong as its network of users and as strong as the number of users who are committed to buying or holding the asset, even when the price decreases.  I have been thoroughly impressed by the projects, entrepreneurs and software developers who continue to work in the bitcoin space during the past few months, even though the price is down so much this year. User’s commitment to the product tells me it’s not scam, but again, I am not writing this to change anyone’s mind.

  1. Is the team behind this product on track to be successful? Do they have a successful track record? Is the team mainly interested in a pump-and-dump project, where they can take profit in the short term and neglect the long term development of the product?

Nobody really knows who created bitcoin in the first place. All we know is someone created a revolutionary product and fought for it to succeed in its early stages when nobody gave a shit about it, even though the creator was probably viewed as crazy by at least 50% of the people to whom he introduced the product.  One of the best things about bitcoin, in regards to other cryptocurrency projects, is there was no Initial Coin Offering (ICO.) When a cryptocurrency launches via an ICO, they generally fail more often than not. Not always, but let’s just say ICOs do not have a great track record because the teams behind the ICO are generally more short term profit-motivated, rather than caring about the long term success of the cryptocurrency.

To sum up, what does the fundamental analysis of bitcoin tell me? It tells me that there is some value to bitcoin. However, how does the current price of bitcoin compare to its fundamental value? Is it a good time to buy because this price will increase? What is the supply and demand for bitcoin telling us right now? These questions can be answered with the help of technical analysis.

Technical Analysis Basics

This form of asset price analysis centers around reading market data. What does the current price and price history of the asset tell us? Is the trend of price movement going up or down? Will the price trend change soon from positive to negative? Is there small or large demand to purchase the asset?

At its core, technical analysis means looking at the price chart of an asset, determining the current trend line (is price going up or down?) and then predicting if the trend will continue or reverse. If it will reverse, when will it reverse?

You can get these answers by figuring out the support and resistance price levels of bitcoin in its current market cycle. Is there a price that bitcoin keeps reaching but then drops immediately? A price that bitcoin’s price just cannot break through and go above? This is the resistance level. You can identify several resistance levels from looking a bitcoin’s history. When you connect the different resistant levels with a trend line, this is the resistance trend line.

Conversely, is there a price of bitcoin that the price just will not go below? Whenever bitcoin drops to this price, it always seems to spike back up? This is the support level.  When you connect the different support levels with a trend line, this is the support trend line. Analyzing the different support levels and resistance levels of bitcoins recent price history shows the way the market is moving. Can resistance levels and support levels ever touch each other on the chart? Yes, yes they can. Those are the magic spots, where the price either drops or rises and breaks one of the trends.

What I will show below is not financial advice. This is basic technical analysis and I do not want to try to explain all of technical analysis of bitcoin in one blog post. Anyway, below is analysis of bitcoin’s price of the past 16 months. The resistance level line (black line) was trending towards pushing bitcoin down to zero. The support levels (red line) slowly increased over time. What happened when the resistance and support level trend lines hit? Bitcoin’s price went up, which meant the support won out. This is a bullish sign for bitcoin.

BTC Technical Analysis

Conclusion

Fundamental and technical analysis are two useful tools for valuing cryptocurrencies, such as bitcoin. Investors and traders must perform massive amounts of research in order to not lose all of their investments due to poor decision making. If you are interested in learning more about these investment analysis methods, please contact me using the form below stating your interest in a free financial literacy consultation. We specialize in introducing financial technology and investment research to those seeking knowledge.

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