Successful investing in cryptocurrencies requires having a solid framework in place for making decisions.

Successful investing in cryptocurrencies requires a solid value-based decision-making framework. The efficient market hypothesis suggests that prices already include all available information about the asset and that prices reflect the ideal value.

However, there are thousands of examples in the cryptocurrency and stock markets that contradict this theory. The truth is that markets are inefficient. Why did Apple’s stock price fall 30% during the Covid-19 crash in February 2020? Did Apple sell 30% fewer products? Did Apple earn 30% less? Why did GAP stock collapse 70% in 49 days? Did the largest clothing retailer in the United States suddenly sell 70% fewer clothes?

The answer to all of these questions is a resounding “no”. Markets are often irrational and prices do not reflect value. As Warren Buffett said: “Mr. ‘The market is psychotic.’

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Hence the concept of value investing. Value investing attempts to identify securities that are undervalued due to market irrationality. These securities trade below market value (i.e., with a margin of safety), and investors who buy them hope that the price will one day reflect the value of the security. The greatest investor of all time, Warren Buffett, said it again: “Price is what you pay, value is what you get.” »

The same thing happens with crypto assets. The price of Bitcoin (BTC) fell 50% during the coronavirus crisis in March 2020 – only to return to previous levels 55 days later and double its price over the following five months. Do these price movements accurately represent the true value, activity, active wallets, trading volume, and interest of the network? Do prices reflect value?

The answer is no. The trick is having the right tools to spot these opportunities – tools like fundamental analysis.

Fundamental analysis allows traditional institutional investors to understand the industry, attract more capital, and create more startups, similar to what has happened in the Internet and consumer industries. These fundamental techniques are also increasingly becoming a standard for retail investors seeking the highest investment potential over a long-term investment horizon.

Hype versus growth, price versus value

Certain axioms are very important for any asset, including crypto assets. Although cryptoassets are a relatively new asset class, they inherit similar basic principles:

  • Most crypto assets represent an underlying network, utility, or community, built on some decentralization.
  • The market constantly oscillates between bullish sentiment and bearish sentiment, between greed and fear, between unsustainable optimism and unjustified pessimism. Valuation methods are important for maintaining a rational investment strategy.
  • The future performance of an investment depends on its current price relative to its fundamental valuation.
  • It is possible to reduce risk by avoiding overpaying for overpriced projects by looking at their valuation metrics rather than their prices.

So what’s the difference between price and value?

Prices are the result of many other variables that often differ from value: sentiment, hype or market crash, speculation, fear, greed, exaggerated news, etc. All assets contain a significant amount of irrationality, but cryptocurrencies sometimes suffer from this irrationality to a greater degree – especially recently in the meme sector. Specifically, many factors can affect cryptocurrency prices, including market demand, market sentiment, government policies, regulatory changes, technological innovations, industry partnerships, project progress, and more.

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Valuation refers specifically to determining the financial value of an asset. Valuation involves analyzing data to determine the intrinsic value of an asset using fundamental analysis. As the sector gradually matures, we are discovering that traditional financial valuation methods can help identify projects with sustainable growth potential, whether due to an undervalued market valuation or the volume of projects still to build. Market opportunities exploited.

A framework for evaluating coding

Given the diversity of crypto assets on the market, there is no “universal” valuation method. Investors should consider different options and see which one suits each individual case. The first step is asset classification. Is it a non-fungible token (NFT)? Payment code? Utility code? Or something else ? (Ultimately, unlike securities, cryptocurrencies and tokens have a broader range of purposes and utilities and provide investors with different rights.)

For the original cryptocurrency – like Bitcoin – you can for example use Metcalfe’s law. You can use the same method on the first layer, like Ethereum (ETH), or choose something else, like a stock-to-flow model.

Are you dealing with an NFT, a utility token, or something else? Source: ” Digital Asset Valuation Framework” by Jupiter Cheng

Once the token is classified, use an analysis of your choice — one of the analyzes shown above, or a different analysis from the image below.

Choose a Source section: “The Digital Asset Valuation Framework” by Jupiter Cheng

Successful long-term investing in cryptocurrencies does not require extraordinary IQ, special trading knowledge, or inside information. All you need is a solid framework for making investment decisions based on value rather than speculation. Good investment!

This column is adapted from the “Digital Asset Valuation Framework”, published by HashKey Capital in April 2024.

Jupiter Cheng He is a research and liquid funds partner at HashKey Capital, a financial services company with offices in Tokyo and Singapore. He previously served as Vice President of FinTech at Zhongtai Financial and Senior Research Associate at BOCOM International. He holds a bachelor’s degree in applied physics from Beihang University and a post-graduate diploma in operations research and business statistics from Hong Kong Baptist University.

This article is intended for general information purposes and is not intended and should not be relied upon as legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

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