Fireside with SOULLY: Educational series episode 9— Due diligence process and why fundamental analysis is important.
Welcome to the weekly minutes from this week’s fireside chat. The full video of this transcription can be found via the following link: https://www.youtube.com/watch?v=EUIEm4kqUys&t=1031s
As always, this information is for educational purposes only and presented in order to objectively impart value to the wider Fantom community.
Enjoy.
Transcription:
After many requests from the community, It seems some people are prepping their techniques, sharpening the knives so to speak for the next bull cycle and want some revision on various processes for conducting Due Diligence, which I heavily advocate. So let’s break this down.
First off whether you’re dealing with century-old stocks or nascent cryptocurrencies — there’s no exact science involved. Or, if there is, Wall Street’s top players ensure that the formula remains a well-kept secret.
What we have instead is a vast array of tools and methodologies that investors employ in order to give them an edge over the house. For the most part, you can sort these techniques into two categories: fundamental analysis (FA) and technical analysis (TA).
By combining both of the processes in these methodologies together investors hope to avoid being scammed, identify ponzinomics, pick investments that have sound logic to their product offering & identify solutions offered by the products underneath these investments that are likely to give the company or protocol the edge thus giving the investor the best chance of making a good return on their investment.
For the sake of keeping this presentation as detailed as possible but sticking to our new time frame protocol, we will be focusing on Fundamental analysis specifically in this segment. Lets dive in.
Fundamental analysis first emerged in 1934 with the publication of “Security Analysis,” a book about investing, at the time. Its processes were widely adopted by the public and have evolved along with the evolution of market types and styles of investing.
It is a method used by investors and traders which aims to draw out and identify intrinsic value of assets or businesses.
TradFI FA and Crypto FA vary due to differences in market metrics:
This is due to the fact that Traditional Fundamental Analysis takes equations into consideration that don’t necessarily exist in Crypto markets as mentioned above, as markets evolve the processes of Fundamental Analysis must also.
The process in itself aims to value these accurately, so potential investors will engage in Fundamental Analysis by rigorously studying internal and external factors to determine whether the asset or business in question is overvalued or undervalued by the market at the time of their potential investment execution. Their conclusions can then help to better formulate a strategy that will be more likely to yield good returns.
The end goal with this type of analysis is to generate an expected share price and to compare it with the current price. If the number is higher than the current price, you might conclude that it’s undervalued. If it’s lower than the market price, then you could assume that it’s presently overvalued. Armed with the data from your analysis, you can make informed decisions about whether to buy or sell that particular company’s stock.
Metrics between L1 and L3 protocols also vary :
As mentioned previously, metrics between tradfi and Crypto vary, which is why processes must be adapted. But this variation also applies to layer 1 and layer 3 protocols.
So firstly, before we look at specific processes of Fundamental analysis of these, lets quickly define and separate them.
A layer 1 protocol:
Is a blockchain in itself, it is a network that hosts and supports an ecosystem within itself.
Examples include:
- AVAX
- BSC
- ETH
- And of course FTM
Layer 3:
Is essentially an ecosystem that exists by the support of a layer 1, commonly referred to as DApp’s. SpiritSwap is an example of a Layer 3 protocol built on top of Fantom, by virtue of its network support. Without Layer 1 there to host the application, SpiritSwap would not have the infrastructure to exist.
Fundamental analysis — L1
Due to metric differences between L1 and L3’s, different assessment metrics need to be employed.
Some of the more common metrics investigated by wood be investors in L1’s are as follows.
OnChain metrics:
On-chain metrics are those that can be observed by looking at data provided by the blockchain. We could do this ourselves by running a node for example in order to acquire the required data, but that can be time-consuming and expensive.
A more straightforward solution would be to pull the information from websites or APIs specifically designed for the purpose of informing investment decisions. For example, CoinMarketCap’s on-chain analysis .
Transaction count:
Gives us a good indication of the L1 networks health by measuring the level of activity taking place on a network. By plotting the number for set periods (or by using moving averages), we can see how this activity changes over time.
Note that this metric should be taken with a pinch of salt as these figures can be inflated (we will cover this in active addresses)
Active addresses:
Active addresses are the blockchain addresses that are active in a given period and a common metric to determine measure of growth. Approaches to calculating this vary, but a popular method is to count both the sender and receivers of each transaction over set periods (e.g., days, weeks, or months). Some also examine the number of unique addresses cumulatively, meaning that they track the total over time. As mentioned above this must be taken with a pinch of salt as these figures can be easily inflated, albeit not intentionally, however one can’t be sure that there isn’t just one party transferring funds between their own wallets for various purposes. It’s not uncommon for people to have several wallets so this must be taken into consideration.
Transaction value:
This is quite common, but not to be confused with the transaction count. Rather the transaction value tells us how much value has been transacted within a period. For example, if a total of 100 Fantom transactions, worth $1000 each, were sent on the same day, we would say that the daily transaction value was $100,000. Growth of this metric over time would suggest that the value of capital flowing on this chain is experiencing growth and adoption.
Volume of fees, fees paid or gas prices:
Is often the most overlooked metric, but one of the most important. This metric gives us insight into the demand for block space. One could consider this metric as a measure of bids at an auction. Just like an auction house, in L1 chains, users of the chain will compete with each other to have their transactions included in a timely manner, especially if the defi atmosphere is thriving. Those bidding higher gas prices will have their transactions confirmed far quicker. This is a good indicator that not only validation or miners are receiving healthy incentives for supporting the chain, but also a good indicator that the applications supported by this L1 are also thriving.
NVT — Network Value to Transactions Ratio:
NVT essentially tries to interpret a specific network’s value based on the value of transactions it processes. This is based on the formula network value / daily transaction volume.
For example, say that you are comparing two different protocols: Coin 1 and Coin 2.
Both have a market capitalization of $10,000,000. However, Coin 1 has a daily transaction volume worth $1,000,000, whereas Coin 2’s is worth $250,000.
The NVT ratio for Coin 1 is 10, and the NVT for Coin 2 is 40. Generally speaking, assets with lower NVT ratios are considered undervalued, while those with higher ratios may be considered overvalued. These merits alone suggest that Coin 1 is undervalued in comparison with Coin 2.
Note: These aren’t all of the Fundamental Analysis strategies you can deploy, however they are the main ones. The remaining fundamentals that apply to L3’s can also be applied as Fundamental Analysis metrics for L1’s; however given there is overlap, we will cover these on the next slide.
Fundamental analysis — L3’s
As mentioned, not all metrics are as pertinent to layer 3’s as they are to layer 1’s. Some can be converted in principle, for example active wallets could be converted to the L3 protocols tokens held within wallets, however some of these are moot point.
This slide covers Fundamental Analysis validation metrics that are pertinent to L3’s however the same metrics absolutely overlap to Layer1’s also, so can should be applied to L1 fundamental analysis.
Roadmap, Whitepaper & team:
One of the most popular and common ports of call when conducting due diligence as part of your fundamental analysis involves some good old-fashioned research into the project. Reading a whitepaper gives you insight into understanding a project’s goals, the token use cases, revenue streams along with the underlying technology. Although DeFi predominantly runs on an anonymous pretext, if identified, the track records of team members give you an idea of their ability to build and scale the product. Lastly, a roadmap tells you what the projects direction is, how they plan to scale further, stay competitive and continue to achieve new revenue streams for investors .
Tokenomics and initial distribution:
Some projects create tokens as a solution looking for a problem, this is an important factor to rule out. Understanding the tokenomic model allows you to identify your potential to earn from the token, what its revenue metrics are thus giving you a passive profitability forecast. Furthermore taking a deep dive into the distribution model might unearth any risks that exist. For instance, if the vast majority of the supply was owned by only a few parties, we might reach the conclusion that this is a risky investment, as those parties could eventually manipulate the market.
Market capitalization:
Examining the MC can be a useful tool, but also a double edged sword. Market capitalization is used to gauge the growth potential of the protocol in question. Some crypto investors view “small-cap” coins as offering more growth potential compared to “large-cap” ones. While others go by the premise that large-caps have stronger network effects thus offer a better chance than less battle tested small-caps.
BE AWARE! By itself, market capitalization can be misleading. One example being that any protocol could spin up useless tokens with a supply of ten million. If just one of those tokens were traded for $1, then the market cap would hit an inflated value of $10 million. This valuation is obviously manipulated — Considering this scenario, without a value proposition that offers strength, it’s unlikely that the wider market would be interested in the token and you could be left bag holding garbage. The Market cap metric should be taken with a pinch of salt and applied with caution in conjunction with other metrics surrounding fundamental analysis.
Volume and Liquidity:
Is a measure of how liquid an asset is. This will indicate how easily a token can be purchased or sold and what slippage you might incur. Issues that can be encountered with an illiquid market is that investors aren’t able to sell their assets at a “fair” price or true market rate as slippage on large spreads means unrealized P/L is simply fiction covered up under the guise of a phony market cap. Assessing spreads, which is the difference between asks and bids, is a good indicator of how “liquid” a market may be.
Now we have looked at SOME OF common assessment metrics for executing fundamental analysis, let’s take a look at the pros and cons before concluding comments.
As with all Fireside topics, we like to be as objective as possible and examine the validity of all topics discussed. As such we have taken the liberty of compiling a quick pros and cons list to consider.
Let’s take a look at the Pros:
Fundamental Analysis: Assesses viability of potential profitability in a manner that any format of Technical Analysis can not. This said, and although not covered in this particular FireSide, technical analysis also has its strengths. When applied with in conjunction with each other (TA and FA that is) both offer profound insight into the potential profit of an investment.
Anyone can do Fundamental Analysis: You just have to have a metric assessment plan ensuring you are combining the correct mix assessment metrics and the ability to read between the lines. This is due to the fact that to be done well, it only relies on tried and true techniques, so long as you have access to the Qualitative data required. If this data is not available, this is a big redflag and would likely validate looking for other investment options.
If done correctly: It provides profound insight into the growth prospects of a potential investment. Look at what the big players do. Time and time again Top investors like Benjamin Graham & Warren Buffett , Firms such as Vanguard and Black Rock have been consistent in exemplifying that rigorous research into businesses using such methods can yield tremendous success when making investment based decisions.
The cons and things to be mindful of:
GOOD Fundamental Analysis requires time and dedication: The inherent impatience of the crypto market often sees this as a barrier of entry, just wanting to ape and catch the wave before everyone else does, climbing the ponzi ladder so to speak. Many factors need to be assessed and the learning curve for doing so can be extremely steep, don’t expect to get it right all at once, learn as you go and recognize that you are in fact on a learning journey. Don’t invest more than you can afford to lose and make sure to learn from any mistakes and apply these learnings to your models moving forward.
Fundamental Analysis is better suited to long-term trades than short-term ones: This is because it applies metrics that require time to mature or come to fruition, for example, tokennomic metrics as they gear up over time, bonding curves are a good example of this.
Nothing is a given, there are no crystal balls: Don’t take anything for granted. Investments that appear undervalued (by every metric) are not guaranteed to deliver any future growth.
I will leave you all with a quote from the 1930’s economist John Maynard Keynes. “Markets can stay irrational longer than you can stay solvent.”
With the presentation coming to an end, I want to give my closing thoughts and reiterate what we covered today.
Fundamental Analysis:
Is a powerful tool that can empower users to see beyond the apes. However, as Keynes poignantly reminds us, markets can be irrational from both a bull and bear perspective, and this should always be taken into consideration.
Take all the time you need:
Consider all metrics on offer and study them rigorously. Robust Fundamental Analysis strategies are composed of many different components, leave no stone unturned.
Applying a combination of Technical Analysis and Fundamental Analysis Is recommended:
TA will often identify factors that Fundamental Analysis misses, “qualitative vs quantitative in a sense” and vice versa. This approach may take more time but could save you or make you a lot of money.
Fundamental Analysis is an art that is perfected over time:
We have merely scratched the surface today, but my goal of this discussion is to bring this vastly overlooked and underutilized topic to light, in hope that once the bull market resumes, and the apes start aping once again, all of you will consider these tools of thought and research in your future investments strategies, not only to yield more profitability, but to protect capital also.
Thank You for your time, I hope I managed to impart some value this evening.
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