Bitcoin traders and digital currency investors use a wide range of different analysis techniques, tools, and methods to predict the movements of securities. These tools are able to deliver a great deal of insight into the patterns of digital currency prices that allow Bitcoin investors to generate a significant amount of income by analyzing pricing trends and the economic zeitgeist.
Developing a firm grasp of these tools is critical in assembling an effective digital currency investment strategy that yields optimal returns. The competitive edge provided by these techniques is self-evident, but the various methodologies available to traders are themselves a subject of heated debate in the digital currency investment community.
Using these different techniques, Bitcoin investors and traders are able to analyze key price determinants, which are referred to as “fundamentals”, to gain an insight into the intrinsic value of the currency. This process, called fundamental analysis, is one of the most popular analytical techniques used by traders to infer the future movements of digital currency prices.
Armed with the insight delivered by fundamental analysis, investors are able to determine whether Bitcoin or other digital currencies are either undervalued or overvalued at their current price, and then exploit these inferences and integrate them into their trading strategy. Fundamental analysis is one of the easiest techniques to perform, and can be a powerful tool that guides a purchasing or selling decision.
Fundamental Analysis vs. Technical Analysis
To gain a perspective on the methodology employed by fundamental analysis, it’s a good idea to take a look at its counterpart, technical analysis, which takes a more empirical, psychological approach to the digital currency market.
Technical analysis typically involves the practice of evaluating trader sentiment and market trends by assessing price and volume data, and is primarily concerned with statistical interpretations of price movements. Fundamental analysis, however, focuses on the driving factors behind shifts in digital currency prices in order to gain a deeper understanding of its actual value.
Fundamental Analysis And Bitcoin
Traders and investors have been applying fundamental analysis techniques to the stock market for decades. Bitcoin, when compared to traditional securities, however, is highly volatile, so the nascent digital currency market requires a slightly different approach when integrating fundamental analysis methodologies.
Traders that utilize fundamental analysis assess Bitcoin through the lens of a divergent perspective that differs from the techniques used to apply the methodology to stock market assessment. Financial analysts attempting to glean insight into the stock market often assess financial metrics such as the earnings and revenue of a company.
When assessing the digital currency market, financial analysts applying fundamental analysis techniques will instead focus on a wider range of factors, such as transaction volume and user activity in order to determine the intrinsic value of Bitcoin.
Key Factors To Consider
Before incorporating fundamental analysis into your digital currency investment strategy, there are a number of key considerations that should be contemplated. Firstly, not all digital currency investors support the use of fundamental analysis as an effective predictive model to base purchasing or selling decisions on.
Many traders support the efficient market hypothesis, which posits that the prices of securities already incorporate all of the disparate data points that could possibly affect their price, and therefore any attempt to gain further insight from market assessment is redundant. The efficient market hypothesis postulates that investors are unable to “beat the market” over the long term, as the price of a security represents the total sum of available information.
While the assertions of the efficient market hypothesis may seem resolute, it’s important to note that many innovative investors and traders have already beaten the market. American business magnate Warren Buffet has frequently been referred to as an oracle with regards to his profound insights into market trends, and, by leveraging a variety of different analytical techniques, has consistently produced powerful positive returns over more than half a century.
Buffet, alongside other high profile investors, provide tangible evidence that it is indeed possible to beat the market through analytical techniques, or at the very least present a strong argument for fundamental analysis as an element of a balanced trading strategy.
Quantitative vs. Qualitative Factors
The first step of incorporating fundamental analysis methodology into any investment strategy is to understand that the approach involves both qualitative and quantitative factors. In the case of fundamental analysis, both types of information carry the same amount of weight, and are considered equal.
Most traders and analysts that leverage the insights delivered by fundamental analysis rely on both qualitative and quantitative factors to make informed decisions on the true value of any given security. To present a simpler example of these factors, we’ll use the shares of international fast food juggernaut McDonald’s Corporation.
When assessing the worth of McDonald’s Corporation shares, fundamental analysts are likely to consider a range of quantitative factors such as the revenue of the organization and earnings. To obtain a balanced understanding of the share price, however, a fundamental analysis would also incorporate qualitative factors such as the McDonald’s brand and its overall global footprint.
To apply these same principles to the fundamental analysis of bitcoin, fundamental analysts would consider the trading volume of the currency as a quantitative factor. The qualitative factors of bitcoin are also integrated into a fundamental analysis in the form of Bitcoin’s potential future prospects as a popularized and more common medium of exchange.
The belief that digital currencies will eventually supersede other currencies as a medium of exchange would typically be incorporated into a long term view of the potential prospects of the currency- to simplify, fundamental analysis doesn’t only assess the numerical value of Bitcoin, but also the opportunities it presents in the future.
A unique feature of Bitcoin as a currency is that the total supply of the currency is fixed at 21 million units. Of this total volume, between 16 and 17 million have been mined, a number that is rapidly increasing. This places Bitcoin in a unique category of its own- unlike fiat currency, which a central bank can continue to generate as much as is desired, Bitcoin possesses a fixed and predictable total supply volume.
The unique way in which Bitcoin can be stored, however, accounts for a small volume of what is referred to as “lost bitcoin”. Early adopters of the currency, in many cases, have discarded drives containing the keys required to access their Bitcoin. Some of these early adopters have reportedly lost access to tens of thousands of bitcoins, which no doubt represents a significant amount of regret given the current trading price of the currency.
The elusive, pseudonymous creator of Bitcoin- Satoshi Nakamoto- who is often referred to as the “Banksy of Bitcoin”, is believed by many industry experts to possess a vast fortune in Bitcoin. Sergio Lerner, a cryptocurrency designer and one of the lead developers responsible for the creation of Bitcoin, estimated in 2013 that Satoshi held more than 1 million units of the currency. Many dismiss these claims as pure speculation, while others posit that these units will never move.
Like any security, Bitcoin value is governed by both supply and demand. The key variables that determine the demand for Bitcoin are trading volume and transaction availability, which can both be regarded as measures of user adoption rates. Essentially, as Bitcoin becomes used by more people as a way to transfer monetary worth, the more it becomes entrenched as a monetary standard. Both transaction availability and trading volume are extremely important indicators of the movements of Bitcoin.
Bitcoin has been making slow and steady progress toward widespread use as a standardized medium of exchange, which is made evident by the staggering growth in transaction volume over the last few years. Similarly, Bitcoin has been adopted as a payment method by tens of thousands of businesses and ecommerce platforms globally- in April 2017, for example, two of the largest retail electronics retail chains in Japan announced their intent to accept Bitcoin in more than 260,000 stores.
Since 2009, the list of companies that accept Bitcoin as a payment method has grown exponentially. The first real-world transaction conducted with Bitcoin occurred on the 22nd of May in 2010, when programmer Laszlo Hanyecz paid a fellow crypto enthusiast 10,000 BTC- roughly $38 million USD at today’s exchange rate- for two Papa John’s pizzas.
Bitcoin is now accepted by organizations such as Dell, Overstock.com, Microsoft, PayPal, Newegg, Shopify, and Amazon. The total number of Bitcoin transactions that have occurred since the creation of the currency has demonstrated an upward trend, with a dramatic spike in frequency occurring at the beginning of 2012. The average daily transaction total of Bitcoin currently sits at around 33,000, and is growing rapidly.
The trading volume of Bitcoin follows a similar trajectory. In the beginning of July 2010, Bitcoin’s monthly trading volume sat at less than 32,000 BTC. By the end of October 2016, the trading volume of the currency had reached nearly 60 million BTC.
Critical Economic Events
As with any security, global economic events can exert a powerful influence on Bitcoin prices. It’s important to incorporate these economic shifts when using fundamental analysis in a trading strategy. Events that affect the price of Bitcoin can be both related and unrelated to the currency, but both can have a profound impact.
A highly-publicized and important crypto-related event such as the halving, which affected the subsidy the Bitcoin network uses to compensate miners, has a clear and easily recognizable impact on the future supply rate of the currency. High-profile hacks on major Bitcoin exchanges can also impact price, as can governmental legislative decisions, such as the Chinese government’s recent expression of intent to shut down Bitcoin exchanges.
Events that appear unrelated to Bitcoin can also have a significant impact on its price. Historically, Bitcoin prices have surged in response to events that presented clearly defined global economic strife. The ongoing financial and economic challenges in Greece, for example, have been attributed to the rising price of Bitcoin.
Trading Fundamental Analysis Conclusion
Leveraging the insights delivered by fundamental analysis can provide Bitcoin traders and investors with a deeper understanding of the intrinsic price of the currency, which ultimately assists in making more informed and profitable trading decisions.
Opponents of fundamental analysis commonly criticize the technique for its speculative and theoretical nature, as it is primarily concerned with the hypothetical worth of a security rather than its actual value at any given point in time. To balance out the speculative element of fundamental analysis, it’s best to combine the insights it delivers with technical analysis to gain a complete and balanced perspective on Bitcoin price.
For example, after assessing a number of Bitcoin’s fundamentals and drawing the conclusion that it is currently overpriced, a trader may then be motivated to calculate the optimal time to sell. Technical analysis can be used at this point to identify a profitable exit point. Technical analysis can also be used to assess the recent volume and price data of Bitcoin to calculate the best time to buy, which can then be balanced with a fundamental analysis to confirm the buying decision.
Ultimately, each trader must decide which techniques to incorporate into their trading strategy autonomously. One fact remains true for any trading strategy, however- in the world of digital currency, knowledge is power, so the more you know about Bitcoin, the more successful your investment strategy will be.