Investing in cryptocurrency requires a solid framework for making value-based decisions. While the efficient-market hypothesis suggests that asset prices already reflect all available information and perfect value, the reality is that markets are often inefficient. Apple’s stock price, for example, declined by 30% during the Covid-19 crash in February 2020, despite no significant changes in product sales or earnings. Similarly, GAP’s stock crashed by 70% over 49 days, even though the company didn’t experience a 70% decrease in clothing sales. These examples demonstrate that markets can be irrational and that prices may not accurately reflect value.
Value investing is a concept that aims to identify underpriced securities due to market irrationality. These securities are trading below their market value, and investors who buy them hope that the price will eventually reflect their true value. The same principle applies to crypto assets. Bitcoin, for instance, experienced a 50% price drop during the Covid-19 crash in March 2020, only to recover to previous levels 55 days later and double its price in the subsequent five months. These price movements did not accurately represent the real value of the network, its activity, active wallets, transaction volume, and network usefulness.
To spot investment opportunities in crypto assets, it is crucial to have the right tools, such as fundamental analysis. Fundamental analysis enables investors to understand the industry and identify undervalued assets, attracting more capital and fostering growth. This analysis technique is increasingly being adopted by retail investors seeking high-potential long-term investments.
When it comes to valuation, it is important to differentiate between price and value. Prices are influenced by variables such as sentiment, market hype, speculation, fear, and greed, among others. They often do not accurately represent the true value of an asset. Valuation, on the other hand, involves determining an asset’s financial value by analyzing data using fundamental analysis. As the crypto industry matures, traditional financial valuation methods can help identify projects with sustainable growth potential, whether they are undervalued by the market or have untapped market opportunities.
Given the diversity of crypto assets, there is no one-size-fits-all valuation method. Investors must categorize the asset and choose an appropriate analysis method. For example, Metcalfe’s Law can be used to value native cryptocurrencies like Bitcoin, while a stock-to-flow model or other methods may be suitable for other assets.
Successful investing in crypto relies on a framework based on value rather than speculation. It doesn’t require extraordinary intelligence or insider information, but rather a solid decision-making process.