Successful crypto investing requires a solid framework for value-based decisions. The efficient-market hypothesis suggests that prices already include all the information that is available about an asset, and that prices reflect the perfect value.
However, there are thousands of examples in crypto and stock markets to contradict this theory. The reality is that markets are inefficient. Why did Apple’s stock price decline by 30% in during the Covid-19 crash in February 2020? Did Apple sell 30% fewer products? Did Apple earn 30% less? Why did GAP’s stock crash 70% over 49 days? Did the biggest clothing retailer in the United States suddenly sell 70% fewer clothes?
The answer to all these questions is a resounding “No.” Markets are often irrational, and prices will not reflect value. As Warren Buffett said, “Mr. Market is a drunken psycho.”
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This is where the concept of value investing comes from. Value investing tries to identify securities that are underpriced due to market irrationality. These securities are trading below market value (i.e., with a margin of safety), and investors who buy them, hope that one day, the price will reflect the value of the stock. Quoting the greatest investor Warren Buffett of all time again: “Price is what you pay, value is what you get.”
The same happens with crypto assets. Bitcoin’s (BTC) price fell 50% 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. Did these movements in price accurately represent the real value of the network, its activity, active wallets, transaction volume, and network usefulness? Did the prices reflect the value?
The answer is no. The trick is having the right tools to spot these opportunities — tools like fundamental analysis.
Fundamental analysis enables traditional institutional investors to understand the industry, attracting more capital and giving rise to more unicorns, similar to what happened in the internet and consumer industries. These core techniques are also becoming increasingly standard for retail investors looking for the highest-potential investments across a long-term investment horizon.
Hype versus growth, price versus value
There are a few axioms that are very important to any asset, including crypto assets. And although crypto assets are a relatively new asset class, they inherit similar core principles:
- Most crypto assets represent an underlying network, utility, or community, built on some spectrum of decentralization.
- The market forever swings between bull sentiment and bear sentiment, between greed and fear, between unsustainable optimism and unjustified pessimism. Valuation methods are important to maintain a rational investment strategy.
- The future performance of an investment is a function of its present price compared to its fundamental valuation.
- It is possible…
Read More: How do you put the right valuation on digital assets?
