How to analyze cryptocurrencies
With the growing popularity and use of cryptocurrencies worldwide, a basic question always crosses the mind of any investor: what is a good cryptocurrency to invest in?
In this article we will learn how to analyze cryptocurrencies. It will be an article unlike anything you have ever read, because I will address details from those who really study this market seriously.
The goal of this article is NOT to find a crypto that can increase in value 1000x within a month.
Our goal will be to evaluate a project for the long term. So let’s get started:
There are 20 important questions you need to ask about a project. Each of these questions requires extensive research to answer.
It is common that some of these questions you will not be able to find answers to, because not all information is public or easy to find.
The solution in these cases is to search for data within the projects’ communities (forums, Discord) by talking to ambassadors or enthusiasts who are very familiar with them and can help you with the answers.
But before you start the analysis, you need to follow some rules. These will serve as your basic research methodology:
Basic rules for evaluating projects
Rule 1: always prioritize official sources. For example, when reading about the explanation of a project, do not rely on Youtube reviews or random sites, but look for information from the official whitepaper, official website/blog/Twitter, etc. You can look for supplementary material to facilitate understanding/didactics, but always keep in mind that misinterpretations or misinformation are common.
Rule 2: Be suspicious of official data. That’s right. The founders of a project or community members are not the owners of the truth. They can lie, tamper with information, act in bad faith. If a project says that the foundation owns x tokens, try to verify this somehow (on the blockchain network) or with certifications from external audits, for example.
Rule 3: always be skeptical and fight the emotional. When liking a project, it is common to reduce the criticality. This is a mistake. You are here to study, not to fall in love. Always criticize. If you already bought it, criticize even more.
Rule 4: Stay away from social bubbles. Almost every crypto community is a bubble. They are clusters of people who think the same thing, believe the same things, and are deluded by the same things. Extract as much information as you can from them, but look for the contradictory, read opinions of haters and critics. This will bring more lucidity.
Rule 5: keep yourself updated. Buy and forget is not good advice. It is important that you check the status of metrics and project development from time to time (annually), as well as the market and competitor situation, to reassess your allocation. This is a market of many changes.
So now that we have acquired a critical methodology, it is time to find out which aspects are important to evaluate in cryptocurrencies.
20 questions to ask about a cryptocurrency
Although the questions below are numbered, they are not necessarily in order of importance. The ordering of the questions is more in the logical sense of what to check first, because questions are easier to answer if other questions have already been answered. But this is also just a suggestion.
The most important thing is that they are all answered as clearly as possible.
1) What is the main concept of the project?
You must be able to explain briefly what problem the project tries to solve, the reason for its existence, its main focus. You should be able to give a short answer (1 or 2 sentences) and also a longer answer (1 or 2 paragraphs) explaining what this cryptocurrency is all about, in general.
2) What is the utility of the token (why not use BTC/ETH/USDC…?)
Many proposals do not need a new token. For example, imagine a digital marketplace project, where people buy and sell items over the internet. A digital marketplace can be built using blockchain technology and smart contracts. But is it necessary to create a new token for this or is it possible to use a stablecoin, or even ETH, BTC? Which would make more sense?
In many cases the token is only useful for governance, i.e. participation in the decisions of the project. A governance token has no utility demand other than voting, so it needs to be evaluated very carefully.
Would you be willing to invest money just to make decisions in a decentralized project? Why? If you have no interest in spending money just to help with decisions, why should others?
In other words, the question about the utility of the token can be broken down into other questions related to day-to-day operation. For example: would it make sense to put money into using the token for the purpose for which it was designated?
3) What is the technical basis of the project?
Now that you know how to explain the purpose of the project and its native token, it is time to go deeper and check the technical soundness. After all, there is no point in having the idea of colonizing Jupiter without a convincing technical basis for such a feat.
This is one of the most difficult analyses and requires the most knowledge, a knowledge that few possess. But you do not need to be an expert in cryptography to perform this task. You can look for signs of soundness.
Of course, ideally you should read the entire whitepaper(s), understand the technologies, and analyze whether it is feasible or innovative. But being realistic, what you’re really going to do is look for signs.
You will look superficially at the whitepaper and evaluate its structure. For example, you can read the introduction, the subtopic titles, see if it is written with scientific principles (using deductions, proofs, demonstrations, simulations, references), something that gives confidence and credibility.
More solid signs would be to have the whitepaper published in cryptography congresses, reviewed by independent experts, passed by peer-review.
If the paper is in Google Scholar or some scientific portal, you can check how many and which citations the paper has received. This also helps to show that more professionals and experts have analyzed or used the paper as a reference.
Another thing you can do even if you are not an expert is to compare the marketing claims with the technical materials. For example, if the project promises to do X, Y, and Z, are each of these aspects explained in detail in the technical materials?
Be wary of claims that are too bold. If a project claims it will be 100x faster than Ethereum, how exactly will this be done? Look for technical checks on the technologies used, whether there really is innovation or just empty marketing.
Part of this analysis of technical basis is complemented by the next question:
4) Who is the core team?
Every project starts with a core development team. In this case, having scientists, PhDs, researchers, is a sign of technical strength, a brain potential to realize the proposed objectives.
Having an academic team is positive, but professional experience is another pillar. For example: if a project aims to operate in the food logistics area, having professionals with experience in the field counts for a lot.
It is very common to have advisors. Don’t be impressed by them, because usually advisors are paid to appear on the team, to make it seem that the project has more credibility. If you really liked the presence of an advisor, evaluate the advisor’s real involvement, what his or her contributions are, see if he or she is enthusiastic about the project, if he or she believes in the cause, or if is just marketing.
Two more caveats are worth making. The first is that many times the project developers opt for anonymity, so you will have no way to know the technical staff better. There are also cases where a resume does not seem to impress, but the person is very intelligent. This there is no way to know initially.
The second caveat is that titles and resumes are no guarantee of competence, nor of commitment.
For these reasons, the team analysis is a very subjective parameter, but it should not be disregarded.
5) How active is the Github repository?
If the project is open source, you can check its repository. Look at the activity: how many commits are made per day, when was the last update, open some commits to evaluate if code has really been created or if updates are inflated.
Even if it doesn’t serve as a final conclusion (after all, volume doesn’t mean quality), generally enough activity on Github is a sign of work being done and productivity.
6) How engaged is the Community?
Moving away from the core team a bit, you should look at the community. It is fundamental that a cryptocurrency has a community that is passionate and engaged with the project. Search for forums, Discord, Telegram, and any official community interaction vehicles.
The closer the community is to the core team, the better.
A good community is not a group of people talking about the price of the token. It is people discussing technical aspects of the project, giving ideas, giving critiques, developing applications, or fostering adoption.
See if there are enough people doing this, for enough time. The longer a user is engaged interacting with the same project, the better. These are the enthusiasts.
If there are lots of real enthusiasts, not superficial ones talking about making money, that increases the chances of adoption, because everything starts with a community, it’s the starting point.
More people besides the core team need to believe and get involved with the cause. If this isn’t happening, it’s a sign that something is wrong.
7) Are there relevant partnerships?
Thinking about adoption, the ideal is to have case studies already happening in the project. This is usually achieved initially with partnerships.
For example, a platform with product tracking solutions might have a partnership with a coffee production company.
Other examples of partnerships can be technical, with other teams sharing knowledge.
Partnerships are very important and can make a lot of difference in the adoption of a project, but it is very easy to get it wrong. You need to know exactly what the involvement of the supposed partners is.
In fact, you first need to check if the partnership really exists. Many projects, for example, contract some service from Amazon and claim that Amazon is a technical partner. This is not a partnership.
Similarly, many projects pay companies to use their services, for marketing purposes. This is not a partnership either.
The best partnerships are organic, with advantages for both sides. To be a relevant partnership, there needs to be involvement, real and frequent participation. It is often difficult to find this information, so if you don’t, don’t add the supposed partnership as a positive point in your analysis.
8) What are the competitors and how does this project stand out?
Once you understand well the concept of the project, you can look for competitors, projects that propose to do something similar.
If there are other projects acting in the same area, you need to evaluate well how this one will get its space. Why would users prefer this project over another?
It is true that the crypto market is large and there is room for more than one player in each sector, but this does not change the fact that comparisons are important, not least because any person or company planning to choose a solution to use will evaluate, compare, and opt for one of them. Put yourself in that person’s shoes to decide who has the competitive advantage.
9) What are the network’s current fees and how does it intend to scale?
It’s time to evaluate the blockchain trilemma: security, decentralization, and scalability. Analyzing the technical soundness was a first step that helps signal whether the project is built with foundations in security, such as security to consensus attacks, spam attacks, among others.
Now you need to look at scalability, which is crucial for any project that aims to have mass adoption. If currently, with only a few users, the fees are already high or the network is already congested, this is a sign of weakness in this pillar.
See if there have been times in the past when a sudden increase in demand has generated congestion.
What are the prospects for change? Are there simulations of network load and stress? Does future scalability increase compromise security?
Note that the blockchain trilemma always needs to be considered together, and current scalability is possible to evaluate.
10) Is the project really decentralized?
Since we are talking about blockchain trilemma, decentralization is a sacred pillar, often overlooked.
I particularly consider this one of the most important topics. If a project is not decentralized, it should not be considered a cryptocurrency, but rather a private currency owned by a company.
The biggest differentiator of Bitcoin and what fostered the web3 revolution is precisely the concept of decentralization.
And decentralization should occur in all spheres: consensus protocol, nodes, and development team.
In other words, the ideal is that there are many independent validators in the consensus, many independent custodians of full nodes, and that development is not centralized in the hand of a closed team or company, but that it has some open contribution or contracting process that can be considered decentralized.
11) How is the Rich list/concentration of tokens?
Decentralization needs to be reflected in token holders as well. If a large portion of tokens are in the hands of a few people, they can manipulate the price, governance, or bring extra risk to the project.
12) How fair is the tokenomics?
Tokenomics is the token distribution curve. For example: 10% to the founding team, 20% as airdrops to the community, 40% to miners/validators, etc.
The structure of the tokenomics is key to financial decentralization and democratization. Ideally, founders should not take more than 5% of the supply, and there should be incentives for different types of players in the ecosystem.
13) What is the incentive for validators?
Speaking of incentive, the validators in the network usually play the most relevant security role, so it is important that they have the appropriate incentives.
14) What is the long-term sustainability?
A project needs to be sustainable in the long term. This involves salary/rewards for code developers, appropriate payments to network validators, etc.
So the question has a strong relationship with tokenomics, assessing whether it is possible to keep the project operating even in adverse market situations. For example, is there enough cash (treasury) to pay for the development for the next 5 years?
15) What is the current adoption of the project?
Many metrics help show the level of adoption (usage) of a protocol. Some examples are: total transaction volume, number of active wallets, TVL (Total Value Locked), number of dApps running, among others, depending on the scope of the project.
16) Is interoperability with other projects facilitated?
Because it is a very new market, there will probably be many cryptocurrencies that will one day be used massively.
Protocols that integrate easily have a good potential for adoption, since interoperability is a feature that adds value.
17) Is there a roadmap?
Roamap serves to show what the delivery goals of the project are. Even if there are no specific release dates, it is important that there is clarity about what the team is currently developing and what the future goals are.
18) Is there transparent communication?
In addition to being open source, it is important that there is clear communication between the creators of a cryptocurrency and the public. Posts with summaries about what has been done, open spaces for questions and various updates are fundamental.
19) What is the regulatory risk?
All cryptocurrencies have some risk in relation to government regulation, because there is always the possibility of some country changing its legislation in a favorable or unfavorable way.
But special care needs to be taken regarding cryptocurrencies that have gone through ICOs, especially in the United States where the SEC can fine or severely punish projects that have raised funds without formal authorization.
There are many cases of court battles that have ruined projects. Notifications can occur even many years after the ICO.
20) What extra rewards can I get?
Depending on the consensus protocol, there may be some incentive for holding. For example, Proof of Stake protocols remunerate those who delegate their coins (staking). This extra remuneration is a factor that can contribute positively to the allocation of a portfolio.
Final Thoughts and Practical Examples
Keep in mind that these questions are guides for you to follow, not a closed list. You can add extra information if you deem it appropriate.
Want to see some examples of in-depth cryptocurrency analysis? Check them out below:
