Basic Valuation Principles for Cryptocurrencies

Two Basic Questions

How do you evaluate a cryptocurrency? This is a very important question. Before we even begin the discussion there is one thing that is important to understand, none of the cryptocurrencies out there are stocks from a legal point of view. They may look like stocks for the inexperienced investor but that’s an illusion. This market is nearly completely unregulated. There are no annual reports to study. Even more, the market is so volatile, simple looking at valuation isn’t enough.

Obviously, you can’t use classic fundamental analysis here like you can in the stock market. So what should you look at when studying a potential investment in this field? Where do you even start?

I suggest you start by asking yourself two basic questions:

  1. Is there a limited supply of this coin? There will never be more than 21 million Bitcoins. That’s an example of limited supply. But there are also coins that have no limited supply. The coin rate can be inflated forever. Don’t even think about investing in such a currency.
  2. Is there an unlimited demand for this coin? Does the coin solve a big enough problem that a lot of people have? If it does, then demand for it could become limitless. Now, obviously, it is not reasonable to expect a completely limitless demand for every coin worth investing in. You will want to pay close attention to the potential market size. Let’s say your crypto wins 5% of a $20 billion market. It will then be worth $1 billion.
valuation gamble
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Image credit: Marco Verch/Flickr

What Else?

If you believe you can answer yes to the two questions above you might be looking at a winner. You should then move forward and ask some additional questions.

What does the team look like? The founders must have the ability to win in the market long-term. What previous business experience do they have?

Is there any real use for the coin? Does the crypto really have a true purpose in the market or is it purely someone’s idea for making a quick buck? There are many stupid use cases out there. Please don’t be naïve. Look beyond the marketing. Look beyond the fancy words in the white paper.

Who are the backers? Do your homework and identify the major players in the market. The best investors got the ability to open doors and make things happen. This greatly increases the chances of success.

Are You Comfortable After Doing Your Homework?

So you have done your homework as well as you can. And every single one of the above question could be answered with a yes. It’s now up to you. If you’re comfortable with your findings then go ahead and invest.

Remember that in a market like this you should never invest more money than you can afford to lose. This might sound like a cliché but it’s true. In this market, you can actually make a lot of money with as little as $100.

You must also develop an “outcome neutral” mindset if you want to win in this game. The crypto market is very volatile. If you are going to lose money it should be because you made an analytical mistake, not because you sold in panic when the market dipped temporarily.

Disclaimer: The comments, views, opinions and any forecasts of future events reflect the opinion of the quoted author or speaker, do not necessarily reflect the views of BlockTelegraph or any affiliated entities, are not guarantees of future events, returns or results and are not intended to provide financial planning or investment advice.

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Hans Norén is a staff writer for Block Telegraph. He covers cryptocurrencies mainly from an investment perspective. Norén has been an active investor in the stock market for over 25 years. He is also the author of several books and eBooks about investing.

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