Crypto only tracks macro fundamentals
Many experienced business professors, analysts and those who have attended business school sometimes wonder how to analyze digital crypto assets. Apart from negative impressions from high-profile implosions of entities in the crypto space such as Three Arrows Capital, Terra/Luna, Celsius and FTX/Alameda, they can afford to analyze and see these “digital assets”. In fact, old-timers like Jamie Dimon of JP Morgan or Warren Buffett of Berkshire Hathaway simply reject these.
For those coming from a corporate equity analysis background, it becomes difficult to analyze because they look for discounted cash flows, earnings per share, price-to-earnings ratios and the like. What they fail to consider is that crypto is more of a commodity and has none of the typical analytical factors that corporate stocks have. Although there are some metrics that are useful, let’s take a look at them.
Those with a macroeconomics background usually love crypto. Crypto can essentially track macroeconomic reasons, so if they can predict what will happen to the economy, they can predict where crypto can go. The joke is that all you have to do is listen to Jerome Powell and the Fed statements and it can lead the way. Of course, it’s a bit more sophisticated than that.
Crypto and technology stocks are what are called “risk-on” assets. When there is a lot of excess money floating around in the economy, people buy it in the hope of getting rich. But when interest rates rise and prices rise due to inflation, most of that money goes to pay higher rents, mortgage payments, car loans, etc., leaving little money for discretionary spending like iPhones—”risk-on” assets.
Crypto basically tracks liquidity (or excess money) in the markets. This is the task of many macroeconomists. If there is cheap debt (low interest rates) caused by low inflation, then it bodes well for crypto. But since debt has long-term and short-term cycles, crypto is also affected by it. When central bankers want to reduce liquidity, they normally raise interest rates. When they want to encourage economic activity, they lower interest rates and use quantitative easing, which is buying bonds and securities from banks and other entities to get more money into the system.
The CARES Act of 2020 pumped $2.2T of stimulus money into the economy and into the hands of ordinary people. That blew the US M2 money supply in circulation sky high, thus leading to inflation. This generated a lot of money for stocks and cryptos that reached bubble levels. The Fed finally popped this bubble when it started its interest rate hikes and started tightening its balance sheet by selling off some of the assets it had accumulated earlier to try to reduce the money in circulation.
Generally, if there is a lot of cheap debt and money floods the economy as measured by a high M2 money supply, crypto usually goes up. As the M2 supply that indicates liquidity dries up and dries up, less money goes into risky assets like stocks and crypto. Tech stocks and crypto have been somewhat correlated in recent years, with crypto not burdened by disappointing earnings reports. It only tracks basic macro fundamentals.
In terms of useful metrics for specific crypto tokens, one of these is the tokenomics of the crypto itself. What is the ratio of tokens sold to the public to the actual number of tokens minted? Is it like Bitcoin limited to a hard number (like 21 million)? Or can issuers mint tokens at will? The problem is that if only a small percentage of tokens are actually released to the public, the advocates can easily become whales, manipulating the price movements and dumping tokens at will.
Another metric that is useful is Total Market Cap divided by Total Value Locked. Total market value is the spot price of one token in the market times the total number of available tokens. If it says fully diluted market cap, it means that it counts all the tokens out there, including those that have not yet been released to the public. Total Value Locked, on the other hand, refers to things like the amount of crypto staked, the number of transaction fees, and other indicators that crypto is actually being used and not just being speculated on. If the TMC/TVL ratio is large, it generally means that the token is overvalued, because TVL is small. One can compare the TMC/TVL ratio with the P/E ratio in stocks, although these are slightly different.
Like shares, there is also the Relative Strength Index (RSI) from 0 to 100 which measures whether a token is oversold or undersold. If it is oversold (an RSI above 70), it means that the market is oversaturated with a particular token and may dump. If it is undersold (an RSI below 40), there could possibly be an upward movement in price, but there is no guarantee of that.
Finally, there is the Stock to Flow model used by a former Dutch fund manager with a background in quantitative finance, whose pseudonym is Plan B. Stock to Flow, abbreviated to S2F, provides a valuation based on scarcity similar to how we value gold. S2F divides the stock (available amount) by the flow (use or consumption).
According to Plan B, the flow cannot be increased and is constant, but the stock counter is depleted over time because the peak supply when it started is set at 21 million Bitcoin. Unlike gold, where you can discover a new gold mine and thus increase your stock holding, it remains fixed in Bitcoin. Thus the exponential increase in prices.
Crypto is here to stay. There are other indicators that professional technical traders use that are beyond the scope of this article. Just because it doesn’t follow the usual methods of analysis for corporate stocks doesn’t mean it isn’t an asset that can’t stand on its own.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice regarding your specific situation.
