“Risk is not inherent in an investment; it is always relative to the price paid. Uncertainty is not the same as risk….”
– Seth Klarman
Pursuant to Paragraph 6.2(h) and Schedule 1 of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission, licenced institutions are required to remind their clients:
“The prices of securities fluctuate, sometimes dramatically. The price of a security may move up or down, and may become valueless…”
In reality, much of such warnings is nothing more than white noises to the listener and does little to mitigate investment risk. This is why proper research and understanding of products is crucial.
Do Your Own Research | Common Crypto Analysis
When it comes to the question of how to make a profitable [crypto] investment, a lot of factors are important and is responsible for one’s results. There are three (3) common types of analysis commonly employed within the crypto ecosystem. Whilst a lot of traders would pivot that only one type matters (and therefore prevails over the others), reality is that they all matter to a certain degree.
Common Analytics 1: Technical Analysis
A technical analysis is the analysis of past price action of an asset. This usually take the form of performing analytics on price charts with a view to find discernible patterns (often from investor psychology). It should be stressed that:
- one cannot expect to make great investment decisions purely by looking at charts; and
- results may be bogus.
Common Analytics 2: Sentiment Analysis (AKA Sentiment & Fundamental Indicators)
Sentiment Analysis is the study of how the general population ‘feels’ about a certain stock or crypto. Market sentiment studies will often make reference to the overall attitude of investors toward a particular security or financial market.
As such, the foundation of the analysis is the feeling or tone of a market (AKA crowd psychology). Data can be extracted through the activity and price movement of the securities traded in that market. In broader terms, while rising prices will indicate bullish market sentiment, falling prices on the other hand will indicate a bearish market sentiment.
While feels cannot be measured per se, recent breakthrough in big data and artificial intelligence technology enables the use of various tools to gage internet activities and formulate a sentiment score.
As effective as the tool may sound, common shortcomings of sentiment analysis include:
- Data being easily manipulated;
- Data not reflective of long term trend in nature (diminishing in value over time); and
- Difficult to analyse and interpret.
Common Analytics 3: Fundamental Analysis
A fundamental analysis is the actual study of the composition of a particular crypto project. Such analysis includes the study of the following information (usually found within a project’s whitepaper): –
- team composition;
- track record;
- and specific project objectives.
The Default Tone | Always Play the Devil’s Advocate
It is always important to keep in mind that each action should have an objective in mind. The research of a crypto is no exception.
“Healthy scepticism is the basis of all accurate observations”
– Arthur Conan Doyle
One of the biggest issues faced by crypto-investors is the ‘fear of missing out’ (“FOMO”). To combat this phenomena, the goal of any crypto research should be to play the role of the Devil’s Advocate as, whilst it is easy to see an investment as investible, it will often take a lot more effort to make an investment look bad. As such, one should always look for drawbacks. Where a product still generates interest after spotting all drawbacks, then it may be investible.
Tokenomics is the study of the economy of a virtual asset. Data to Tokenomics of specific projects can usually be found on the project’s website or whitepaper. The first thing to find out about a token is whether it is an inflationary or deflationary asset.
- Inflationary assets are assets that can be created in perpetuity (e.g. USD or RMB where central banks can just print indefinitely). Inflationary assets decrease in value over time in absence of increasing demand.
- Deflationary assets are assets that will decrease over time (e.g., being burnt upon use). Example includes collector cards.
Many crypto assets are a mixed class. For example, Bitcoin at present is inflationary as more can be mined BUT will eventually be exhausted (at which point will become deflationary). Farm tokens are another form of highly inflationary assets.
Another dataset to look into is presale data. Tokens are oftentimes circulated presale via (i) private investors, (ii) early users (via airdrops) and (iii) miners. Depending on a project’s vision, it may influence price of the asset over time. Common issuing method includes Initial Coin Offerings, Premine, Presale and Algorithmic Issuance.
It is no understatement that the people behind a token is essential to the token’s future. Where a team comprise crypto-veterans, the likelihood of success of a new project increases owing to the strategic experience they bring to the table. On the contrary, lesser known developers may associate higher risk (e.g., as veterans have reputation risks to worry about).
Final Factor | Vision
Lastly, a project will only have value if it has a problem to solve. For example, Bitcoin is seen to have value as it endeavours to solve the issue of inflation. Ethereum on the other hand aim to solve issues with expensive and slow banks. Polkadot aims to become the internet of blockchain.
Ultimately, the goal of any token research should be to assess where an asset deserves to be. Therefore, always remember, before investing, do technical analysis and read the whitepapers.
This article was first published in the Hong Kong Lawyer, the official journal of The Law Society of Hong Kong.
This article is co-authored by Ohoon Kwon of Cha & Kwon.