What Cryptocurrencies and Value Investing Have In Common

The word 'cryptocurrency' is a synonym for 'gambling' in the minds of many traditional stock market investors. It's definitely true that assets like Bitcoin and Ethereum are of a very speculative and volatile nature.

However, the steadily increasing market capitalization of cryptocurrency shows that the general trend is upwards. At the moment, the total market cap of all crypto assets combined sits at around $170 bln. That’s a twelve-fold increase from last year.

Value investing is a strategy where stocks are selected that trade at a discount to their intrinsic value. The actual value of a share is obviously impossible to estimate. Investors try to make an accurate guess by analyzing a company's financial reports.  Very often, value investors manage to profit after an asset has been battered by panic selling or other irrational situations.

Cryptocurrencies don't have balance sheets or an income statement, and their value can’t be properly evaluated. Nonetheless, some of the core principles of value investing can still be applied to this asset group.

Understand what you invest in

Rule number one in value investing is only to get involved in investments one understands. This also applies to cryptocurrencies. In the long-run, misinformed crypto investors will end up losing money. Random betting is simply not a viable investment strategy. Successful cryptocurrency investors are well-informed, closely monitor news that could impact their portfolio and are always looking for new opportunities.

Reacting to market irrationality

"The market capitalization of all cryptocurrencies combined is roughly one fourth of the value of Facebook. Keeping in mind that cryptocurrencies make up a whole industry, this number is extremely low."

Additionally, cryptocurrencies bring uneven wealth distribution to a new level, since the top 315 Bitcoin addresses own 25 percent of all circulating coins. The combination of a small market cap with an uneven distribution of wealth is part of the reason why cryptocurrencies are currently so volatile.

A large sell order from a single cryptocurrency holder can quickly cause a panic reaction from hundreds of smaller investors. Days where a reputable crypto asset tanks by 15 percent, seemingly for no reason, are normal.

Buying when there is blood on the streets is centuries old investment advice. This wisdom is as true in the cryptocurrency world as it is in the stock market. 'Buying the dips' can be a very effective investment strategy if the investor keeps a cool head.  

Fundamental analysis of cryptocurrencies

In fundamental analysis, value investors read through financial reports and research the market in order to try to predict the success of a company in the future. 

In the crypto world, there are no balance sheets to analyze. The value of a cryptocurrency is tied to its network effects, adoption and speculation on possible future applications.  These value-affecting factors can't be predicted accurately. However, cryptocurrency investors can get a rough idea in what direction a crypto asset is moving by checking its fundamentals.

"The most important fundamentals of a cryptocurrency are its white paper, community, current achievements and roadmap."

Value investors will find it impossible to estimate the intrinsic value of a cryptocurrency because its mechanics are completely different from the ones of a traditional business.

However, cryptocurrencies and value investing do have one thing in common: the mentality of the investor.