Crypto Just Tracks Macro Fundamentals

Many experienced business professors, analysts, and those who have attended business school sometimes wonder how to analyze crypto digital assets. Aside from negative impressions from high-profile implosions of entities in the crypto space like Three Arrows Capital, Terra/Luna, Celsius, and FTX/Alameda, they are at a loss on how to analyze and view these "digital assets." In fact, old-timers like Jamie Dimon of JP Morgan or Warren Buffett of Berkshire Hathaway simply dismiss these outright.

For those who come from a corporate stock analysis background, it becomes hard to analyze because they are looking 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 analysis factors that corporate stocks have. Although there are some metrics that are useful, let's take a look at them.

Those with a macroeconomic background usually love crypto. Crypto can essentially track macroeconomic fundamentals, so if they can predict what will happen to the economy, they can predict where crypto might go.The joke is that all you need to do is to listen to Jerome Powell and the Fed pronouncements and that can lead the way. Of course, it is a bit more sophisticated than that.

Crypto and tech stocks are what are known as "risk-on" assets. When there is a lot of excess money flowing around in the economy, people buy these hoping to get rich. But when interest rates rise and prices rise because of inflation, most money goes into paying higher rent, home mortgage payments, car loans, etc., which leaves little money for nice-to-have discretionary spending like iPhones—"risk-on" assets.

Crypto basically tracks liquidity (or excess money) in the markets. This is the thesis of many macroeconomists. If there is cheap debt (low interest rates) brought about by low inflation, then that augurs well for crypto. But since debt has long- and short-term cycles, crypto is also affected by that. When central bankers want to reduce liquidity, they normally raise rates. When they want to encourage economic activity, they lower rates and employ quantitative easing, which is buying bonds and securities from banks and other entities to get more money into the system.

The 2020 CARES Act pumped $2.2T of stimulus money into the economy and into the hands of ordinary people. It blew the US M2 money supply in circulation sky high, thus leading to inflation. This generated a lot of money for stocks and crypto which reached asset-bubble levels. The Fed finally popped this bubble when it started its interest rate hikes and began to tighten its balance sheet by selling off some of the assets it had accumulated in the past to try and reduce the money in circulation.

In general, if there is a lot of cheap debt and money floods the economy as measured with a high M2 money supply, crypto usually goes up. When the M2 supply that indicates liquidity is mopped up and dries up, less money goes into risk-on 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 just basically tracks macro fundamentals.

Regarding useful metrics for specific crypto tokens, one of these is the tokenomics of crypto itself. What is the ratio of tokens being sold to the public versus the actual number of tokens minted? Is it like Bitcoin capped to a hard number (like 21 million)? Or can the issuers mint tokens at will? The problem is if only a small percentage of tokens are actually released to the public, the proponents can easily become whales who manipulate the price movements, dumping tokens at will.

Another metric that is useful is Total Market Cap divided by Total Value Locked. Total market cap 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 it counts all the tokens out there including those not yet 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, then that generally implies that the token is overvalued, because the TVL is small. One can compare the TMC/TVL ratio to the P/E ratio in stocks, though these are slightly different.

Similar to stocks, there is also the Relative Strength Index (RSI) from 0 to 100 that measures if a token is over or undersold. If it is oversold (an RSI above 70), that means that the market is oversaturated with a particular token and might dump. If it is undersold (an RSI below 40), there might possibly be an upward movement in price, but there is no guarantee of that.

Finally, there is the Stock to Flow model being used by a former Dutch fund manager with a background in quantitative finance whose pseudonym is Plan B. Stock to Flow, shortened as S2F, gives a valuation based on scarcity similar to how we value gold. S2F divides the stock (amount available) over the flow (usage or consumption).

According to Plan B, the flow cannot be increased and is constant but the stock numerator gets depleted over time because the peak supply when it started is fixed at 21 million Bitcoin. Unlike gold, where you can discover a new gold mine and thus increase the stock, in Bitcoin it remains fixed. Thus the exponential rise 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 does not follow the normal analysis methods for corporate shares does not mean that it is not an asset that cannot stand on its own.

The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.