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CoinMarketCap, one of the leading providers of cryptocurrency price data, lists over nine thousand digital assets on its website. That’s a vast universe of potential investments compared with the largest US stocks index by market capitalisation for instance, which consists of 500 companies (according to the S&P 500 index).
Narrowing down which tokens deserve a spot in an investor’s portfolio is a challenge, given the relative ease with which new tokens can be issued, not to mention their varying quality. Investors need to make sure that they thoroughly research opportunities, especially when diverging from the largest assets by market cap.
A key part of this research is fundamental analysis, which assesses a security’s intrinsic value. In the mainstream markets, investors examine financial metrics like a company’s profitability, but the process can also be applied to digital assets.
Utility of Cryptocurrency Projects
Investors need to understand a project’s real-world applications, such as the problem it solves or how it disrupts an industry, to ensure that its native token has utility beyond speculative trading. To put this into perspective, let’s explore Uniswap and Chainlink, whose tokens back two of CoinShares’ Physical exchange-traded products (ETPs).
Launched in 2018 and built on Ethereum, Uniswap is the world’s largest decentralised exchange (DEX). It operates as an automated market maker (AMM), which means users trade with pools containing pairs of ERC20 tokens (the Ethereum standard). These pools are smart contracts which are programmed to process the trades. The benefit of the AMM model over centralised exchanges, which rely on order books (a list of buy and sell orders), is there’s no counterparty risk, the possibility that one party involved in a trade will fail to meet its obligations. In addition to trading, users can create new markets on Uniswap and earn passive income by providing liquidity to existing pools in return for rewards in the form of UNI, the platform’s native token.
Chainlink is an oracle, an entity which links blockchains to external data. Smart contracts work seamlessly when the inputs required to satisfy the conditions of the underlying agreement exist on the blockchain, such as settling a transaction between two digital wallets. However, to broaden their functionality, smart contracts need to respond to events that occur in the real world. If this data comes from a centralised source, it represents a potential single point of failure in terms of the data’s quality or reliability. Chainlink solved this problem by developing Decentralised Oracle Networks (DONs), which transmit data from multiple reliable sources. These DONs deliver price feeds for some of the biggest DEXs, while Chainlink has also partnered with the SWIFT payment network to allow banks to transfer tokens across different blockchains.
Tokenomics Analysis
Tokenomics is the study of how a project structures its native token, including the total supply and its distribution model, utility and governance. Investors should take tokenomics into account when analysing an opportunity because it’s the source of a token’s value.
As mentioned in the previous section, UNI is the native token of Uniswap. UNI is a governance token which holders can use to submit or vote on proposals suggesting changes or updates to the protocol. UNI holders also control the community treasury.
Uniswap minted one billion tokens in September 2020 which were divided between the community, the founding team, investors and advisers. The community’s portion was split among traders and liquidity providers and the project’s treasury, which distributes them over a four-year period and through various initiatives like contributor grants. The tokens allocated to the team, investors and advisors also vest over four years, ensuring the interests of all stakeholders align.
Chainlink’s native token goes by the ticker LINK. Its main utility is to incentivise node operators (the entities that run the infrastructure underpinning the DONs) who must provide LINK as collateral to participate in the ecosystem. They’re rewarded with additional LINK for fulfilling their obligations, while they lose tokens if they transmit inaccurate data. Holders can also stake LINK to enhance the security of the oracles, similar to validators in the Ethereum network.
LINK was issued through an initial coin offering, the crypto version of a company listing its shares on a stock exchange, in September 2017. Out of a total supply of one billion tokens:
35% were distributed via the ICO and a subsequent token sale
35% were allocated to node operators and for ecosystem rewards
The founding team received the remaining 30%
Team Expertise
Investors should assess the founding team’s expertise because it demonstrates their qualifications to effectively run a project and establishes credibility among the crypto community and backers such as venture capitalists. A track record of launching other successful projects also shows that the team has the necessary vision and leadership skills to drive a project forward.
Hayden Williams is the founder and chief executive of Uniswap Labs. Williams studied mechanical engineering in university before starting his career with the industrial manufacturer Siemens. In 2017, a friend suggested he explore the world of crypto, which led Williams to build an AMM inspired by a blog post published by Vitalik Buterin, the founder of Ethereum. This AMM became Uniswap and launched in 2018, supported by an Ethereum foundation grant.
Chainlink was founded in 2019 by chief executive Sergey Nazarov and chief technical officer Steve Ellis. Nazarov’s first exposure to crypto came in 2011 while working for a venture capital firm that specialized in backing early Web3 projects. He went on to launch two crypto startups with Ellis before Chainlink: Secure Asset Exchange (a DEX) and an oracle called SmartContract. Before teaming up with Nazarov, Ellis studied computer science at New York University and gained engineering experience at a software development consultancy.
Conclusion
Thousands of tokens have been issued by crypto projects of varying quality, so investors need to conduct thorough due diligence when considering which ones to add to their portfolio. Fundamental analysis is a key step in the research process, as it involves assessing a security’s intrinsic value. When applied to crypto, it should focus on three areas: the real-world application of the project that issues the token, the way the token is structured (known as tokenomics) and the expertise and track record of the project’s founding team.