Investing in Cryptocurrencies in 2024

As of May 14th, 2024, the total cryptocurrency market capitalisation has crossed $2.36 trillion of valuation, which is more than the US dollar currency in circulation.

Cryptocurrencies have seen various phases of boom and bust but this recent surge has drawn various eyeballs around its investment thesis. Even the US SEC has lately approved the Bitcoin ETF.

But why are people investing in cryptocurrencies even though they do not come with a sovereign backing. Let’s understand.

In 2012, the US dollar currency in circulation was around $1.12 trillion. However, it has reached over $2.34 trillion today. The central banks throw money (packages) at every problem and this was one of the reasons why we saw uncontrollable inflation in the US in the last few years after COVID relief packages were announced and interest rates were kept too low than they should’ve been.ry

While governments can print unlimited money, cryptos are designed with a fixed supply cap or a particular issuance model. The issuance of new coins depends on several factors market demand, competition, technology, and security.

Proponents of cryptos say that the scarcity aspect of cryptocurrencies acts as a hedge against inflation, as the capped supply of cryptocurrencies like bitcoins cannot be diluted by creating more coins.

They further add that cryptocurrencies are not tied to the economic policies of a single economy, which makes them potentially more stable as an investment instrument, as they are not affected by any economic crises that can lead to currency devaluation.

However, it is quite critical to mention that the volatile nature of cryptocurrencies can increase risks. Their potential as an inflation hedge and their scarcity make them an attractive option for investors who want to diversify their portfolios with assets that are not influenced by economic cycles and policies.

It is noteworthy to mention that one should not invest in cryptos without understanding the risks involved. Even if the arguments in favour of cryptos are correct, it is critical that one invests (if at all) only a very small fraction of their overall portfolio, say, in early single digit percentages, to take exposure to cryptos, due to the nascent stage of this asset class and the risks involved, especially deep correction risk that has been witnessed in the past.

One may score cryptocurrencies based on these four parameters:

Liquidity Analysis

The Amihud Liquidity Measure assesses cryptocurrency liquidity by calculating the inverse of the mean of the daily Amihud Ratio, indicating how easily a coin can be traded without significantly impacting its price. The Amihud Ratio is the daily return divided by the dollar volume.A lower Amihud Ratio signifies higher liquidity, making trading easy for investors to buy or sell the cryptocurrency without causing drastic changes in the price.

Valuation Metrics

Historical Network Value to Transactions Ratio

The historical NVT ratio evaluates whether a cryptocurrency is overvalued or under-valued compared to its historical performance. This ratio compares the market capitalisation of the cryptocurrency to its on-chain transaction volume, indicating whether it is overvalued or undervalued historically.A higher ratio indicates that the cryptocurrency is overvalued and a lower ratio suggests that the cryptocurrency is undervalued.

P/F Ratio

Analogous to the price-to-earnings (P/E) ratio used in equities, the price-to-fees (P/F) ratio assesses the valuation of cryptocurrencies based on the fees generated by their underlying protocols. A lower P/F ratio suggests undervaluation relative to fees and a higher ratio indicates overvaluation.

Market Activity

Total Exchange $ Volume

This metric evaluates the popularity and liquidity of a cryptocurrency exchange. It measures the total dollar value of trades on an exchange. A higher value reflects positively on the native token of the exchange where the trading activity takes place.

Circulating Supply

This metric helps us understand the liquidity and potential inflationary pressures of a cryptocurrency A lower circulating supply suggests scarcity and a higher supply suggests that the transaction demand is being met.

Adoption

Active Addresses

The number of active actresses helps gauge the adoption and usage of a cryptocurrency, reflecting the size of the active user base engaging with a block chain network. A higher number of active addresses indicates a larger community and wider acceptance.

Tokenholders

The number of tokenholders assesses the distribution and decentralisation of cryptocurrencies. A diverse and growing tokenholder base reflects healthy adoption levels and network decentralisation, contributing to blockchain resilience.

On-Chain Activity

Chain TVL

The Chain Total Value Locked (TVL) metric assesses blockchain activity and trustworthiness of a token by measuring total locked value across all protocols of that specific chain. It gives a comprehensive view of the total number of tokens staked in the blockchain environment. A higher Chain TVL indicates a more active and trusted ecosystem.

Protocol TVL

The Protocol TVL metric focuses on value locked within a specific protocol, combining the TVLs from all chains where the protocol operates. A high protocol TVL signifies that users have more confidence in the protocol’s security, interoperability, and adaptability across different blockchain ecosystems.