One of the major issues hindering the mass adoption of cryptocurrencies is the lack of fundamental analysis that exists in traditional markets like the stock market. It is hard to do any form of analysis on cryptocurrencies without having significant knowledge of blockchain and technical analysis. The majority of retail investors in the cryptocurrency market have little to no knowledge of the value of what they are investing in. They are only investing in cryptocurrencies based on recommendations from individuals such as myself.
Three questions I am frequently asked are:
- “Which coin can I buy today?”
- “Is it the right time to enter the market?”
- “How can I analyze cryptocurrencies?”
So far, the most dominant form of analysis in cryptocurrency trading/investing is the study of price action called technical analysis. However, by utilizing the wealth of information provided by public blockchains such as Bitcoin and Ethereum, we get a unique perspective that has never been seen before in traditional assets and one which can complement other analyses.
Although there is no straight path to doing cryptocurrency analysis, I would say, because blockchain operates as a public digital ledger of transactions that is duplicated and distributed across the entire network of computer systems on the blockchain, it has created a new form of analysis that never existed before, even in traditional markets. These new forms of analysis are called “On-Chain Analysis.”
On-chain analysis (or blockchain analysis) is an emerging field that examines the fundamental factors of cryptocurrencies to improve investment and trading decisions.
How is this possible, you may ask; well, cryptocurrencies are the first asset class that can record and extract investor activity from massive data sets through each cryptocurrency asset’s public ledger, which captures every on-chain action that has taken place.
Since blockchains are praised for being a treasure trove of open, incorruptible financial data, we can pinpoint measures of economic activity in these networks. This allows for the collection and study of this data which we can use to measure sentiment and investor behaviour.
On-chain analysis is a fundamentals-driven approach rather than one based on hype, sentiment, technical analysis or word of mouth from others. This type of analysis can focus exclusively on one crypto-asset by looking at historical trends or it can be used to compare different crypto-assets to identify undervalued/overvalued coins.
On-chain analysis can trace its history to 2011 when “coin days destroyed” was created as a valuation metric for Bitcoin and was the first indicator to use the age of Bitcoin addresses.
In the summer of 2017, CoinMetrics’ Chris Burniske and Jack Tatar created the Network Value to Transaction (NVT) ratio, which was used to determine the utility value of a cryptocurrency, specifically how much the market was willing to pay for the transactional utility of the blockchain.
Another on-chain metric soon emerged from the dissatisfaction with simplistic measures from technical analysis (such as price/volume) and other concepts borrowed from traditional markets, such as market capitalization. Because of the weakness with market capitalization and the pitfalls of applying traditional metrics bluntly to cryptocurrencies, a new set of tools have been developed that can help traders to more accurately and precisely assess the worth of cryptocurrencies. This led to the creation of on-chain metrics, such as realized capitalization, HODL waves and percentage of supply in profit/loss.
Top on-chain metrics to be considered before investing
Two important on-chain metrics to be considered before trading/investing are:
- The number of active addresses
- The number of transactions
These on-chain metrics are indicators for the demand and usage of a blockchain network. For example, when the number of active addresses and transactions rise sharply, investors can predict that a price rise is expected.
Asides from these two, we have several other metrics which are:
This helps to know the participation of long-term investors. It helps to indicate an overheated market and a market with heavy reliance on short-term speculation. When used with the market capitalization metric, it helps traders find optimal zones to buy and sell.
Length of time an address has not moved Bitcoins
This uses a UTXO set by aggregating these sets to see how many investors are holding Bitcoin. An increase in the number of investors holding would mean that the circulating supply is lower, which should ultimately increase the price if demand is constant. It also points to confidence in the asset’s future performance.
Where to find on-chain analytics
Many sites offer on-chain analyses, Nairametrics recommends Glassnode. You can access basic on-chain metrics for free but some indicators have a time lag under the free membership. You have to pay for advanced indicators and high-frequency time series data.
Other sites include IntoTheBlock, Look Into Bitcoin, CoinMetrics, Santiment/Sanbase and CQ.Live.
Despite the promise that on-chain analysis brings, it is still in its development stage, and given the limited back history of data, the use of the metrics may evolve over time, or new trends may be highlighted that lead to the creation of new metrics as the industry matures.
The major limitation of on-chain analysis is the fact that not all blockchains are made equal. For example, Bitcoin is focused on being a digital gold while Ethereum’s blockchain is used for a wider range of activities including the support of applications called smart contracts. Because of the disparity in blockchains, different interpretations can be deduced from a particular metric when performing analysis on both cryptocurrencies, which makes the process of analysis a bit confusing.
Another limitation is that when comparing Bitcoin with other newer altcoins, Bitcoin has over a decade of data to back historical analysis, while the newer altcoins have fewer data. This means some metrics may become less reliable or their interpretation may change because newer altcoins have very limited data.
Finally, on-chain analysis may not be an advisable tool for short-term traders because these metrics usually produce actionable signals for longer-term market cycles.