On-chain transaction volume is the pulse of blockchain networks. For digital asset investors, monitoring these flows within the network and comparing them across protocols is a way to determine adoption rates and utility of the protocol, and determine whether a project is evolving further, or an outdated relic of the previous market cycle .
This perspective gives us valuable insights into user activity, network utility, and the overall health of the crypto ecosystem. An increase in transaction volume often indicates increased network usage, adoption and trading activity. This could indicate growing interest, new protocol utility, or even speculative zeal. Conversely, a decrease in on-chain transaction volumes may indicate reduced network development, protocol stagnation, or loss of market share to other competitors.
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Several factors drive blockchain trading volume, and understanding these nuances helps us navigate the ever-evolving crypto market cycle. During bullish phases, when the crypto market looks like a bullish feast of excess, trading volumes tend to rise. Positive news, such as regulatory clarity, institutional acceptance or significant protocol upgrades, can trigger increased trading activity.
Moreover, market sentiment plays a crucial role. Bullish sentiment often drives traders and investors to flock to decentralized exchanges, causing a surge in on-chain transactions. There, they tend to be more focused on trading newer innovative products such as NFTs and smaller token launches, which have a greater impact on chain activity than large tokens traded within centralized exchanges. This contributes to increased trading volumes during bullish cycles.
Conversely, during bearish periods, trading volumes begin to decline, with bursts of activity surrounding periods of deleveraging. Uncertainty, negative news, regulatory crackdowns or market corrections often lead to a decrease in trading. Investors can take a wait-and-see approach, resulting in reduced transaction volumes, and they can move their assets to cold storage or stablecoins, reducing overall trading activity on exchanges.
To better dig into the usefulness of on-chain transaction volume data, we use data provided by Sonarverse, which provides OnChain Trading Dollar Volume by protocol, and compare volume across Bitcoin, Ethereum and Polygon protocols.
To normalize the volume across these protocols, we divide the transaction volume by market capitalization of the protocol. (see Figure 1 below)
Figure 1: On-Chain Trading Volume / Market Cap, by protocol, 30d smoothed, Source: Sonarverse, CoinDesk Indices Research
Here we can see the relatively low and steady transaction volume of bitcoin, with Ethereum and Polygon having peak and relatively clearing activity, which makes sense since Polygon is an EVM-scale solution for Ethereum-based protocols.
To further highlight the investment benefits of this data, we perform a very simple backtest, where we rotate across Ethereum and Polygon protocols based on recent normalized volume activity in the chain with the simple rule that when normalized Polygon trading activity is greater than Ethereum, we rotate in Polygon, otherwise we hold Ether token (see Figure 2 below for hypothetical backtesting strategy).
The rotation strategy improves absolute and risk-adjusted returns over a crypto market cycle compared to separate allocations to Ether and Polygon tokens. This outperformance may be due to the information contained in the on-chain trading volume metric, which tilts the hypothetical strategy towards protocols with greater recent activity, and by association, greater blockchain protocol demand.
Figure 2: Ether / Polygon Rotation Strategy, Long Only. Source: Sonarverse, CoinDesk Indices Research
By understanding the dynamics of chain activity, we can better gauge market sentiment, and make more informed trading decisions by evaluating the underlying protocol health. During bullish phases, high trading volumes can indicate potential profit-taking opportunities or increased volatility. In bearish cycles, low volumes can indicate possible market bottoms or opportunities for accumulation.
Keeping an eye on on-chain transaction volumes and other blockchain metrics like TVL is like listening to the heartbeat of the crypto market, allowing investors to tune in to its twists and turns caused by industry developments. navigate.
Disclaimer for Uncirculars, with a Touch of Personality:
While we love diving into the exciting world of crypto here at Uncirculars, remember that this post, and all our content, is purely for your information and exploration. Think of it as your crypto compass, pointing you in the right direction to do your own research and make informed decisions.
No legal, tax, investment, or financial advice should be inferred from these pixels. We’re not fortune tellers or stockbrokers, just passionate crypto enthusiasts sharing our knowledge.
And just like that rollercoaster ride in your favorite DeFi protocol, past performance isn’t a guarantee of future thrills. The value of crypto assets can be as unpredictable as a moon landing, so buckle up and do your due diligence before taking the plunge.
Ultimately, any crypto adventure you embark on is yours alone. We’re just happy to be your crypto companion, cheering you on from the sidelines (and maybe sharing some snacks along the way). So research, explore, and remember, with a little knowledge and a lot of curiosity, you can navigate the crypto cosmos like a pro!
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