Five on-chain indicators investors should follow: chain analysis

Analyzing cryptocurrency markets may seem easier than traditional markets because blockchain technology has more built-in transparency, allowing anyone to analyze and audit on-chain data.

At the same time, however, there are challenges in tapping into forward-looking figures that provide insight into current and future price trends. Philip Gradwell, chief economist at blockchain intelligence firm Chainalysis, joined CoinDesk earlier this week to discuss the five must-track on-chain indicators for all traders.

“The first indicator I look at every day is exchange inflows,” Gradwell said.

Investors usually transfer coins from their wallets to exchanges when they want to liquidate their holdings and hold their holdings directly when they have a bullish view on the cryptocurrency.

An increase in inflows in a rising market can be seen as a sign that investors lack confidence in the uptrend. “When you see big inflows, it’s time to be careful,” Gradwell added.

Nevertheless, inflow does not imply immediate liquidation. Investors can keep their coins on exchange as much time as they want.

“Historically, coins have been liquidated with a delay of 12 to 36 hours,” Gradwell said, adding that during the March crash there was panic selling.

So this indicator is only one piece of the puzzle because we don’t know when the transferred coins will be sold. What’s more, an increase in inflows or selling pressure is often accompanied by equal or more significant buying pressure.

To determine the impact of currency inflows on the supply side, investors should monitor the demand side using the “trading intensity” metric, which measures the number of times an inflowing coin is traded.

“It tells us how many people are willing to buy bitcoins that are sent to exchanges,” Gradwell said. An increase in trading intensity shows that buyers are outweighing sellers and is a sign of trend strength.

Bitcoin jumped more than 7% to 15-month highs above $12,300 on Wednesday. Amid the price surge, cryptocurrency exchanges tracked by blockchain intelligence firm Chainalysis received a total of 106,519 BTC on Wednesday, the highest daily inflow since October 2.

However, the increase in inflows failed to put a brake on the price increase because demand was strong. Bitcoin’s trading intensity jumped to a two-month high of 5.8, more than double the 90-day average.

While exchange inflows and trading intensity help measure short-term market conditions, the remaining three indicators are more about long-term trends.

Investors can buy cryptocurrencies with fiat currencies like the US dollar or use dollar-backed stablecoins like binder to fund purchases.

Crypto-to-fiat exchanges facilitate the exchange of dollars for cryptocurrencies, while crypto-to-crypto exchanges use stablecoins as a gateway to crypto trading.

Investors can determine whether the market is driven by fiat buyers (such as institutions) or binding traders by keeping track of the net flows between these two types of exchanges.

Net flows from crypto-to-fiat exchanges to crypto-to-crypto exchanges indicate that the market is dominated by stablecoin traders. In this scenario, a rise in the issuance of the stablecoin can be considered a leading indicator of an impending price rally.

However, this is not set in stone either. Since March, crypto-to-fiat exchanges have received 206,000 BTC from crypto-to-crypto exchanges, according to Chainalysis. “This suggests that fiat buyers have primarily driven the market,” Gradwell noted, adding that the data confirms the bullish narrative of rising institutional participation in the top cryptocurrency.

Investors can gauge the hodling sentiment in the market by keeping track of the number of liquid and illiquid entities – groups of addresses controlled by the same participants in a network. Chainlist identifies entities by analyzing blockchain transaction patterns to identify which addresses are controlled by a single person or business. This gives a more accurate picture of what is going on, as the data better reflects the actual holdings and transfers between people and business, reducing the noise of internal movements of cryptocurrency.

Liquidity is the average ratio of net to gross flows of an entity’s assets over the entity’s lifetime, across all addresses controlled by the entity. Chainalysis defines a liquid entity as one that sends on average at least 25% of the assets it receives, while an illiquid entity is one that sends less than 25% of its received assets.

Essentially, an illiquid entity is one that appears to believe in the cryptocurrency’s long-term prospects and is hoarding coins. This has a weakening effect on selling pressure in the market. For this reason, a sustained rise in the number of illiquid entities is a sign of strong hodling sentiment and a bullish indicator.

The chart above shows the liquidity of bitcoin has fallen to the lowest level since mid-2017. Bitcoin’s meteoric rise from $5,000 to $20,000 that happened in the last quarter of that year.

The amount of illiquid bitcoin has also risen sharply. “It’s increased at a greater rate this year than it did before. So you have more investors than ever before. But there’s also less bitcoin that’s liquid and available to buy than ever before,” Gradwell said.

This may be why bitcoin has held steady above $10,000 recently despite the BitMEX indictments, KuCoin hack, OKEx private key drama, US President Donald Trump’s health scare and a global stock market selloff.

Value transfer refers to the US dollar value of total units on a blockchain transferred on a given day. This essentially represents the use of the blockchain and is accompanied by an increase in the transaction count.

“When there’s a greater use of a cryptocurrency, there’s more demand, and that drives up the price,” Gradwell said.

Ether’s value transfer started to rise sharply in mid-July. A week later, the cryptocurrency saw a strong bid around $250 and rose to $470 by mid-August. Ether led the broader market higher in July and August, outperforming bitcoin by improving 53% and 26% respectively.

Until last year, bitcoin pretty much led the broader market in both bull and bear runs. Most investors would buy ether and other alternative cryptocurrencies during bitcoin’s bull run and sell those other cryptocurrencies when bitcoin was falling.

However, the dynamic has changed this year with the explosive growth of Ethereum-based decentralized finance protocols, making it essential for investors to track the on-chain activity of ether and other coins.

As crypto markets continue to grow and mature, the demand for deeper analysis of the chain is likely to increase. “With on-chain data, there is an amount of work that needs to be done first, to go from raw blockchain concepts like an address to a more meaningful economic concept like the flow to an exchange. But once that’s done, the user a meaningful data set to act on and make decisions,” said Gradwell.