What Is Bitcoin On-Chain Analysis?

on chain bitcoin analysis

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The bitcoin time chain is an open distributed ledger; anyone can access the data stored on the chain, preferably doing it directly by running a bitcoin full node or by using a third-party service like a block explorer service. While most of us tracking the bitcoin blockchain would only be interested in a few aspects, such as have our transactions have been confirmed. What is the current fee to perform an on-chain transaction? There are professional big data analysts spending hours combing through the data and creating models and graphs, and providing additional analysis.

On-chain analysis refers to methods of using information from a blockchain ledger to determine market sentiment or track user behaviour on a specific network, in this case, the bitcoin network. While on-chain data analytics exists for other chains, very few chains offer the affordable verifiability that bitcoin does and being the largest of these digital networks means most of the resources in on-chain analysis focus on bitcoin and bitcoin adjacent data.

Chain analysis not only looks at the “health” metrics of the chain but also looks at the use of the chain, which involves looking at transaction data and bitcoin wallet balances – two things that are useful when trying to decide whether sentiment is positive or negative and some may use these on-chain metrics as part of their thesis to invest or not.

After all, the chain is the source of truth, a source of information that cannot be corrupted and a database protected by encrypted energy.

What Is bitcoin on-chain analysis?

Big data, machine learning and data analysis have become a multi-billion dollar industry, and companies of all sizes leverage it to find opportunities within data sets and none more so than financial markets. The issue with big data is you need to have a constant flow of reliable information to feed your models and then adjust them accordingly.

While data integrity remains an issue for centralised services, The fact that bitcoin and it’s data are secured on a public blockchain makes it uniquely well suited for data science and machine learning, naturally birthing the field of on-chain analytics.

The study examines the fundamentals, utility, and transaction activity of bitcoin and blockchain data. In the field of on-chain data mining, Analysts try to improve their understanding of network movements by analysing various metrics. 

Some of the most common types of analysis include transaction volumes, block details, price correlation, transaction sizes, transaction fees, mempool clearing times, exchange inflows and outflows, user adoption, and more.

To give you an idea of the subsets of data chain analytics firms track and process, we’ll take a look at the most popular metrics and reports.

On-chain analysis to measure the network strength

The following metrics give investors and traders an overview of the network, including how secure it is, how much it is being used, and how its monetary policy is functioning.

These metrics are used to gauge the usage of the network and if that usage is growing, and by how much.

1. Active addresses

Active addresses show the number of active addresses on the network. While it doesn’t show exactly how many users there are on a network, it shows the number of addresses used by exchanges, miners, and individuals. Historically, active addresses have correlated with price. 

2. Transaction volume

Transaction volume represents the fiat (usually in US dollars) amount of a bitcoin exchanged between addresses.

3. Daily issuance

Daily issuance is the total amount of new coins that miners are awarded each day. This is a look at bitcoins monetary policy and if it is functioning correctly. Coupling daily issuance with the supply halving roughly every four years is all part of bitcoin’s promise to ensure a fixed supply of 21 million coins. 

4. Supply distribution

Supply distribution shows the percentage of coins held in addresses categorized by size. For example, addresses holding more than ten thousand bitcoin have decreased over the past few years, as compared addresses holding less than ten bitcoin have increased. While we start to see addresses with less than one bitcoin continue to grow faster than ever before.

5. Miner revenue

Miner revenue is the sum of newly mined bitcoin plus transaction fees. High revenues reflect a healthy network where miners are incentivised to protect the long-term interests of the network. Miner revenue can also be matched with current trading prices to give traders an idea of how profitable miners can be and if it’s worth investing in bitcoin mining stocks.

6. Hash rate

Hash rate measures the amount of processing power that miners generate to secure the network. Overall, the higher the hash rate, the more secure it is. 

On-chain analysis to see who’s buying and selling

While the on-chain indicators above represent the long-term health of the network, the following indicators are more reflective of the short to mid-term market action. Specifically focusing on how much is being held by miners, exchanges and individuals.

It also shows whether they’re in profit or are currently at a loss, telling traders and analysts the cost basis for entry into the market.

1. Cointime destroyed

Cointime destroyed is calculated by taking the number of coins transacted in a day and multiplying them by the time they were previously held. In essence, it shows us the turnover time of a cryptocurrency. An increase in coin time destroyed implies that holders are moving coins out of storage and taking profits.

2. Realised profits and losses

Realised profits and losses measure the dollar value of bitcoins sold at either a profit or loss. For example, if a coin was purchased for $10k and sold for $50k, that’s a $40k profit. 

3. Supply in profits and loss

Supply in profits and loss shows the number of coins currently in profit or loss compared to their last purchase price. In a growing market, more coins will be in profit than loss. 

4. Realised capitalisation

Realised capitalisation adds the most recent purchase price of every bitcoin in supply. Compare this to market capitalisation, the number of coins multiplied by the current price. When the realised cap is higher than the market cap, then the overall market is sitting in profit. 

5. Thermo capitalisation

Thermo capitalization is the dollar value of the cryptocurrency paid to miners for validating the network. Compared to the market cap, the decreasing thermo cap over time shows that the supply pressures from miners are declining and having less of an impact on the price. 

6. HODL waves

The term ‘hodl’ is an endearing and popular term for bitcoin investors who hold their coins for the long term rather than trading them. HODL waves illustrate the percentage of bitcoin that has been held for different periods, from less than one month to more than seven years. For example, the amount of coins held for more than seven years has grown considerably, showing that ‘hodlers’ are controlling a growing portion of the network. 

On-chain metrics to evaluate price

Those who plan to trade bitcoin frequently use on-chain analysis to gauge the market’s sentiment. They want to know exactly what’s happening via the chain and centralised exchange markets. Comparing the flow of funds on the chain and that into the wallets of exchanges, certain traders can determine if it’s a good time to be aggressive or cautious and allocate to positions accordingly.

Reviewing metrics for trading following ratios can help give you an idea of the short-term trends in the market. 

1. Market Value to Realized Value (MVRV)

Market Value to Realized Value (MVRV) is the ratio between market capitalisation and realised capitalisation. For example, a high MVRV for bitcoin has historically signalled that its price was near a local maximum. In contrast, a low ratio has indicated that the price is near a local minimum.

2. Network Value to Transaction (NVT)

The Network Value to Transaction ratio compares the market cap to the transaction volume. It’s often compared to an approximation in the bitcoin space to the Price to Earnings ratio used in traditional finance. Ultimately, it aims to compare the fundamental value of the network to the current price.

A low NVT shows bearish sentiment, while a high NVT signals bullish sentiment. 

3. Stock-to-flow ratio

The stock-to-flow ratio is a model that gives a price prediction for bitcoin if its demand continues growing at the same pace. The S2F model doesn’t take into account any unknowns and merely tries to apply today’s demand extrapolated out into the future. The S2F model has been paraded as a gimmick to drive bullish sentiment because of the way it calculates potential price movements into the future.

4. Stablecoin Supply Ratio (SSR)

The Stablecoin Supply Ratio is the ratio between bitcoins supply and stablecoin supply. Essentially, it shows the short-term bitcoin buying power and if capital is trending towards exiting to fiat or towards bitcoin in the short term. 

Which companies do chain analysis?

According to Blockdata, there are over 100 chain analysis and research firms in operation, some specialising in bitcoin, while others tend to include other blockchain networks. Some chain analysis firms offer B2C packages with many of these on-chain analytics platforms are either free or at least offer plenty of free features. While the vast majority of them are focused on B2B customers, like exchanges, financial institutions, online media publications and even governments who require this data either for compliance or research purposes.

Some of the popular ones include:

Chain analysis of your privacy

Although Bitcoin is initially pseudonymous by design, these chain analysis firms dedicate so many resources and time to eroding this built-in privacy. Leveraging external data sources like exchanges, these firms can overlay additional metadata like personally identifiable information to label and track funds moving on the chain. Regulated exchanges, governments and chain analysis companies often work together to reduce the privacy of Bitcoin users.

KYC and AML compliance by custodians and exchanges provide this starting data. If the ownership of a specific UTXO is known, and once that UTXO is labelled, it can be flagged should it hit a centralised exchange? Additionally, coins labelled for illegal use or have gone through a mixing process might be rejected by centralised exchanges harming the fungibility of bitcoin.

Are you a bitcoin privacy advocate?

Did you know that your actions on the chain are being monitored by companies worldwide? Does that freak you out? What are you doing to ensure you remain private when using bitcoin? Are you using non-KYC bitcoin exchanges? Which app or privacy method is your favourite?

Do you have one you’d like us to cover? Let us know in the comments down below.

Sources:

  1. https://primexbt.com/
  2. https://www.cointree.com/

Disclaimer: This article should not be taken as, and is not intended to provide any investment advice. It is for educational and entertainment purposes only. As of the time posting, the writers may or may not have holdings in some of the coins or tokens they cover. Please conduct your own thorough research before investing in any cryptocurrency, as all investments contain risk. All opinions expressed in these articles are my own and are in no way a reflection of the opinions of The Bitcoin Manual

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