What is on-chain analysis

If you are familiar with the blockchain technology and public ledgers, you know that in this world, everything is transparent. The data recorded on the blockchain can be viewed and traced by everyone. This data includes the transactions, the number of coins being transferred, the addresses from/to which the transactions have been made, the time of the transaction, etc. All this data extracted from blockchains is called “on-chain data”, and the analysis made based on it is called “on-chain analysis”.

The on-chain data is a valuable tool for predicting the market trend and making correct decisions. Professional traders and investors frequently make use of this tool. In this article, we are going to explain the concept of on-chain analysis and introduce some of its best metrics. Stay with us.

What is on-chain analysis and how can it help traders/investors?

Cryptocurrencies are among the first assets whose users’ activities are recorded and announced publicly. Analyzing these activities can let you understand if other users are holding their coins, if they are sending them to exchanges to sell them, if demand is increasing supply or vice versa, and what sentiments they have in general.

Two main applications of on-chain analysis are “studying investors’ behaviors”, and “predicting the future trend of the market”. We will elaborate more on these two use cases in the next sections.

Studying investors’ behaviors

Using on-chain analysis, you can investigate different addresses and check the time duration they have held their cryptocurrencies. If the number of users who have held their cryptocurrencies increases, this means that the demand for that specific cryptocurrency is high, and the price won’t decrease (at least in the near future). On the other side, if the number of addresses that are sending their cryptocurrencies to exchanges increases, this means that the supply is going to increase and the price is likely to decrease.

Predicting the future trend of the market

As we mentioned in the previous part, studying investors’ behaviors finally leads to predicting the future trend of the market. Imagine a cryptocurrency like Bitcoin faces some bad news that threatens its value. In this situation, investors start selling their bitcoins to preserve the value of their investments and prevent more losses. This rush for selling bitcoins increases the supply of this cryptocurrency in the market, and decreases the price even more. So, you can predict that a bearish market is about to happen.

Important metrics in on-chain analysis

What we explained up to here was a general explanation of on-chain analysis and its applications. On-chain analysis has advanced in the recent years and new metrics have been extracted from it. Relying on one metric is never completely safe, but using a combination of different metrics can expand your vision and help you a lot. Some of the most important on-chain analysis metrics include:

Unrealized profit and loss

“Unrealized profit and loss” is calculated by subtracting the realized price from the market price. If the market has a bullish trend, this metric is interpreted as below:

Giving up – hope – optimism – greed – satisfaction

If the market has a bearish trend, this metric is interpreted as below:

Satisfaction – greed – optimism – hope – giving up

The MVRV ratio

To calculate this metric, first the realized market cap should be calculated. For example, the price of each bitcoin when it was last transferred is determined. Then all these prices are summed up and the average price is calculated. This average is multiplied by the total number of coins in circulation, and the amount is compared with the market cap. In long term, this metric gives us an effective vision of bitcoin’s value. If this number is more than 7, it means that bitcoin is overvalued, and it is a good time to sell. If it is less than 1, it means that bitcoin is undervalued, and it is a good time to buy.

The Puell Multiple or PM

At some times, the value of newly-mined bitcoins is significantly more or less than bitcoin’s historical value. Finding this time period is very useful for investors, and it is done through the Puell Multiple. The Puell Multiple is calculated by dividing the total value of newly-mined bitcoins in each day by the one-year moving average (MA). So, the formula of the PM is as follows:

PM = the total value of newly-mined bitcoins in each day / the 365-day moving average (MA)

The Puell Multiple has a green and a red area. If this multiple enters the green area, bitcoin is undervalued, and it’s a good time to buy. If it enters the red area, it is overvalued, and it’s a good time to sell.

You can see the Puell Multiple’s red and green areas in the image bellow:

The reserve risk metric

The reserve risk metric is another useful on-chain metric. When both the price and the reserve risk metric are low, it’s a good time to enter the market. When the price and the reserve risk metric are both high, you’d better not enter the market.

On-chain analysis sources

The good news is that you don’t need to calculate these metrics personally, and several websites and platforms exist that do this for you. As the final section, we will introduce and go through some of these websites:

  • Coinmetrics: a website that provides its users with the on-chain data of 37 different cryptocurrencies
  • LookIntoBitcoin: a free source that visualizes different market cycles and on-chain data
  • Glassnode: a platform with useful, simpler metrics at the free level, and more advanced metrics at the premium level
  • Santiment: a collection of on-chain data and visualizations with both free and premium accounts
  • CryptoQuant: a connection of useful metrics for Bitcoin, Ethereum, and stablecoins.

Conclusion

There are a number of metrics in on-chain analysis that you can use to analyze the market. However, to use these metrics most efficiently, you have to increase your knowledge as much as you can, and have a good technical and fundamental perception.

On-chain analysis is an appropriate tool for long-term investors that want to buy low and sell high. Have you ever used on-chain analysis? Which on-chain metric or platform do you find most useful? Share your opinions with us.