On-Chain Analysis

What is On-Chain Analysis?

On-chain analysis is the act of using publicly available information on blockchains to determine market sentiment.

The Long Definition

On-chain analysis is the act of analyzing publicly available blockchain data, like wallet balances and transaction data. The goal is to determine market sentiment in order to spot investment opportunities and make the right decisions.

Investors use specialized tools and platforms to conduct on-chain analysis. Popular examples of such tools are Nansen, Glassnode, and Dune Analytics.

On-Chain Analysis Explained

Cryptocurrencies have grown to become a popular investment instrument. Today, many people trade and invest in crypto with the hope of making a profit.

But as with all investments, in order to succeed, users need as much information as possible. They need data that gives them insights into the market. That way, they can more accurately predict price changes.

Fortunately, cryptocurrencies run on public blockchains. Each protocol contains a record of all transactions involving its native coins and tokens. Think of it as a ledger; since it’s public, this ledger can be viewed and analyzed by anyone.

This analysis is what constitutes on-chain analysis. Investors use it to determine important metrics, like user activity, transaction volume, and asset movement. They then use this information to determine the right buy and sell decisions.

On-Chain Analysis Tools

To make work easier, investors use tools that extract and process the data on their behalf. Examples include Nansen, IntoTheBlock, Dune, and Glassnode.

These should not be confused with blockchain explorers like EtherScan. Blockchain explorers allow you to view transactions, smart contracts, and wallet addresses. However, they don’t aggregate the data in a way that’s useful for trading or investing.

Therefore, traders prefer using the specialized platforms mentioned above. These provide insightful charts that break down the data into useful sections for investors.

Components of On-Chain Analysis

The specific components of on-chain analysis may vary from platform to platform. But generally, here are metrics you might expect to see:

Exchange Flow

Centralized exchanges provide a platform to exchange fiat currency for crypto and vice versa. The exchange flow metric looks at the movement of assets in and out of exchanges from non-custodial wallet addresses. Why is it important?

Generally, investors move a coin/token to and from exchanges depending on whether they want to hold or sell it. A large inflow of an asset into CEXs is often a sign of incoming selling pressure. Investors think the asset’s value has peaked. Therefore, they’re looking to cash in by selling it on exchanges.

On the other hand, a large outflow of a coin/token shows that investors are taking to self-custody. This can be a signal that they expect the asset to increase in value. Therefore, they intend to hold it.

Bitcoin Movements

Bitcoin (BTC) is the most popular cryptocurrency and the most valuable, with the largest market cap of any coin. As a result, BTC price movements tend to spill into the rest of the market.

For instance, if the price of BTC rises, the price of most other crypto assets also rises. If it falls, the same happens to other assets. Therefore, most investors closely monitor bitcoin’s price.

And it’s not just the price that’s worth looking at. Chain analysis tools check other metrics, like the mining difficulty, market cap, and the activity of whales.

Whale Activity

Whales are people who hold large amounts of crypto– usually in the millions of dollars. Since they have such large stakes, it’s assumed that they know more about the markets. Therefore, retail traders monitor them closely. When whales start selling, it’s a sign that investors should also sell.

This practice is known as whale watching. It is made possible thanks to chain analysis.

Smart Money

The term smart money refers to repeatedly profitable wallets. These are wallets that have consistently displayed high trading intelligence. It can also refer to wallets that belong to or are associated with major crypto institutions or funds.

Whatever the case, smart money wallets are believed to have a better understanding of the markets. They might even beat whales in this regard. Therefore, investors tend to imitate them.

Identifying smart money wallets is almost impossible without on-chain analysis tools.

Liquidity

Liquidity is an important metric for investors in decentralized finance (DeFi). This is because it shows how much value is locked in smart contracts in various DeFi protocols. Usually, protocols with the highest liquidity offer the best opportunities.

Movements in liquidity also hint at where the next opportunities will be.

Why is On-Chain Analysis Important?

On-chain analysis allows investors to make informed decisions. In crypto, using data is what separates investment from gambling.

Note that on-chain analysis tools don’t make decisions for you. Rather, they provide you with metrics. It is up to you to use these metrics to identify trends and make your own decisions.