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Understanding On-Chain Analysis: A Comprehensive Guide

Last Updated March 4, 2024 3:01 PM
Andrew Kamsky
Last Updated March 4, 2024 3:01 PM

Key Takeaways

  • On-chain analysis involves studying blockchain data to gain insights into cryptocurrency networks and market trends.
  • Web platforms like LookIntoBitcoin and CryptoQuant provide valuable on-chain analysis tools and data.
  • Key on-chain analysis metrics include exchange reserves, transaction volume, and indicators like the Pi Cycle Top.
  • On-chain analysis benefits traders by offering trading signals, market timing insights, and risk management strategies.

A blockchain is designed to timestamp and securely store all recorded transactions on an immutable blockchain. Stakeholders such as investors, traders and miners, interpret the behavior of transactions made on the blockchain in various ways illustrated in charts. 

These charts offer insights into the current market cycle, provide on-chain market indicators and movements, keep track of address balances, offer mining data, and keep up to date with derivatives and information on the lightning network. 

What Is On-chain Analysis And Why Does It Matter?

On-chain analysis involves studying a blockchain, which is a publicly accessible ledger that records all transactions within a cryptocurrency network, such as Bitcoin and Ethereum. These transactions are considered verifiable and are openly viewable to anyone interested in tracking them.

Different kinds of data can be extracted out of the blockchain that makes on-chain analysis an important tool when forecasting price movement and market sentiment. Every Bitcoin transfer, no matter how small, leaves a trace on this ledger. On-chain analysis is the art of interpreting these movements to gain insights into Bitcoin’s network and its participants.

How Does On-Chain Analysis Work?

On-chain analysis relies on authenticated and documented blockchain data to anticipate trends and assess market sentiment. In essence, on-chain research entails observing the flow of funds within the blockchain to identify potential investment prospects.

By extracting the above information and illustrating the data in a 2D chart, investors, traders and miners can identify market trends that assist in predicting price movements in the short, medium, or long term. 

The primary advantage lies in the indisputable nature of the data that is being analyzed, as it is directly derived from the blockchain. Understanding on-chain data helps an individual decipher market trends, investor sentiment, and even potential price movements. 

Web Platforms That Provide On-Chain Analysis

To perform on-chain analysis, the right tools are required. There are various platforms and software that provide access to on-chain data. Some popular ones include:

  • LookIntoBitcoin: Provides live Bitcoin charts and information using market cycle and on-chain analysis. The user interface is fairly easy to understand and information offered is of a high standard updated daily. 
  • CryptoQuant: An analytics platform offering a wealth of data and metrics. Offering comprehensive data for crypto trading including market data, on-chain data, short/long-term indicators for Bitcoin, Ethereum, Stablecoins, and ERC-20 tokens.
  • Glassnode Studio: Delivers insights into blockchains and cryptocurrencies using curated dashboards and custom tools to explore blockchain on-chain data and metrics across the most popular assets and platforms.
  • Blockchain Explorer: Allows individual transactions to be inspected along with addresses, and blocks in real-time. Websites like Blockstream.info and Blockchain.com offer user-friendly interfaces for this purpose.

Key On-chain Analysis Data Worth Understanding

BTC: All Exchanges Reserve 

The total amount of Bitcoin reserves held on all exchanges is a measure of potential coins to sell on the market. This means the Exchange Reserve  is simply a collective measure of potential coins that are ready to be sold on exchanges. 

BTC: All Exchanges Reserve | Credit: Cryptoquant

Therefore, an increase in the All Exchanges Reserve on-chain indicator highlights the growing selling power of Bitcoin. A decrease in reserve occurs when a large number of bitcoins flow out of all exchanges, hence the price is likely to go up due to a sell-side liquidity crunch.

ETH: All Exchanges Reserve 

The same goes for all exchange reserves of Ethereum for predicting sell pressure. This means the Exchange Reserve  identified below is a collective measure of potential Ether coins that are ready to be sold on exchanges. 

ETH: All Exchanges Reserve | Credit: Cryptoquant

The increase in Exchanges Reserve  indicates growing sell power in Ethereum. A decrease in reserve occurs when a large number of Ethereum’s flow out of all exchanges, hence the price is likely to go up due to a sell-side liquidity crunch or coins becoming more scarce as more Ether gets locked away.

Transaction Count (Total) For Both BTC And ETH

Transaction Count (Total) BTC | Credit: Cryptoquant

This measures the total value of Bitcoin and Ethereum transacted on a given day. High transaction count  often signals increased market activity.

In public blockchain networks like Bitcoin and Ethereum, an uptick in transaction count can indicate that the network is functioning healthily and that there is demand for its services. It reflects the robustness of the blockchain’s infrastructure.

PI-Cycle Top Indicator

The Pi Cycle Top Indicator  serves as an extremely valuable tool for forecasting the peaks of Bitcoin’s market cycles, aiming to predict when the cryptocurrency’s price is likely to reach its all-time-high before undergoing a downturn. 

PI-Cycle Top Indicator | Credit: LookIntoBitcoin

It primarily operates on significant high time frames and has demonstrated a strong track record in identifying the highest points in Bitcoin’s major price movements over the years.

Bitcoin MVRV-Z Score

The MVRV Z-score , is a tool that helps spot when the market value significantly deviates from the realized value. 

Bitcoin MVRV-Z Score | Credit: LookIntoBitcoin

When the z-score registers a level between 7 to 9, it signals the peak of market cycles. Conversely, when the z-score registers a point at -0.10 or less it indicates that the market value is considerably lower than the realized value, which historically leads to substantial returns for those who bought Bitcoin during such periods.

Net Unrealised Profit/Loss (NUPL)

The NUPL reveals the current and past sentiments  among market participants at a specific point in time. 

Net Unrealised Profit/Loss (NUPL) | Credit: LookIntoBitcoin

It provides valuable insights for forecasting Bitcoin’s future price movements by identifying the level of sentiment at any given time. Historically the most lucrative times to sell are when the chart is entering the Euphoria / Greed mark. 

Bitcoin Network Hashrate

The hashrate reflects the computational power  securing the Bitcoin network. A rising hashrate indicates increased network security.

Bitcoin Network Hashrate | Credit: LookIntoBitcoin

The above chart signals the rate of mining which stands as a security measure for Bitcoin, as it signifies the extent of computational power engaged on the network. With higher levels of hashing power in operation, the network becomes increasingly resistant to potential attempts to overpower or undermine its security.

Wallet Balances

Analyzing wallet balances  can reveal accumulation or distribution patterns among investors. Large wallet movements can be indicative of market sentiment. 

Wallet Balances | Credit: LookIntoBitcoin

Wallet addresses can be used to understand whether adoption is increasing or decreasing generally for Bitcoin over time, and also whether usage is increasing or decreasing among specific cohorts.

On-chain Analysis Strategies

Here are some strategies to consider when using on-chain analysis to develop trading or investing strategies:

  • Long-term holding vs. active trading: By analyzing wallet balances and transaction patterns, you can decide whether you want to HODL for the long term or actively trade based on short-term trends.
  • Timing the market: Studying transaction volume and Pi-Cycle ratios can help you identify potential market tops and bottoms, aiding in strategic buying and selling.
  • Tracking institutional activity: Onchain analysis can reveal when big players, like institutions or whales, are moving large sums of Bitcoin. This information can guide your decisions by keeping track of the largest wallets by using the blockchain explorer.

On-chain Analysis Benefits

After understanding the advantages of on-chain data, the investor or trader will be empowered to utilize the analysis learned to improve financial choices. Here are the key advantages provided by on-chain analysis:

  • Trading signals: Metrics such as transaction volume, wallet balances, and network activity can help traders identify potential buy or sell opportunities based on historical patterns.
  • Market timing: Traders can better time their entry and exit points in the market. For example, monitoring the MVRV-Z score, Pi-Cycle ratio or transaction volume can help traders identify overbought or oversold conditions, improving the timing of their trades.
  • Risk management: Traders can use data on wallet movements and large transactions to assess the market’s overall sentiment and potential price volatility, allowing for more effective risk mitigation strategies.
  • Long-term investment insights: For long-term investors, on-chain analysis can provide insights into the health and adoption of a cryptocurrency. Metrics like active addresses and network growth can help investors see which projects hold long-term potential.
  • Identifying accumulation or distribution phases: Recognizing these patterns can help traders and investors make decisions about whether the market is in an accumulation phase (potentially indicating future price appreciation) or a distribution phase (potentially signaling a price decline).
  • Confirmation of fundamentals: If a blockchain-based project claims to have a high level of user activity but on-chain analysis shows low transaction volume, it may raise questions about the project’s legitimacy.
  • Technical analysis validation: Onchain analysis can complement traditional technical analysis by providing fundamental data to validate technical indicators. This synergy between technical and on-chain analysis can enhance the accuracy of trading decisions.
  • Trend confirmation: On-chain analysis can help traders confirm or challenge the trends they observe in price charts. If on-chain data aligns with price movements, it can provide traders with more confidence in their chosen trading strategies.

On-Chain Analysis Limitations

Onchain analysis is a valuable tool for gaining insights into a specific blockchain, but it has its limitations. Here are some of the key limitations when using on-chain analysis data:

  • Incomplete information: Onchain analysis relies solely on the data available on the blockchain. It doesn’t take into account external factors that can influence the market, such as news events, regulatory changes, or macroeconomic trends. 
  • Whale manipulation: Whales can use their influence to create false signals in the data.
  • Market depth: Onchain analysis typically focuses on historical data which may not provide insights into future price behavior. Some on-chain analysis might no longer be as accurate as it used to be in the past.
  • Network upgrades and forks: Onchain analysis may not account for network upgrades or forks that can fundamentally change the blockchain’s behavior. 
  • Small sample sizes: Some on-chain metrics, especially those related to rare events or specific patterns, may have small sample sizes, making it difficult to draw statistically significant conclusions.
  • Data manipulation: In some cases, bad actors may attempt to manipulate on-chain data by creating fake transactions or artificially inflating metrics. This can distort the analysis and lead to incorrect conclusions.

Conclusion

In summary, on-chain analysis is a helpful tool to gain insights into blockchain-based assets, like Bitcoin and Ethereum, by examining various forms of data. It offers advantages such as identifying trading signals and improving timing.

However, it has limitations, including a lack of consideration for external factors and potential data manipulation. To use it effectively, it should complement other analyses and be applied with a holistic market understanding. 

FAQs:

What is on-chain analysis and its significance? 

On-chain analysis is the study of blockchain data to understand cryptocurrency networks and trends, crucial for informed decision-making.

Where can I access on-chain analysis tools? 

Platforms like LookIntoBitcoin, CryptoQuant, Glassnode Studio, and Blockchain Explorers offer valuable on-chain analysis tools for Bitcoin, Ethereum and other cryptocurrencies.

What key metrics are used in on-chain analysis? 

Metrics like exchange reserves, transaction volume, Pi Cycle Top, and more benefit traders by providing insights into market behavior.

What are the limitations of on-chain analysis? 

On-chain analysis has limitations, including incomplete data, potential manipulation, and not accounting for external factors. It should complement other analyses for a holistic view.

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