On-Chain Analysis 101: How to Use It to Make Sound Cryptocurrency Investing Choices
On-chain analysis is to cryptocurrency investing what fundamental analysis is to stock market investing. If both forms of analysis are flying right over your head, not to worry. Netcoins is proud to equip you, the progressive investor, with a basic overview of what on-chain analysis is and how you can use it to gain an edge in the crypto market.
Bitcoin: The Birth of Cryptocurrency and On-Chain Analysis
The Bitcoin blockchain launched in January of 2009. Ever since that day, all the transaction data the blockchain is creating was, is, and always will be public information. A site like blockchain.com is a pioneer in on-chain analysis, allowing every investor to view every transaction on the blockchain alongside interesting charts and graphics from the very beginning.
While blockchain.com continues to be a great resource for beginners today, on-chain analysis continues to evolve, both in terms of the metrics used in evaluating the value of the blockchain, and in terms of the tools available to investors who want to dive deeper into the numbers as a means of validating their own investing philosophies.
Below are some of the most popular on-chain measures investors use today.
Coin Days Destroyed
The first widely adopted on-chain metric to gain any traction is referred to as Coin Days Destroyed. It measures economic activity in a way that values coins that haven’t been spent in a long time over coins that are constantly being used for transactions. It’s an alternative to looking at straight up transaction volume that aims to more accurately value those transactions.
A ‘coin day’ simply represents each and every day that a coin sits on the same address and doesn’t move. Coin Days Destroyed represents the number of coins moving in a transaction and the number of coin days that have to be subtracted to accurately represent that.
Network Value to Transaction Ratio
Popularized by the founders of an analytics website called CoinMetrics (Chris Burniske and Jack Tatar) in the summer of 2017, is Network Value to Transaction Ratio (NVT). NVT ratio attempts to provide a valuation for the utility of a project’s blockchain. It defines how much investors in the market are willing to pay for access to the transactional utility of a given blockchain.
To calculate the NVT ratio, you have to multiply the price of the cryptocurrency by the adjusted supply available and then divide that number by the transaction value. The number you end up with is the blockchain equivalent of a price-to-sales ratio. It essentially defines how much the market is willing to pay for future value.
If you want to make your NVT calculation a bit more refined, you can use a 90-day moving average for transaction volume.
The stock market equivalent would be price-to-earnings ratio. A high ratio means you’re paying a high price in exchange for the profit potential that future earnings will provide. A low ratio means that you’re getting lots of value in return. As a bullish investor, you want to be on the lookout for low NVT and price to earnings ratios.
Market capitalization is perhaps the most beginner-friendly way to evaluate a cryptocurrency. Take the total number of coins in circulation and multiply it by the price of each coin to get the market capitalization.
Bitcoin and Ethereum have different circulating coin supplies and total coin supplies. That said, if you’re only multiplying the current supply in circulation by the price to get the market capitalization, you get a glimpse of the value of each project on equal footing regardless of how many tokens are circulating.
One measure of market capitalization you may not have used before is realized market capitalization. Realized market capitalization tries to account for lost coins. Lost coins can live on a Bitcoin wallet that no longer has an owner. Those coins would still count towards market capitalization because they are not circulating, but they also won’t be recovered. Therefore, the value of those missing coins is never going to be realized. Thus, those coins are not counted in realized market capitalization.
This measure is unique to cryptocurrencies. Market capitalization is used in the stock market, but there is no such thing as losing a share in a company. You either own it, or you sell it and make it available to the supply of outstanding shares for someone else to buy.
Net Unrealized Profit/Loss
Net Unrealized Profit and Loss (NUPL) measures how many Bitcoin addresses are in the profit and still holding onto their money bag. That’s why the term unrealized is included in the acronym. Think about it logically. If you’re holding onto Bitcoin having already earned a handsome profit, it’s obvious that you believe one of two things. Either you think the price still has room to run in the short term, or you’re a long-term HODLer who isn’t going to sell anytime soon.
Either way, when the NUPL of Bitcoin addresses reaches a really high level, it’s usually a sign that a bull run is about to end. Conversely, when NUPL is really low, it’s likely signalling the end of a bearish trend.
Two Key Fundamental Metrics for Day Traders and Short-Term Investors
Not all progressive investors are created equally. Many of you like to buy and hold and a lot of you like to trade and capitalize on short-term gains. For those in the latter group, the number of active addresses and the raw volume of transactions taking place on the blockchain are two key metrics you’ll want to follow. When the number of active addresses increases and the transaction volume also increases, it’s a bullish signal that the price is going up.
The present moment is a great example. At the time of this writing, we’re learning that Elon Musk, the founder of Tesla Motors, invested $1.5 billion USD of the company’s cash in Bitcoin. The news means that one Bitcoin is now worth over $56,000 Canadian. It also means the number of active addresses and the volume of transactions occurring on the Bitcoin network in the short term is going to skyrocket. Makes sense, right?
Tools You Can Use to Conduct On-chain Analysis on Bitcoin, Ethereum and Other Blockchains
There are many third-party tools you can use to dig deep into blockchain data and perform your own on-chain analysis. Before diving into that however, keep in mind there is one often overlooked tool you can use if you really want to get your hands dirty.
That first tool is a node. In other words, you can join the blockchain yourself and become a miner. This means you’ll be running a node directly connected to the blockchain. In order to do that, you need to download all the blockchain data. That makes sense after all because you’ll be adding to it.
While running a node, you’ll have access to all the data you need to do your own on-chain analysis. The catch of course is that you need to know enough to get involved in running that node and you need to be able to analyse data yourself without third-party tools. Otherwise this option is not for you. Let’s go to the more user-friendly options.
Given the founders of CoinMetrics invented the NVT ratio explained earlier in this post, you can bet the company’s blockchain analytics tools are top-notch. Benefit from accurate NVT calculations and many other ratios using their tools.
Messari and Glassnode
Messari and Glassnode are two competitors of CoinMetrics. You can do some analysis on all three tools for free, and you can pay for more functionality and features if you wish to dive deeper into what they have to offer. I personally have referenced charts from Glassnode many times here at Netcoins, as do many crypto influencers on Twitter and YouTube.
Messari is a great alternative and offers really nice visuals to go with the data.
LookIntoBitcoin offers really simple but really nice charts for you to look at for free. Easily study all kinds of fundamental and technical analysis metrics. If you want to go with the premium subscription, LookIntoBitcoin promises to send you alerts when technical indicators trigger. You also get access to a monthly newsletter, updated information related to fundamental ratios and the statistical significance of various activities occurring on-chain.
Using the above tools (even if you never opt to pay for the premium versions), you’ll be leaps and bounds ahead of the average progressive investor. Continue growing in your knowledge of the fundamentals and don’t be afraid to try your best to understand the data. It can tell you a lot if you know what to look for.
Buy Bitcoin with Netcoins
With Elon Musk pushing his company into Bitcoin in a big way and both fundamental and technical indicators proving time and time again that cryptocurrency is going to be a big part of our future, there’s no better time than right now to buy Bitcoin at Netcoins.
Netcoins is a cryptocurrency exchange in Vancouver that allows you to buy Bitcoin, Ethereum and a handful of other cryptocurrencies at fair market prices. Governments around the world are devaluing fiat currencies. That’s pushing more and more investors and publicly traded companies to hedge against that devaluation with decentralized currencies. The future is bright for the progressive investor.
Even Elon Musk is hedging now. Are you going to do the same?
Writer, content marketing at Netcoins.