On-chain analysis is a crucial aspect to successful cryptocurrency investing, and one that emerges from blockchain technology’s core properties.
Blockchains function using distributed ledger technology. With distributed ledgers, the network broadcasts every single transaction, and every node/participant in the network owns a complete record of all transactions. By broadcasting every transaction to a group of node operators/maintainers, the network possesses no single point of failure.
Bitcoin originally implemented this technology to solve the “double spend problem.” Bitcoin formed a chain of transactions with each block reliant on the prior block meaning malicious actors could not change a block’s contents without changing all the blocks prior, granting the Bitcoin’s ledger the feature of immutability.
This immutable, distributed ledger is auditable by every network participant as well as by outsiders, granting traders and investors unprecedented access to information – indeed, the ability to track every trade, deposit, and interaction by and between every entity – relative to traditional financial markets.
As a result, traders who properly leverage on-chain analysis have a significant advantage compared to regular traders.
What is On-Chain Analysis?
On-chain analysis examines blockchain transaction activity to understand how investors react to market forces/events and determine emerging trends/investor sentiment. In layman’s terms, on-chain analysis involves watching how money moves on the blockchain to help spot potential opportunities.
On-chain analysis remains extraordinarily popular because of the sheer quantity of data available to investors. This unique insight into market movement does not exist in traditional finance and allows investors to develop a more intimate relationship with an asset or market.
Two guides are attached for readers who want a fuller overview of on-chain analysis and its usefulness: Blockchain Analytics: The ultimate tool to understanding crypto & Using On-Chain Data to Get an Edge.
How Does it Work?
On-chain analysis consists of various metrics in relation to price action of a given digital asset.
One classic example is exchange flows. Centralized exchanges are the banks of the crypto ecosystem where investors can exchange fiat for digital assets. A large inflow of an asset onto an exchange often signals incoming sell pressure as investors look to lock in profits. Meanwhile, the inverse is also true: large outflows of an asset from an exchange signal that investors are taking self-custody of the asset and intend to hold it. Investors typically hold assets that they expect to climb in value, and by tracking these flows traders can gain insight into overall market sentiment.
Another popular example is often referred to as whale watching. More prominent or exceptionally large players, it can be safely assumed, know more about the markets than retail traders. When large wallets start selling crypto, typically, this is a good sign that investors should also be offloading. If an event happens and long-term holders continue to hold, chances are the current price action is nothing but short-term racket. But when these larger investors who have held for significant periods start to dump on the open market, investors should follow them toward the exit. You can find a complete guide to whale watching here.
When executed properly, on-chain analysis turns transaction data into actionable moves for investors. This data rests on blockchain explorers, and on-chain analytics companies such as Nansen incorporate and present massive quantities of this data, combine it with millions of labeled wallets, and deliver visualized market insights to investors.
Popular Blockchains for On-Chain Analysis?
Perhaps the most popular blockchain for on-chain analysis is Ethereum, the home of the majority of DeFi’s Total Value Locked (TVL).
The growth of DeFi and the proliferation of wallet labeling have opened up fresh horizons for on-chain analysis as a new field of study; Nansen is a pioneer in this emerging discipline. Through analyzing capital flows between smart contracts in DeFi, fund movements between sovereign blockchains, and observing how individual market participants engage in the environment, Nansen seeks to map out DeFi and economic activity on-chain at a hyper-granular level and help investors make better, more informed, investment decisions.
What Can Crypto Traders Learn From On-Chain Analysis
Beginning with a more macro perspective, tracking wallet activity shows how many agents engage with a particular blockchain. This is especially helpful for understanding layer one blockchains. Every transaction on a layer one blockchain requires the native token to purchase block space, and therefore an increasing number of transactions and daily active addresses means more economic activity – hence, greater demand for the native token. This simple metric can help drive prices for native layer one tokens much higher.
Wallet activity also helps determine the fundamental strength of narratives. As an example, in recent months a sizeable movement has been growing around airdrops on Twitter, specifically Arbitrum. A look at the daily transactions on the blockchain, specifically the recent spike, shows investors are keen to claim this airdrop, and the data backs up the rumor.
Another common question for on-chain analysts is, where is all the liquidity? Currently, the largest liquidity pools ranked by total volume locked show a clear trend, and readers will quickly notice the prevalence of stablecoins, ultimately hinting at a risk-off sentiment in the market.
Staked ETH paired with ETH represents the third largest pool. Recently Ethereum has provided investors with many earning opportunities since the Merge and the implementation of Proof of Stake (PoS). Staked ETH and ETH paired form a great LP token as both assets behave similarly, reducing the risk of impermanent loss. You can find a more detailed explanation of impermanent loss here: The Complete Guide to Liquidity Mining.
A look at single-sided staking, meanwhile shows PancakeSwap’s CAKE pool at the top by a significant berth due to the attractive yield offered. Additionally, investors who stake CAKE receive yield boosts on PancakeSwap’s core farms. Again, stablecoins remain prolific, with Stargate, the cross-chain bridge protocol dominating the list due to its lucrative yields.
The graph above features cross-chain DeFi liquidity pools ranked by the number of Smart Money holders. Smart Money supplies liquidity primarily to ETH pools paired with other assets. PancakeSwap’s core CAKE-BNB can be seen, likely with boosted yields for smart money. The following section takes a closer look at Smart Money.
Tracking Smart Money is one of Nansen’s core features. Wallets receive the label smart money after displaying consistent trading/investing acumen, or due to their association with a major institution or fund. These wallets have been repeatedly profitable and belong to people who understand crypto markets better than most. Imitation is a crucial element in skill development; on-chain analytics allow investors to watch the best and, if desired, copy their every move.
Using Nansen, investors can see the largest token holdings of Smart Money, tracking inflows and outflows for all major assets.
Nansen also allows on-chain analysts to examine Smart Money holdings via the total positive change in a 30-day period. This allows investors to see where Smart Money allocates funds, outlining potential opportunities.
In recent months, Smart Money has been holding stablecoins. The percentage of stablecoin started to increase in April and has remained high since outlining an expectation of Smart Money for further capitulation.
Want to track which assets top-performing Smart Money addresses are buying in real-time? Sign up for a Nansen plan today!
Another key part of on-chain analysis is following the money: where money flows, profits often follow.
Nansen's Hot Contracts shows precisely this: the various smart contracts attracting the most liquidity in a selected time period. Investors can move in and out of these positions, and each contract attracting liquidity represents a great opportunity. Top of the list is GearBox staked ETH pool. At the time of writing, GearBox, a lending protocol allowing for leveraged farming, offers 6.87% on Staked ETH thanks to its liquidity mining program. On-chain analysis shows people are moving into this pool to soak up the early rewards.
While select contracts might be popular among investors, the same is true of entire layer-1s. When an ecosystem attracts liquidity, it bolsters the prices of all the assets within that ecosystem. Nansen's Bridge Builder shows where investors are moving their money and, therefore, where growth can be expected.
Useful Tools for On-Chain Analytics?
The tools employed by investors depend on the asset that interests them. For DeFi and NFTs, Nansen provides everything investors need to cut through the noise and make better decisions. Nansen provides a guide to all the tools investors can utilize: Best Blockchain Analytics Tools.
Are There Limitations to On-Chain Analysis?
On-chain analysis functions in the same way as any methodological approach. The more data available, the more substantial the conclusion. On-chain analysts have to be aware of this, and many metrics commonly applied now may be thrown out in the future with the addition of new data. Another core limitation of data would be its time window. On-chain analysis can often unsuitable for day traders and favors outlining trends instead of scalping opportunities.
Future of On-Chain Analysis?
On-chain analysis grows more dependable as the data set grows, and in Nansen’s case, the more accurately labeled wallets. In short, the more data available, the more reliable on-chain analysis will become. Due to its reliance on data sets, it represents a natural application for machine learning. Heading into the future, as increasingly large data sets become accessible, the proficiency of on-chain analysis will grow in tandem.
On-chain data remains an incredible tool for investors and one that is unique to blockchain and crypto assets. Thanks to the distributed ledger technology these systems are built upon, investors receive a bird’s eye view of how liquidity moves. This new age of transparency marks a distinct departure from traditional finance, and Nansen provides the toolkit to fully leverage this unprecedented data landscape.