Commonly used market metrics when investing in crypto

Published on:

August 26, 2021

June 4, 2021

Have you ever wondered what sort of metrics one can use to gauge the general interest/sentiment levels in the crypto markets? Whether the market is overly bullish or bearish? Wondered why some influential traders on CT (crypto twitter) have recently spoken out about the importance of metrics levels?

In this article, we will take a look at some of the commonly used metrics in crypto and how they can be used to assess the interest/sentiment levels in the broader crypto market.

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(1) Funding Rates

If you have tried playing with leverage via perpetual contracts on exchanges before, you would have encountered a “funding rate” figure, usually at the top of the page.

Funding rates are periodic payments, shown as a percentage and usually quoted in eight-hourly rates, that are paid to either long or short traders based on the difference between the spot price and the perpetual contract market.

Nansen - Funding Rates
Funding rates tend to be shown in eight-hourly rates (Binance Futures)

Perpetual contracts (“Perp”) are a type of futures contract that do not have an expiry date (no settlement dates), making it similar to trading on a spot market - hence the term “perpetual”. Traders use these contracts to get leveraged exposure on a particular token as they would only need to put up a fraction of the total contract value as collateral.

Unlike traditional futures contracts where the futures price will eventually converge with the contract price at settlement, perpetual contracts utilize funding rates to ensure that the perpetual contract price and spot price converge on a regular basis.

Another simple way to understand funding rates is to visualize it as payments made to arbitrageurs to ensure that the perp price is tracking the underlying spot price (essentially paying for the difference between the two prices).    

When there is high volatility, the perp price may diverge from the underlying spot price. Depending on the direction and spread of the divergence, funding rates can either be positive or negative.

➕ A positive funding rate occurs when the perp price is higher than the spot price (a.k.a. contango) - participants are bullish and traders who are long will have to pay for short positions.

➖ A negative funding rate occurs when the perp price is below the spot price (a.k.a. backwardation) - participants are bearish and traders who are short will have to pay for long positions.

Funding rates generally comprise of two components: interest rate, and premium. Interest rates are generally fixed at 0.01% for each funding interval (usually every 8-hours), whilst the premium is dependent on the differential between the perp price and spot price (as described above).

As the interest rates are fixed at 0.01% per interval, 0.01% tends to be viewed as the “market-neutral” funding rate. When viewed through this lens, funding rates can be used as a yardstick to gauge how overheated or oversold a particular asset is.

And how do they correlate with market sentiments? Funding rates tend to move in-line with the general trend of the underlying asset, i.e. funding rates tend to be positive and increasingly elevated as the price of the underlying asset increases.

Nansen - Funding Rates
Chart of BTC’s price and the BTC Perp’s funding rate (Source)

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(2) Open interest (OI)

Another way to gauge interest in the crypto market is to look at a volume-based metric; for example, we can look at how many contracts are being traded in the market and so on.

Open interest is one of the more popular volume-based metrics - it accounts for the total amount of open positions (both long and short positions) held by market participants at any given point in time.

In other words, open interest is basically the sum of all opened trade positions (long and short) less trades that have been closed.

Why is open interest important? It is a general indicator of capital flows into markets - as more capital flows in, the amount of open interest increases, and vice versa. For this reason, it is also used as an indicator of market sentiments.

Because open interest includes both long and short open positions, a high value of open interest usually indicates increased volatility in prices. As such, when combined with price trends, open interest can be useful in determining market tops/bottoms.

For example, if an asset’s price is rising along with its open interest, it could indicate a bullish sentiment. On the flipside, if the price is rising but open interest is declining, it could mean that sentiment is bearish and there is less strength behind the price movement.

Nansen - Open interest trends
Potential interpretation of market sentiments using price and open interest trends
Exchange BTC open interest - chart taken from bybt.com
Exchange BTC open interest, chart taken from bybt.com (Source)

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(3) Stablecoin flows

If there is a market sell-off and investors are expecting the value of their crypto investment to decline, they may rotate into stablecoins as a safe haven, whilst giving them the quick flexibility of deploying capital back into the crypto market easily.

As such, it would be useful to also look at the general trend of stablecoins volume and activity, which you can do so through Nansen’s Stablecoin Master dashboard.  

For example, stablecoins daily on-chain volume had been on an uptrend leading up to the May 19th drawdown, and subsequently spiked on May 19th itself.

Nansen - Daily on-chain volume for stablecoins
Daily on-chain volume for stablecoins (Nansen)

On the flipside, a fast increasing stablecoins supply (measured via market cap) relative to the total crypto market cap may potentially act as a bottom signal post a market drawdown, as it could imply ample “dry powder” available that can easily flow back into crypto assets.

Nansen - Stablecoin Market Caps
Stablecoin market caps (Nansen)

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(4) Exchange flows

If market participants are bearish and worried that the value of their crypto holdings may drop, they would try to sell down their holdings via exchanges.

Net exchange flows is a metric that displays this trend; it measures the net amount of tokens coming into/out of exchanges. If there has been a sudden uptick in net inflows of a particular token into exchanges, it could imply that participants are trying to exit that asset by selling them on exchanges, and vice versa.

Nansen - ETH Exchange Flow
ETH net exchange flows, taken from Nansen’s ETH Tracker dashboard (Nansen)

For the same reason, one can also view a particular token’s balance change held on exchanges via Nansen’s Token God Mode dashboard to assess whether participants are trying to exit (positive balance change as they sell the token to exchanges) or enter (negative balance change as they buy the token from exchanges).

Nansen - Balance change in wBTC on exchanges
Balance change in wBTC on exchanges, taken from Nansen’s Token God Mode dashboard (Nansen)

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(5) Fear & Greed Index

A popular metric to gauge sentiment levels in the crypto market is the Crypto Fear & Greed Index. In most markets, participants tend to be emotional with their behavior. Market participants often get overly greedy (FOMO) when prices are on a euphoric rise, whilst they also tend to be overly fearful when prices are down (and irrationally selling their positions at a loss).

The Fear & Greed Index is an index that tracks the current sentiment of the Bitcoin market from several sources, namely:

# Volatility: measuring current volatility and max. drawdowns of BTC relative to average values in the last 30 days and 90 days

# Market momentum / volume: measuring current volume and market momentum relative to average values in the last 30 days and 90 days (measuring the market’s overreaction)

# Social media: no. of posts with the Bitcoin hashtag and their interaction rate

# Bitcoin dominance: rising dominance tends to be caused by a fear / sell-off in higher risk alt-coins

# Google Trends: search volumes for positive/ negative searches of Bitcoin

The index starts from zero to 100, with zero meaning “Extreme Fear” (a potential bottom signal as investors are overly worried), and 100 meaning “Extreme Greed” (a potential top signal as investors are overly bullish).  

Historically, the Fear & Greed Index has been a good indicator of market bottoms; for instance, the index hovered at around the 10-20 range (Extreme Fear) for roughly 3-4 weeks during the ‘18-’19 bear market bottom as well as the COVID-19 crash bottom.

Crypto Fear & Greed Index - taken from alternative.me
Crypto Fear & Greed Index, taken from alternative.me (Source)

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The next time when you are trying to analyze the crypto markets and gauge sentiments, do keep these metrics in mind as they might serve you well in providing useful insights!

Disclaimer: Any information contained in this article is for information purposes only, and does not constitute financial advice. It is based on current publicly available information, internal data and other sources that we consider reliable but which may not have been verified independently. While every effort is made to ensure the accuracy and completeness of this information, we do not represent that it is accurate or complete. Reliance upon information in this material is at your sole discretion.

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