Understanding on-chain data and why it’s important in crypto trading

Investy.ai November 5 2024

To keep up with the fast paced world of crypto trading, it’s best that one understands the critical information the blockchain provides. Unlike traditional markets, where data comes from external financial reports, on-chain data provides real time visibility into blockchain activity.

When combined with AI, this data can reveal hidden patterns and insights, helping traders make better decisions. Let’s take a closer look.

What is on-chain data and why is it important?

On-chain data refers to the information recorded on the blockchain. They include transaction volumes, wallet balances, exchange inflows and outflows, and active addresses. Since blockchain is a public ledger, anyone can access this data, making it possible to track every move within the network in real time.

For example, you can head to the Ethereum blockchain, or the blockchain explorer, Etherscan, and get viewing access to everything that goes on, such as wallet addresses, token minting, and even pending transactions.

Veteran traders find these data useful because they often indicate changes in the network that may impact their investments. For example, tracking the number of active wallet addresses can help them gauge user interest in a crypto asset.

You can also monitor transactions on the blockchain, especially large transactions made by high-net worth individuals or institutions, often called whales. These whale transactions usually signal major buying or selling moves.

These are only some of the fundamental data you can gather on the blockchain. Looking further into the network will allow you to see more detailed information, such as daily gas used, average gas prices, unique addresses and more.

How on-chain data helps users understand the crypto market

On-chain data provides a unique window into the conditions of the crypto market that go beyond price charts and trading volumes. For example, experienced traders can analyze blockchain transactions to figure out a trend.

Investor sentiment

Similar to social and political sentiments, investors' behaviors can have a direct impact on the cryptocurrencies. We can gauge investor sentiment by looking at on-chain metrics such as active (wallet) addresses and wallet balances. A sudden increase in active addresses, for example, may indicate growing interest for a particular coin. On the other hand, large withdrawals from crypto exchanges mean users are moving assets to private storage, reflecting confidence in long-term holdings.

Market liquidity

Inflows and outflows from crypto exchanges can be powerful indicators of market liquidity. A large inflow can signal selling pressure, as more coins are made available for trade, while high outflows might indicate that holders are holding on to their assets, increasing scarcity and reducing supply.

Supply distribution and wealth concentration

Tracking whale transactions allows users to see how large holders (whales) are behaving. When whales go on a buying spree, it can signal confidence in the asset's value. On the flipside, when they start selling off abruptly (some call this a panic sell), it may signal an incoming price drop for that same asset. This insight helps traders anticipate volatility and make more informed decisions.

Network security and health

On-chain data also provides clues about a network's overall health. Metrics such as hash rate (for proof-of-work chains) and staking levels (for proof-of-stake networks) indicate the security and engagement level of participants. These data tell us more about the network’s overall reliability and stability. 

Hash rate is the measure of how much computing power the blockchain has for validating transactions and other activities. Higher hash rate means there are more validators working for the network. This makes it more difficult to attack the blockchain, thus indicating higher security.

Staking levels refer to the amount of cryptocurrency validators have put on lock (stake) to secure the blockchain. In proof-of-stake networks like Ethereum 2.0, Solana, and Cardano, participants need to “stake” an amount of their own tokens in order to start validating transactions for the network and start earning. Higher staking levels indicate a high number of tokens locked in the blockchain, contributing to security.

Popular on-chain metrics for analyzing the crypto market

There are numerous on-chain metrics, each defining a specific area of the crypto market. Some traders have their own set of metrics to fine tune their financial decisions, but here are a few of the popular ones.

MVRV Ratio (Market Value to Realized Value)

MVRV is a ratio that compares the market value (what everyone thinks a cryptocurrency is worth based on its current price) to the realized value (the average price at which people actually bought). Think of it as checking if the current price is way higher or lower than what people paid on average.

MVRV helps us identify whether a crypto coin is overvalued or undervalued. High MVRV (> 3-4) could mean the price is pumped up, and we might be in a bubble. People might start selling to cash in on profits. Low MVRV (< 1) suggests the price is below what most people paid, which might mean it’s undervalued. This can be a good entry point for buyers.

When MVRV is high, traders might consider taking profits because the price is above average buying levels, signaling it could drop. When MVRV is low, it might indicate a buying opportunity since the price is close to or below the average cost.

The Puell Multiple

The Puell Multiple is a measure of how much Bitcoin miners are making compared to the past. It’s a ratio of the daily value of Bitcoin issued (in USD) to its 365-day average. Basically, it tells us if miners’ earnings are unusually high or low.

Daily issuance in USD: the value of all new Bitcoin mined per day.

365-Day Moving Average: The average of miners’ daily earnings over the past year.

Since miners play a huge role in the Bitcoin ecosystem, their profits can tell us a lot about the market. High Puell Multiple means miners are earning more than usual. They may be tempted to sell some of their BTC holdings, which can add selling pressure. Low Puell Multiple suggests miners aren’t making much money. If they’re holding onto their Bitcoin, it might be a good sign that they expect prices to rise.

Exchange Flows

Exchange Flows track the movement of crypto assets in and out of exchanges. There are two main types:

Inflows: Coins moving into exchanges. This usually means people are getting ready to sell, since they’re putting their coins where they can quickly trade or cash out.

Outflows: Coins moving out of exchanges. This often means people are planning to hold their crypto, moving it to wallets for storage, which reduces selling pressure.

Exchange Flows give us a hint of what’s happening in the market. For example, high inflows can signal a potential sell-off. When a lot of coins flow into exchanges, it’s usually because people are getting ready to sell. High outflows suggest that people are planning to hold onto their crypto, reducing the supply available on exchanges. This can be bullish since fewer coins are up for grabs.

Conclusion

Using on-chain data and metrics can help traders at any level gain deeper insights into the behavior of the network as well as the overall conditions of the market. They may not dictate your every financial decision, but understanding these data can place a trader in a threshold that provides less risk and more potential gain.

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DISCLAIMER: the information above is only intended to educate and not meant to be financial advice. You can do everything right and follow every formula to the T and the market can still turn you down. Such is the reality of investment.

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