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Introduction to On-Chain Bitcoin Analysis – Bitcoin Magazine: Bitcoin News, Articles, Charts, and How-tos

This article is a collaboration between Glassnode and Bitcoin Magazine to introduce Bitcoiners to the world of on-chain analytics. Our goal is to simplify, demystify, and improve access to on-chain data so you can get started using these powerful new tools.

The Bitcoin blockchain is one of the most organic sources of data on human behavior in a free market the world has ever seen. From its cypherpunk no-price roots to today’s corporate adoption with # LazerRaysTo100K in mind, human demand for ultimate scarcity has drawn buyers and sellers from all walks of life.

At its core, financial markets create a balance between supply and demand that ultimately depicts human psychology and the perception of value versus time. Market analysts have developed and used many tools to evaluate current and future valuations. Their goal is to find market inefficiencies, advantages, and financial advantages over their competitors.

There are basically three main areas of market analysis and approaches used in the traditional financial world:

  • Macroeconomic (Macro): Analysis of the overall relationship between asset classes, geopolitics and central bank policy over very long periods of time. The aim is to identify large-scale macro trends and opportunities, with an emphasis on baskets, indices and asset classes rather than individual “stock picks”.
  • Fundamental Analysis / Value Investing (FA): Analysis of the intrinsic and structural advantages and disadvantages of a particular asset or asset class compared to the entire addressable market and competitors. The aim is to benefit from undervaluation / overvaluation and market inefficiencies and to determine prices with the maximum relative value.
  • Technical Analysis (TA): Analysis of price signals, charts and indicators to extract information, patterns and probabilities related to the balance of supply and demand over time. TA often places less relative emphasis on asset fundamentals and instead focuses on distilling all known information into one metric: price.

Analysts and traders may choose to use any combination of skills and techniques from any field, while others may specialize in just one. In all cases, however, there is a critical input:

Accurate, high quality, timely and preferably asymmetric data.

Data availability is also subject to different schedules. Technical analysts can watch price data to the second, fundamental analysts can watch quarterly reporting seasons, and macro investors watch for monthly central bank meetings and year-on-year changes.

Bitcoin is part of it.

Radical transparency

A solid, digital financial asset that continues to gain a foothold in the minds of investors and analysts around the world. A variety of strategies and models have been developed over the past 12 years to model and project the acceptance curve, performance, and price of Bitcoin. Analysts have used everything from transaction volume to stored value estimates to rainbows with no end in sight to innovation and creativity.

If we go back to the 2011 Bitcointalk forums, we see the first discussion of the concept of “Bitcoin Destroyed Days” (now “Destroyed Coin Days (CDD)”). These early ideas led to an open source iteration and a deeper study of the information contained in the Bitcoin ledger. This has now introduced a brand new concept and field of analysis for the financial markets:

On-chain analysis:: Analysis of the immutable record and objective truth that the Bitcoin Ledger is. Analysts observe supply and demand dynamics, human psychology and decisions, and patterns of spending, HODLing, and miner hashing in a truly free market.

By using the radically transparent and publicly available information that Bitcoin provides, anyone can judge the actual movement of coins, the activity of miners, and the volume and age of wallet holdings. Bitcoin is an immutable record of human behavior, psychology, and decision making in a free market for perfect scarcity.

While Bitcoin itself does not know the price or the trades that are taking place, it has a perfect reminder of every UTXO, difficulty adjustment, and timestamp for events in the chain. Although this information is publicly known, very few know how to properly study it to get a macro view of the Bitcoin market.

Glassnode’s goal is to solve this problem.

Principles of on-chain analysis

It is true that many of the original ideas and concepts required to create on-chain metrics are complex and require knowledge of data science, computation, and coding. However, using ready-made tools like the ones in Glassnode Studio is far less intimidating than you might think!

You don’t have to be a math or code assistant to use on-chain tools. In fact, on-chain analysis gets the most out of Bitcoiners who have a good understanding of the network fundamentals and the incentives of the people who interact with it.

There are two key disciplines of on-chain analysis:

  • Blockchain Archeology: A very special role for someone handling granular data like transactions, exchange credits, and wallet clusters. They convert this “microdata” into reliable and accurate “macrometrics”.
  • On-Chain Analysts: Next, these analysts take the macro metrics and interpret the most likely trends and indicators related to market sentiment and the behavior of various interested parties.

The secret sauce to effective on-chain analysis is asking the right questions and knowing where to look:

  • Who are the network participants whose behavior you are interested in (whales, exchanges, miners, speculators, etc.)?
  • What are their drivers, incentives and weak points (profit and loss, reduced income, accumulation of sats, etc.)?
  • How are their decisions invariably printed in the chain (fees paid, transaction volume, difficulty adjustments, wallet balance, coin rest, etc.)?

Let’s start with a simple example of how smart money investors might behave in the chain.

In practice on a chain

We can assume that smart money and whale investors have an above-average understanding of Bitcoin. They specialize in amassing cheap coins in a bear market, settling in the cold store, and making profits by selling expensive coins in the strength of the bull market. Hence, we have a few metrics to keep track of to track their overall actions:

  • Will long dormant coins be put back into circulation (ASOL and CDD)?

02_cddasol

  • Do large amounts of coins / HODL mature in the refrigerator (e.g. HODL waves)?

03_hodlwaves

As the smart money builds up, we can expect young coins to get into the cold store and mature and fewer coin days to be destroyed. In a “Wallaich season”, more large purses (> 1,000 BTC) may also grow. This can lead to a supply bottleneck and precede the start of an uptrend.

Conversely, given the right conditions, these investors could get their coins out of the cold store and start investing in the economy. These old coins destroy larger amounts of coin days, have a longer average lifespan, convert a large amount of old coins to young coins, and reduce the number of whale wallets.

This example is just one of a combination of on-chain tools that paint a picture of a group of network participants in the macro bitcoin economy. We were also able to observe exchange rates, miner spending behavior and HODL demand and combine these insights with our traditional macroeconomic, fundamental and technical analysis for a holistic assessment.

The beauty of on-chain data is that it reflects the objective and unadulterated truth. It is expensive to do all the actions in the chain because with tight sats you have to pay a fee, burn energy with each hash, and consider the opportunity cost of each expense. As a result, observations in the chain tend to be slower than technical analysis, but have higher conviction than everyday price promotions (making them the perfect tool for HODLers with little time preference!).

On-chain paradigm

For a bitcoiner, you couldn’t really ask for a better playing field for bitcoin to build conviction:

  • Macro background for the ages with a tailwind for hard assets
  • Basic character of the healthiest and hardest money ever invented
  • Technical price chart that will make any analyst’s eyes watery
  • On-chain analytics tools that offer brand new and unique insight into the objective truth of Bitcoin’s heartbeat

Glassnode aims to make on-chain analytics accessible to everyone, regardless of whether you are a Bitcoin pleb or an on-chain Jedi. When the world resigns itself to the paradigm shift that Bitcoin represents, those who develop a deep understanding of what is going on in the chain are likely to find an overwhelming advantage over those who don’t.

On-chain analysis is a technical analysis of bitcoin fundamentals, and bitcoiners are already one step ahead in the starting blocks.

At Glassnode we are expanding our two content areas and introducing new metrics declarations in our academy to integrate more Bitcoin into this new field. One of the best ways to understand Bitcoin is to listen, block by block, to what it is telling you.

Look forward to the next issues in this series brought to you by Glassnode and Bitcoin Magazine. There we will examine how the behavior of different network participants is imprinted in the chain and how we can maximize the knowledge from this non-falsifiable data.

This is a guest post by Glassnode. The opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.

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