On-Chain Metrics and Financial Concepts in DeFi and TradFi
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Our last piece explored the differences between on-chain and off-chain analysis. This article will dive deeper into on-chain analysis, introducing some of the on-chain metrics used to value different cryptocurrencies and showing you some of the different ways that concepts from traditional financial analysis have been adapted to digital assets.
On-chain analysis is an exciting area where DeFi and TradFi merge, and understanding these metrics will help you as you navigate the complex world of crypto investing.
What is On-Chain Analysis?
On-chain literally means that the transaction took place on the blockchain. On-chain transactions are essentially the thing that makes blockchain technologies unique. When you transfer a cryptocurrency to another person on the chain, the transaction is registered and verified by all other participants on that blockchain.
The analysis of on-chain transactions is fairly straightforward. All wallets that sync with the blockchain maintain an identical record of every transaction which includes data on transaction size, source and destination wallets, time and date, difficulty level (for applicable crypto like Bitcoin), and whatever else a particular blockchain records in its hashes.
This type of data has limitations. A person that transfers crypto between their own personal wallets creates blockchain transactions, but the ownership of the coins has not changed. Without the ability to tie a wallet to an owner, knowing for certain whether a blockchain transaction represents a change in ownership is difficult.
Despite this potential limitation, the data available about transactions on the blockchain can provide valuable insights into understanding the fluctuations in cryptocurrency markets.
Network Value to Transaction Ratio (NVT)
One popular metric for on-chain analysis is the Network Value to Transaction (NVT) ratio. The NVT ratio compares the value of a blockchain network to the volume of transactions taking place on that network. A higher ratio means that more transactions are taking place relative to the size of the blockchain, indicating user interest and activity.
The overall value of a blockchain and its sum total of cryptocurrency in circulation is frequently described as its market capitalization — or market cap. The concept of market capitalization — originally used in TradFi to estimate the overall value of a publicly-traded company — has been adapted to the world of cryptocurrencies to capture the overall size and value of a cryptocurrency.
Simply put, the market capitalization of a cryptocurrency is calculated by multiplying the price of a single cryptocurrency by the total number of tokens in circulation. If SampleCoin is trading for $1,000 per coin, and there are 1,000 coins in circulation, SampleCoin has a market cap of $1,000,000.
Network Value to Transaction Ratio Signal (NVTS)
The NVT was improved upon by the Network Value to Transaction Ratio Signal (NVTS), which uses a 90-day moving average of transaction volume. This gives traders a better picture of how a cryptocurrency has been trading recently, eliminating the need to account for longer-term fluctuations in price and transaction frequency. The concept of a short-term moving average was also adopted from traditional financial valuation metrics.
Cryptocurrency Indexes, Market Capitalization, and Volatility
More recently, academic researchers have developed a sophisticated index for crypto-currencies that measures volatility in cryptocurrency markets.
In their 2021 paper in the International Review of Financial Analysis, Alisa Kim, Simon Trimborn, and Wolfgang Karl Härdle “develop a measure and model to capture the expectations of the CC [cryptocurrency] market and map them into an index referred to as VCRIX — a volatility index for CCs.”
The VRCRIX is loosely based on the VIX a.k.a. the CBOE Volatility Index, which seeks to measure the stock market’s expectation of volatility based on options traded on companies in the S&P 500.
The VCRix is based on the CRIX — the CRyptocurrency IndeX (CRIX). The CRIX is a benchmark index for the cryptocurrency market. It is a market capitalization-weighted index, meaning that the relative weight of an individual cryptocurrency in the CRIX depends on its market cap relative to other cryptocurrencies in the index.
From Financial Concepts to On-Chain Metrics
On-chain metrics frequently use these and other traditional financial concepts to make sense of the data available from on-chain transactions. These metrics have provided crypto investors and analysts with valuable tools for investors. The most exciting thing, however, is that we are still in an early stage of development for on-chain metrics.
Our Defy platform will feature these and other new metrics for on-chain analysis. Subscribe to our Defy newsletter and follow our other posts on Medium and DefyTrends.io for other educational content and further updates on our Q1 2022 platform launch. Onward and upward.
Disclaimer: The above post is for educational purposes only, and must not be construed as investment advice. Please do your own research and manage your risks, accordingly.
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