Analyzing the phase position of the crypto cycle from on-chain data

Original Title: “Where Do We Stand in the Crypto Market Cycle? Leveraging On-Chain Data to Contextualize Key Market Trends”

Authors: David Lawant, Gayatri Choudhury, Bitwise

Compiled by: AididiaoJP

After the crypto market crash in the second quarter, July saw a rebound: the Bitwise 10 Crypto Index first fell by 63%, then rose by 37%. Although the broader market outlook remains uncertain, we can see some signs of exhausted selling pressure.

This article attempts to assess the current position of the crypto market cycle using on-chain data from Bitcoin and Ethereum, the two largest cryptocurrencies by market capitalization. Specifically, it focuses on three key trend indicators: geographic flow, investor type, and market sentiment.

All cryptocurrency transactions are recorded anonymously on the blockchain, and by combining on-chain transaction data with other metrics, market trends can be inferred in ways that traditional asset classes cannot achieve.

Geographic Flow

A decisive trend in this crypto bull market is the accumulation by North American entities, although the accumulation trend declined and stagnated in the second quarter.

A unique feature of on-chain data is its ability to track the geographic origin of buying and selling pressure in cryptocurrencies to some extent. By analyzing blockchain transaction data, known addresses of specific crypto entities, and network traffic, one can estimate which countries or regions are sending and receiving assets.

A decisive trend in this bull market has been the continuous accumulation of cryptocurrencies by North American (mainly U.S.) entities, while cryptocurrencies have been flowing out of Asian markets. According to Chainalysis data, from January 1, 2020, to November 9, 2021, when the cryptocurrency market cap reached an all-time high, North American entities had a net inflow of over 645,000 BTC and 4.5 million ETH, exceeding 3% of the total supply of each asset.

However, as shown in the chart below, this trend has not only gradually weakened since then but also slightly reversed during the crash in the second quarter. Since May, the cumulative net inflow of Bitcoin and Ethereum has decreased by 9.6% and 9.9%, respectively, while indicators for Asian and European entities have increased during the same period. In a recent report from Coinbase, a leading North American cryptocurrency exchange, most of the trading volume in the second quarter occurred on offshore exchanges, and the total market cap share of cryptocurrencies held on its platform fell from 11.2% in the first quarter to 9.9% in the second quarter.

North American entities flowed out of cryptocurrencies in the second quarter, while Asia and Europe saw inflows.

Cumulative net inflows for specific regions from January 1, 2020, to July 25, 2022.

Source: Bitwise Asset Management, data from Chainalysis

Changes in Investor Types

Outflows from larger entities and inflows to smaller entities.

Another way to analyze on-chain data is to determine whether entities are investors or speculators based on their holdings of crypto assets. By zooming in on entities with relatively low turnover, we can see cumulative inflows into those holding 0 to 0.1 BTC or ETH, 0.1 to 1, and so on. In this section, we will focus on entities with relatively low turnover, which are more likely to be investors rather than traders, and exclude entities holding large amounts of assets, which are more likely to be exchanges.

As cryptocurrency prices began to plummet significantly in May, larger entities experienced outflows, while relatively smaller entities saw inflows, with the trend being more pronounced for Bitcoin than for Ethereum. Since May, smaller investors have accumulated about 2% of the total supply of Bitcoin, while the cumulative amount for Ethereum is less than 0.5%.

This trend also marks the definitive end of the bull market over the past two years, during which larger entities have exited the largest share of cryptocurrencies, a trend that is more evident for Bitcoin than for Ethereum. The upcoming Ethereum merge and scalability roadmap have drawn increasing attention to Ethereum.

Outflows from exchanges and other larger entities into smaller entities

Accumulation trends by investor size from May 1, 2022, to July 18, 2022.

Source: Bitwise Asset Management, data from Chainalysis

Market Sentiment

Implied unrealized losses suggest that the worst may be over.

The third and final factor to consider is implied unrealized profits, or the current profit and loss of each position held by entities holding Bitcoin and Ethereum.

This metric has been one of the most useful contrarian indicators: the higher the proportion of holders with unrealized losses, the more likely the market is approaching a bottom, making it more favorable for potential buyers. As the stock market adage goes: "Buy on the cannon's roar, sell on the bugle's peal."

The chart below shows the percentage of unrealized losses as a proportion of the total supply of Bitcoin and Ethereum, broken down by the size of the losses.

Currently, the percentage of Bitcoin in a loss is slightly below 50%, while Ethereum exceeds 60%. More notably, among entities holding Bitcoin and Ethereum, 40% have losses exceeding 50%.

Since 2017, such a proportion has only been seen during the market crash in March 2020 due to the COVID outbreak, the market correction period in 2019, and the worst parts of the 2018 crypto market. While further demand shocks cannot be ruled out, historical records indicate that when investor sentiment is this negative, reversals may occur more quickly.

The percentage of supply currently in a loss is only similar to the 2018 crypto winter and the COVID crash.

Percentage of supply categorized by unrealized loss range from January 1, 2020, to July 18, 2022.

Source: Bitwise Asset Management, data from Chainalysis

Conclusion

It is important to note that on-chain data is not perfect. Geographic flows can only estimate entities known to be located in specific areas, and judgments based on network traffic data may not accurately reflect actual trading volumes. For entities not directly participating in the market, it is impossible to detect the positioning of investor types, and no on-chain analytics company has fully described the behavior of all entities holding crypto assets. Additionally, the assumptions made by market sentiment indicators regarding each holder's cost basis may not be entirely accurate.

That said, we can use this data to understand the cyclical position of cryptocurrencies. Based on three main trends (geographic flow, changes in investor types, and market sentiment), the declining willingness of large investors to accumulate may have impacted the crypto market crash in the second quarter. If historical data serves as a guide, the market rarely experiences such negative sentiment, indicating that the current position is attractive for long-term holders.