Is the cryptocurrency market healthy? (II)

How Chainalysis defines the metrics that report the health of the market

In theory, blockchains like Ethereum and Bitcoin will allow anyone to download and analyze their entire transaction history. That said, accessing, tabulating, and making sense of all this data is not a straightforward process. For starters, the volume of data is huge. Furthermore, the data is made up of somewhat inscrutable alphanumeric keys, hashes, and other “metadata” that identify individual wallets, addresses, and transactions.

Using the Chainalysis suite of analytics, Grauer and his research team put all the pieces of the complicated puzzle together into a holistic view.

First, they gather high-level data: transaction volumes, active portfolios, and, yes, prices.

Then, before you can synthesize them into useful conclusions, this raw data must be supplemented with contextual information linking the transactions, where possible, to specific geographies, services and applications, as well as to wallets or groups of wallets. In the parlance of data analysis, this involves myriad "data mergers," or the linking of data from disparate sources to create a bird's-eye view of the market as a whole.

With supplemental data, the Chainalysis team can also look at trends specific to a region or country. “For example, I can search for deals under $100 just in Mexico,” Grauer explains.

Below we summarize three of the most important global metrics that Chainalysis closely tracks, describing how they have held up despite falling prices.

• management : Chainalysis tracks the proportion of Bitcoin or Ethereum wallets that are liquid versus those that are not, and looks at changes in the ratio to determine if the market is experiencing a fundamental change in this area. What defines if an individual portfolio is liquid or not? Chainalysis considers a wallet to be liquid if it sends a significant amount of value rather than just receiving funds. If, over a period of time, the amount sent is 25% or more of the total value of the transaction, it is considered liquid. “Illiquid wallets are the ones that receive money and don't really send funds. They are a kind of sink for the market,” says Grauer.
• retention behavior: Another measure is the length of investor holding periods in major cryptocurrencies. Specifically, Chainalysis tracks the trading behavior of investors over the long term, because their behavior can often be strikingly different from the more frenzied trading of speculators. Many casual cryptocurrency observers don't know that a substantial percentage of the Bitcoin supply, for example, is held by wallets that haven't traded for 9 or 10 years, Grauer says.
• Wealth distribution: The crypto economy encompasses a wide variety of investor types, from retail investors who dip into the water via popular trading platforms, to “whale” investors who own millions in coins. Chainalysis tracks the distribution of wealth analogously to how wealth inequality is measured in other contexts: For example, how much wealth do the richest 10% of wallets own? Does the distribution change over time? Was the distribution of wealth more or less concentrated with the fall in prices?

Chainalysis analyzed the composition of the cryptocurrency market through the lens of these three key metrics, examining data from the periods before and after the cryptocurrency price crash in mid-2022.

To recap, Bitcoin prices plunged in May and June of this year after hitting an all-time high of over $60.000 in November 2021. By mid-June 2022, BTC had fallen below $20.000. As of the end of September 2022, Bitcoin had yet to break above $25.000.

On-chain data refutes the idea that “crypto is dead”. What did Grauer and his team discover? They found that neither liquidity nor hodler behavior nor the distribution of wealth moved much after the fall in the price of cryptocurrencies.

Liquidity remained stable. As speculators fled the market, the proportion of illiquid portfolios increased somewhat, but liquidity levels remained stable.

Holders Did Not Sell: The team also found that during the price decline, most long-term holders did not sell their holdings or suffer losses. Yes, a lot of value was lost among speculative investors who tended to dump their cryptocurrencies as prices fell, but long-term holders tended to hold on to their coin, so any "loss" is purely on paper at Their case.

The distribution of wealth has not changed significantly: The cryptocurrency market is, by some measures, uneven and "top heavy" (like the traditional economy), meaning that a small percentage of portfolios hold a large proportion of the wealth. “In general, the current ecosystem is very similar to that of a year ago, if we look at the distribution of wealth”says Grauer.

For better or worse, drastic price rises and falls have been a perennial feature of the crypto economy.. Bitcoin prices also crashed in 2011, 2012, 2013, 2017, and 2020. In all cases, they eventually recovered. This price instability itself is attractive to opportunistic investors. They have little interest in blockchain technology or cryptography and are really just after making a quick buck on the uploads.

This process feeds on itself, as their herd activity contributes to sharp price spikes on the way up, as well as sharpness on the declines.

Despite the reflexivity of this phenomenon and its effect on prices, the mainstream media still tends to judge the health and momentum of the crypto economy based solely on prices. In the opinion of Grauer and Chainalysis, this has given rise to a climate of alarmism and confusion.

Chainalysis hopes that its research into the underlying stability of the crypto economy will serve as a kind of public service announcement: the sky is not falling.

“This refutes the idea that crypto is dead,” says Grauer. “These metrics that we have been tracking for a long time have remained constant. This makes us realize that this slump has been relatively contained in a few major markets.”

Chainalysis research shows that individual Ethereum and BTC holders held through the bear market and volatility of May 2022. Both assets are largely held on services and by long-term holders. Only 3,4% of the BTC supply is found in wallets less than two weeks old, that is, very active personal wallets.

Looking at specific geographies, cryptocurrency adoption and transaction volume broadly correlate with the size of national economies, as Chainalysis's Global Cryptocurrency Adoption Index 2022 shows. This has not changed after the price drop, says Grauer.

But in certain countries there may be disproportionate adoption due to economic policies or local consumer behavior. For example, Chainalysis sees adoption accelerating in Nigeria, where access to the financial system and movement of capital are restricted by government policy and lack of access; and disproportionate adoption in Argentina, where inflation has eroded the purchasing power of the local currency. The Philippines and Vietnam both have thriving gaming cultures that have embraced cryptocurrency as a medium of exchange.