This post was conducted by Blockdata and sponsored by Chainalysis who share what key vital signs they use to determine whether or not cryptocurrency markets are healthy.
Beyond price volatility and day-to-day trading, the cryptocurrency market has a structure defined by investors’ collective behavior over longer periods of time. Liquidity, volume, and other “macro” trends give the market its overall shape and offer clues on its resilience. Chainalysis’s head of research specializes in analyzing billions of data points to see beyond the crypto economy’s turbulent surface.
In a sense, crypto prices don’t really matter. That may seem like a bold statement, given the endless online chatter and speculation around cryptocurrency price movements. But seen through the lens of Chainalysis’s research team, the cryptocurrency market is actually not defined by the ups-and-downs of prices.
Instead, it’s shaped by less-visible trend lines, such as levels of liquidity, transaction volume, and skews in wealth distribution.
Zooming out, the global crypto economy took a hit in mid-2022 as prices crashed. They haven’t quite recovered yet. Today, there’s a question on the minds of many market participants: did something fundamentally break in the crypto markets?
As worries over a protracted “crypto winter” grew, researchers at Chainalysis recently dug into their billions of data points to get at the answer.
Their aim was to look beyond price to see whether the bear market had shifted one or more of the measurements they see as the fundamentals of market health.
For example: Have long-time “hodlers,” or long-term investors in Bitcoin and Ethereum, cashed out? Has liquidity in the market dried up? Have whales eaten the market?
“The prices are the prices,” says Kimberly Grauer, Chainalysis’s Director of Research. “But how much has fundamentally changed about the cryptocurrency ecosystem during this crash?”
The answer, surprisingly, is: not much.
When looking at trends related to volume, liquidity, wealth distribution, and more, Grauer and her team found more continuity than change.
“By and large, the ecosystem today actually looks very similar to the ecosystem one year ago,” says Grauer.
While adoption has fallen in each of the last two quarters with the bear market, global adoption remains well above its pre-bull market 2019 levels, according to Chainalysis’s 2022 Global Crypto Adoption Index .
Grauer believes the underlying stability in the market’s structure — at least when looking at Bitcoin and Ethereum — is a positive sign for the crypto market’s robustness.
This should reassure institutional investors and other market participants who bet on crypto and web3 for the long term, but feel spooked by the price softness.
Following our previous spotlight on Chainalysis’s work, Blockdata sat down with Grauer to better understand the key vital signs that determine whether or not cryptocurrency markets are healthy.
How Chainalysis defines the metrics that inform market health
Theoretically, 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 isn’t a simple process. To begin with, the data volume is massive. And, the data’s composed of somewhat inscrutable alphanumeric keys, hashes, and other “metadata” that identify individual wallets, addresses, and transactions.
Using Chainalysis’s suite of analytics products, Grauer and her research team put together all the complicated puzzle pieces into a holistic view.
First, they assemble top-level data: transaction volumes, active wallets, and yes, prices.
Then, before it can be synthesized into useful findings, this raw data must be complemented with contextual information that ties transactions, where possible, to specific geographies, services and applications, as well as wallets or groups of wallets. In the language of data analysis, that involves countless “data merges,” or linking data from disparate sources to create a bird’s eye view of the market as a whole.
Using complementary data, the Chainalysis team also is able to look at trends that are specific to one region or country.
“For example, I can look for trades of less than $100 only in Mexico,” Grauer said.
With this more complete picture, Grauer’s able to see and track important metrics that determine the market’s shape.
Below, we summarize three of the more important global metrics Chainalysis follows closely, and describe how they have remained stable despite the price crash.
- Liquidity: Chainalysis tracks the proportion of wallets holding Bitcoin or Ethereum that are liquid versus those that are illiquid, and watches for changes in the ratio to determine whether or not the market is undergoing a fundamental shift in this area. What defines whether an individual wallet is liquid or not? Chainalysis considers a wallet liquid if it sends a significant amount of value rather than just receiving funds. If, over a period of time, the amount sent out is 25% or more of total transaction value, it’s considered liquid. “The illiquid wallets are those that receive money and don’t really send funds. They’re kind of a sink for the market,” says Grauer.
- Holding behavior: Another measurement is the duration of hold periods for investors in the main cryptocurrencies. Specifically, Chainalysis tracks the trading behavior of long-term “hodlers,” because their behavior can often be strikingly different to the more frenetic trading of speculators. Many casual observers of crypto don’t know that a substantial percentage of the supply of Bitcoin, for example, is held by wallets that have not traded for as long as 9 or 10 years, says Grauer.
- Wealth distribution: The crypto economy encompasses a wide variety of investor types, from retail investors dipping their toes in the water via popular trading platforms, to “whale” investors who hold millions in coins. Chainalysis tracks the distribution of wealth in a way analogous to how wealth inequality is measured in other contexts: For example, how much wealth is held by the top 10% of wallets? Does the distribution change over time? Did the wealth distribution become more or less concentrated as prices crashed?
Chainalysis looked at the composition of the crypto market through the lens of these three key metrics, sifting through the data for the periods both before and after the crypto price crash of mid-2022.
To recap, Bitcoin prices crashed in May and June of this year after hitting an all-time high of more than $60,000 in November 2021. By mid-June 2022 BTC had dipped below $20,000. As of late September of 2022 Bitcoin has yet to push above the $25,000-mark.
On-chain data disputes the idea that ‘crypto is dead’
What did Grauer and her team find? They discovered that neither liquidity, hodlers’ behavior, nor wealth distribution budged much in the wake of the crypto price crash.
- Liquidity remained stable. As speculators fled the market the proportion of wallets that were illiquid rose somewhat, but liquidity levels remained largely stable.
- Holders didn’t sell: The team also found that during the price crash, most long-term holders did not sell their holdings and take a loss. Yes, lots of value was lost among speculative investors that tended to shed their crypto as prices slipped, but hodlers tended to hang on to their currency and so any “losses” are purely on paper in their case.
- Wealth distribution didn’t alter significantly: The crypto market is by some measures unequal and “top heavy” (as is the traditional economy), i.e. a small percentage of wallets hold a large proportion of the wealth. “By and large, the ecosystem today looks very similar to the ecosystem one year ago, when you look at the wealth distribution,” says Grauer.
For better or worse, dramatic price falls and rises have been a perennial feature of the crypto economy. Bitcoin prices also crashed in 2011, 2012, 2013, 2017, and 2020. In each case, they eventually roared back. This price instability itself is attractive to opportunistic investors. They have little interest in blockchain technology or cryptography and are really only chasing a quick buck on the upswings.
This process feeds on itself since their herd activity contributes to the steep price rises on the way up, as well as the suddenness of crashes.
Despite the reflexiveness of this phenomenon and its effect on prices, mainstream media outlets still tend to judge the crypto economy’s health and momentum based on prices alone. In the eyes of Grauer and Chainalysis, that’s resulted in a climate of fear-mongering and confusion.
Chainalysis hopes its research on the underlying stability of the crypto economy will serve as a kind of public-service announcement: the sky is not falling.
“It disputes this idea that crypto is dead,” says Grauer. “These metrics that we’ve been tracing for a long time, they’ve remained consistent. It makes you realize that this crash was relatively contained within a few major market participants.”
Chainalysis’s research shows that individual Ethereum and BTC holders held on through the bear market and the volatility in May 2022. Both assets are largely held on services and by long-term holders. Only 3.4% of BTC supply sits in wallets aged less than 2 weeks, i.e. highly active personal wallets.
Speaking to specific geographies, crypto adoption and transaction volume broadly correlates with the size of national economies, as shown by Chainalysis’s 2022 Global Crypto Adoption Index.
That has not changed post-price crash, says Grauer.
But, in particular countries there can be disproportionate adoption due to economic policies or local consumer behavior. For example, Chainalysis sees accelerating adoption in Nigeria, where access to the financial system and movement of capital are restricted by government policy and a lack of access; and outsize adoption in Argentina, where inflation has eroded the local currency’s buying power. The Philippines and Vietnam have thriving gaming cultures that have adopted crypto as a means of exchange.
What’s in store for Chainalysis and the crypto economy?
“Data availability in the crypto economy can be a double-edged sword,” says Grauer.
By this she means that the transparency of public blockchains creates accountability but also means that the world tends to hear a lot about crashes, crypto hacks and swindles, illicit activity, and technical flaws.
Chainalysis’s bread-and-butter is the data analysis it enables for compliance, criminal investigations, and business-intelligence use cases.
Thus, in the past, Chainalysis’s education efforts have sought to counter the misconception of crypto as a Wild West. It still regularly shares data on the tiny proportion of crypto volume associated with illicit activity and still publishes research such as an April blog post explaining that the crypto markets aren’t deep enough to serve as an effective conduit for Russian money trying to evade sanctions.
But, as its clients increasingly grow more sophisticated regarding their web3 knowledge, Chainalysis is already trying to anticipate future questions. If the crypto economy remains fundamentally healthy, as Chainalysis believes, then business and financial services adoption will continue to advance (even if perhaps it’s at a slower rate than in boom years).
What will Chainalysis customers — financial institutions, web3 businesses, governments — want to know a year from now, or three years from now?
One possible area of inquiry is the impact of quickly-evolving regulations, which vary wildly across jurisdictions, and whether these have any effect on business adoption.
A large part of Grauer’s role is finding the right questions to ask of the data, the ones that will open up the most paths toward a better and shared understanding of cryptocurrency.
“In my work, I try to ask those questions, the ones that reveal new ways for the data to be utilized,” says Grauer.