On-Chain Analysis is bullcrap. Here’s why.

Yes, this includes the Stock-To-Flow Model.

Published in

Coinmonks

7 min readNov 10, 2021

If you’re into crypto and everything that surrounds it and you haven’t been living under a rock, chances are you’ve come across the term “On-Chain Analysis” and all sorts of self-proclaimed “On-Chain Analysts”. But just in case you haven’t, let me briefly introduce you to the concept.

On-Chain Analysis consists of the extraction and thorough study of the available data about public Blockchain transactions on any given blockchain (but we’ll focus on Bitcoin’s for this article). This has many different use cases, but primarily it is used by many On-Chain Analysts to try and predict future market movements, and let me tell you right now that they don’t know what they’re talking about.

When it comes to its other use cases it’s fine, I don’t think much of it, but when so-called “On-Chain Analysts” try to use it to predict future prices I get really triggered.

The Logic Behind It

For the sake of not repeating myself too much, I’ll use the letters “OCA” to refer to On-Chain Analysis and “OCAs” to refer to On-Chain Analysts.

Let’s get straight to it.

How does OCA supposedly work to predict future prices?

There are many indicators that OCAs use to create different future predictions of price, some of them are:

Number of Active Addresses

A graph showing the number of active wallets that have received or transferred (In this case BTC) and the presumed correlation with future price movements.

Exchange Outflow

A graph showing the amount of Bitcoin leaving exchanges and seemingly going into cold storage and the presumed correlation with future price movements.

Number of Transactions

A graph showing the number of transactions occurring in BTC’s blockchain and the presumed correlation with future price movements.

Number of Transactions in BTC’s blockchain. (30 day MA)

Historical Number of Transactions in BTC’s blockchain. (7 day MA)

So… Lots of data, but is any of this worth something? In my opinion, no, not really.

All these OCAs presume that for example the amount of BTC leaving exchanges rising also means higher prices in the future due to less offer available to buy in the market. This is completely wrong, as they do not realize that there’s something pushing people to withdrawal BTC out of exchanges in the first place, and that is price.

As soon as prices go down, they’ll start seeing BTC getting sent into exchanges and sold into the market. That’s because what drives people to make that decision is their expectancy of future price movements. And what drives people’s expectancy of future price movements? Actual price movements. Meaning you might as well just be looking at the BTC/USD chart.

The reason why is that the thing you’re trying to accomplish with such indicators is to take into account current and past action such as the number of transactions taking place, or the amount of BTC that is outside of exchanges, or the number of addresses active on the blockchain and use it to predict future action.

This simply doesn’t work because of the fact that these indicators are a result of prices and not a cause of prices.

All these are lagging indicators, to say the least, that show what has already happened as a result of the price moving.

Here you have an example I gave previously: The Number of Active Addresses, you can clearly see below that when prices surge, the number of active addresses rise, and when it drops, it also drops hard. This is the opposite of what should happen if financial markets were rational and driven by offer & demand.

Why does this happen?

In a normal physical, economic market, when prices drop, demand goes UP for the product, more people want to buy it at a discount. And when prices rise, demand goes DOWN for that same product, people don’t want to buy a product that’s expensive.

Think of it as a shoe store. You walk in, see your favorite pair of shoes at a discount, you don’t think twice and you buy them. But if you walk in and it’s up 100% since yesterday you would wait for a discount or just wouldn’t buy it at all.

Well, in financial markets, driven by irrational thinking, we see the OPPOSITE, as shown in the graph above. As prices surge, MORE people want to buy the asset, and as prices go down, LESS people want to buy the asset.

This is because the objective you’re seeking in a physical market is to actually get the value of the physical thing you’re buying, while your objective in a financial market is to make a profit from buying that asset as low as possible and selling it as high as possible.

Therefore we can conclude that the only thing that makes someone want to purchase an asset in a financial market is the expectation of it going up in price and making a profit off of it.

If this expectation isn’t met, this person sells. This is precisely what drives prices. Everyone going through individual, subjective appreciations of current price and the possibilities of future price movements.

Nothing to do with Offer & Demand

Hard to believe, I know. But you have been taught this since you were a child and it’s completely wrong for financial markets. It only works for economic markets.

What actually drives markets is mass psychology, and you can’t predict future price action by analyzing the current offer or demand of the asset because that offer or demand can shift drastically out of nowhere as a result of a sharp price movement.

Doesn’t matter if your asset is scarce and of a fixed amount like Bitcoin, if nobody wants to buy it, it’s not worth anything. Meaning it doesn’t matter if Bitcoin is scarce, to make it worth what it’s worth, demand has to be there, and we’ve seen demand rises only as prices rise. Therefore meaning each Bitcoin costs what it costs because people believe other people also believe it’s worth something.

So no, it’s not the scarcity itself that makes Bitcoin worth $67,000 at the time I’m writing this article, although I do think it does have something to do with how far it has come.

How to actually predict prices

So OCA doesn’t work because it relies on Offer & Demand arguments for future price movements, then how can you accurately predict future market swings?

I’ll get into specifics in future articles, but for this one I’ll give you the simple answer.

As the market moves because of mass psychology, the effect of prices moving show in the moods of people. You can simply enter Twitter and check your feed. If the price has risen, you’ll probably see a lot of people ecstatic, and if it has fallen, you’ll probably see a lot of people pessimistic.

This is where market psychology kicks in. Prices tend to repel extreme moods. Meaning if the price has been rising for a while, and you start seeing people in a complete state of euphoria saying delusional things and chanting only-up narratives, that’s when you should probably sell.

The opposite is also true. If the price has been falling for a while and you start seeing people in a complete state of panic saying things like “we’re going to zero” and world-ending narratives, that’s also probably when you should be buying.

That’s it for today, thanks to everyone for reading.

yRodos.

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