We Solved One of the Longest Standing Mysteries in Bitcoin

As cryptocurrency analysts, we rely on public websites like block explorers and data aggregators to help us with our job. One of the consistent providers of high quality data over the years has been Blockchain.info, which presents a wide variety of useful charts and graphs of the Bitcoin network. However, since its initial publication in 2011, one chart in particular has gotten more attention than any other: Estimated Transaction Value (ETV).

The reason is because of the nature of Bitcoin’s blockchain and transaction structure, which make it very difficult to identify the true value of a Bitcoin transaction. For example, if Alice owns 10 BTC and she wants to send 1 to Bob, she needs to use the entire 10 BTC as an input to the transaction. She sends 1 BTC to Bob’s address and returns 9 BTC to herself as change. It can look something like this:

Source: Blockchain.info, Digital Asset Research

This sounds easy, but complicating matters greatly is the fact that a wallet is collection of addresses which may be impossible for outsiders to identify as being related. This is why Blockchain.info’s methodology for transaction value estimation is so important — they run a wallet service with 24M accounts.

Our Own Methodology

Today, we are happy to announce that we finally understand Blockchain.info’s estimation methodology. Not only that, but we have created our own DAR methodology that also estimates change addresses and improves on a number of measurements, including transactions with data written into the blockchain and transactions that utilize new address types, like Bech32 addresses. We have also ported this methodology to other UTXO based blockchains, like Litecoin, Dash, and Bitcoin Gold.

Source: Digital Asset Research

The key to solving this mystery did not lie in the periodicity of token movements, the reliance on academic papers, or any other well circulated theories, but simply the measurement of the number of inputs and outputs in a particular transaction.

A Comparison of Measurements

So how does our DAR’s methodology compare with Blockchain.info’s? The following chart gives you a sense of the magnitude of the difference in US dollars.

Source: Digital Asset Rearch, Blockchain.info

As you can see, our methodology estimates higher transaction values relative to Blockchain.info until January of this year, when that was inverted.

We expect that as new address types are used more frequently and more data is written into the blockchain, these measurements will increasingly diverge. We are vigilant about new technologies, measurement techniques, and protocol updates, which may impact our estimation methodology.

Why Is This Important?

The importance of estimating true economic activity on a blockchain cannot be understated. First, it underpins the Equation of Exchange, or colloquially MV = PQ, which is still one of the best valuation tools we have at our disposal. The PQ in the equation is simply the on-chain transaction value (in USD), or Estimated Transaction Value (ETV), in our Bitcoin example. We use this equation throughout our valuation framework, which includes Top Down, Bottom Up, and Ratio (NVT ratio) methodologies. Second, it is used in the analysis of token velocity, which is important to understand the debate between Medium of Exchange and Store of Value use cases. Finally, it helps us compare the relative sizes of economic activity on a network, especially when comparing UTXO based protocols like Bitcoin and state based protocols like Ethereum.

Next Steps

We plan to continually review and update our estimation methodology as our understanding about this technology and the tools available to us continues to grow. For those interested in receiving a sample of this data and to find out more about our data and research subscriptions, including market intelligence, blockchain data, and price indices, please fill out a request for information form here.

Maybe for our next project we will finally get around to revealing the true identity of Satoshi Nakamoto.