With new technology comes new ways of using market indicators.
As the largest crypto currencies like Bitcoin and Ethereum have been rallying in recent weeks, some of these new indicators have not been confirming the rally, bringing its sustainability into question.
Today, I am going to introduce you to this new regime of indicators, and discuss what this divergence may be telling us about the next big move in crypto currencies and highly correlated crypto stocks.
Public blockchains are entirely open to the public
Before we get into the new regime of indicators that can now be used by traders to measure crypto trends and possible sentiment extremes/divergences, it’s important to have a very basic understanding of what actually occurs on the Blockchain.
The process of transferring Bitcoin funds from one user to another begins with the submission of a transaction request.
Nodes, which are computers connected to other computers on the blockchain network, verify the transaction details.
Bitcoin transactions consist of three separate elements – input (sender), header (transaction and funds information), and output (recipient info).
Once these elements are verified, the transaction is approved, the funds are transferred, and the transaction becomes part of Bitcoin’s public ledger.
Each transaction undergoes 6 confirmations before being fully verified, and the whole process can take from 10 minutes to 16 hours.
Public blockchains are entirely open to the public and accessible to anyone, which means that anyone with an internet connection is allowed to contribute to and interact with a given blockchain.
Thus, any person can download a public blockchain’s software and run their own node, allowing them to verify its information and/or add new blocks to the blockchain.
Due to being open for anybody’s contribution, popular public blockchains such as Bitcoin and Ethereum are composed of thousands of nodes actively contributing to the maintenance of their blockchains.
This forms a global and decentralized network of independent nodes where each node communicates with and verifies the work of other nodes instead of a single entity, or a small group of entities, controlling the system.
Although participants can remain anonymous during the creation of a blockchain transaction, information regarding numerous metrics generated during these transactions, such as transaction sizes and the number of active addresses, are public information that can be turned into indicators that traders can use to make better decisions.
From data comes indicators
As Figure 1 shows, Bitcoin ran into some resistance near $51K as it neared the 61.8% retracement level of the April through June sell-off this past Monday.
Typically, when the price of a security we are either trading or are interested in trading nears a big level we want to use secondary indicators (indicators other than price) such as sentiment or momentum to get a sense of how difficult it may be to move through that level.
The indicator I want to introduce you to today is one that you’ll never find in any technical analysis books and probably won’t come across when reading articles about trading in the crypto space.
The indicator to which I am referring is the number of active addresses.
Specifically, this indicator represents the number of unique addresses that were active in the network either as a sender or receiver, and only addresses that were active in successful transactions are counted.
For our purposes today, think of this data series as a demand side indicator, which are indicators such as certain volume studies that a trader would typically use to gauge the amount of demand underpinning a price trend.
In Figure 2 below, I’ve plotted the 7-day average of this indicator (solid blue line) against the chart of Bitcoin (dashed blue line).
On the chart above, you’ll notice that demand for the Bitcoin network, measured here by the number of active addresses (solid blue line), has either risen or fallen pretty much in lock-step with the price of the cryptocurrency in recent months.
More recently, however, you’ll notice that the number of active addresses (solid blue line) has been slow to grow at the same pace of the rise in the price of Bitcoin (dashed blue line).
Traditionally, such demand-side indicators of network effects are powerful predictors of future price movements.
Therefore, as the price of Bitcoin stares down the traditional technical resistance (61.8% retracement) shown on Figure 1 above, this obvious lack of demand should be seen by anyone playing Bitcoin or crypto stocks from the long side as a reason to be on the lookout for any signs that Bitcoin’s rally from the July lows is breaking down.
At the same time, the recent strength in Bitcoin prices can possibly be seen as strong HODLing, which, if prices remain stable and demand in the form of active addresses starts to pick up again, could unleash a FOMO rally as reluctant longs are forced to chase the rally.
In other words, the price of Bitcoin sits at a critical juncture between critical resistance at $51,000 and support at $43,935, and the next big move is likely to come on either side of this range.