On-chain Metrics(Part-2)- Steemit Crypto Academy- S4W3- Homework Post for @sapwood

Hello Professor @sapwood. I loved this class from the first time. I think all knowledge that can enrich our understanding of cryptocurrencies is important. The events of the last week prove it, while some are fearful about the fall of Bitcoin and various Altcoins, others of us have peace of mind and understanding of things thanks to Onchain Metrics.

Let's get started.

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1. What is the difference between Realized Cap & Market Cap, How do you calculate Realized Cap in UTXO accounting structures? Explain with examples?

First let's start with the easiest term to understand: the market cap, which is the product of the current asset price times the total amount of currencies in the market.

_{Image taken from: ^Source}

For example, we have LTC which has at the time of this post a price of 163.1 USD (green box) and a total of 66 million coins (blue box). The multiplication of these two data results in Market cap (red box).

So from what we can see the market cap is a reflection of the general and current value of an asset, while on the other the Realized cap is a reflection of the value of the asset at a specific point in time. That specific point refers to the last occasion when the currency/ UTXO moved.

In fact, the Realized cap is nothing more than the sum of all the currencies that moved, at the price on the day the movement occurred.

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As we can see it is a totally different value than the market cap.

Therefore, another difference we can appreciate is that the Market Cap is updated every time the asset price goes up or down or new coins are issued or burned.

In contrast, the Realized cap is updated every time the currency is moved (sold) because it takes into account the price of the asset at that time, which could have been weeks, months, or even years ago.

In fact, a problem with the market cap is that it gives the same value to all UTXO's when in reality each UTXO has a different value. That difference is given by the Realized cap.

Let's imagine a hypothetical situation in a hypothetical cryptocurrency that has a circulation of 100 coins and a current price of 30 USD

On the other hand, let's imagine that the 100 coins are distributed in 5 UTXO's which have the following data:

UTXO	Close Price	Quantity of Units
5 years ago	2 USD	25
1 year ago	10 USD	30
6 Months ago	25 USD	15
1 Months ago	26 USD	20
1 week ago	29 USD	10

While the Market Cap is: 100x30= 3000 USD.

Realized cap is: (2x25)+(10x30)+(25x15)+(26x20)+(29x10)=1445 USD.

Realized cap relative to the market cap is a measure of how the asset has performed in terms of return. We know that the lower the Realized cap the more profitable the asset will be, but for this to happen the UTXO's where the lower price movements are recorded, should be the ones with the highest amount of units. For example, for the same amount of coins let's see a different UTXO distribution.

Realized cap: (2x50)+(10x30)+(25x15)+(26x4)+(29x1)=908 USD.

In other words, this translates to there should be more tokens held than in motion. This is consistent with the law of supply and demand, in which an asset that has been holdover for a long time increases in value by not offering the necessary supply to the market.

On the other hand, a high Realized cap indicates a lower yield, because it means that there were more coins in motion lately, increasing the supply and decreasing the price of the asset.

In fact, it can be the case where the Realized cap is higher than the market cap. This only occurs in bear markets and is a product of a large sum of currencies having moved at a time when the asset price was higher than the current price. For example, let's consider the original distribution, with extremely high prices in the last 3 UTXO's.

Realized cap: (2x25)+(10x30)+(100x15)+(120x20)+(80x10)=5050 USD

Which is much higher than our Market cap = 3000 USD and is reflective of an evidently bearish market.

To understand the relationship between the Market cap and Realized cap a little better and from another point of view, let's consider Block 79600 of the Bitcoin network which was mined on September 13, 2010. It generated a transaction of 50 BTC delivered to the miner. Data taken from Blockchain Explorer .

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According to data taken from the Block Explorer these coins have not been spent since then, so they are in a UTXO more than 10 years old.

To take the Market cap, those coins would be pooled with the rest in circulation and multiplied by the current value of Bitcoin (between 41000 and 42000 at the time of making this post) which would give a value of approx. 2,100,000 USD.

On the other hand, for the Realized cap, those coins would be joined to the rest of the coins in the same UTXO, i.e. those that have not moved since then, and multiplied by the price of BTC at that time (0.062 USD), which would give a total of 3.1 USD.

What we see here is that the Realized cap shows us the potential value of the coins that have not yet moved.... (a batch of coins that at the time was worth 3.1 USD, if it were to be moved now would be worth 2,100,000 USD).

If we wanted to perform a more accurate example, we should through Blockchain explorer locate all the coins that have remained unmoved, multiply them by their price at the time and add them up.

2. Consider the on-chain metrics-- Realized Cap, Market Cap, MVRV Ratio, etc, from any reliable source(Santiment, Glassnode, etc), and create a fundamental analysis model for any UTXO based crypto, e.g. BTC, LTC [create a model for both short-term(up to 3 months) & long-term(more than a year) & compare] and determine the price trend/predict the market (or correlate the data with the price trend)w.r.t. the on-chain metrics? Examples/Analysis/Screenshot?

For my fundamental analysis I have chosen Litecoin (LTC). On the other hand, all on-chain data and graphs are taken from my Santiment account.

REALIZED CAP

SHORT TERM (3 months)

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The Realized cap is a fairly simple indicator to understand, in fact in this chart we see how its behavior contrasts with the price action. For example, at the end of July, the price starts a sideways movement which can be translated as a consolidation period after a previous bearish period. In the bearish period, we see how the Realized cap line becomes slightly descending, on the other hand in the consolidation phase, it becomes totally flat.

Then in early August, a bullish phase begins where we see the Realized cap take a steep bullish shape, indicating that the bullish phase of the price is strong. This is because as the trend gets stronger and the asset rises higher in price, more and more people hold onto their coins, hoping to make even more gains.

LONG TERM (3 years)

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In October 2020 we see that the LTC price is in a sideways accumulation phase, at this point the Realized cap is completely flat in line with expectations.

Then at the end of 2020, the bullish rally occurs and the price soars from USD 75 to USD 393 4 months later. In all this time, the realized cap showed a totally steep bullish contour, thus affirming the strength of the trend.

On the other hand, the interesting thing happens after the bullish phase. In May it starts a strong bearish phase, which made the price fall from 393 to below 120 USD. However, in this time the realized cap as expected did not fall steep but described a shallow decline, which means that people were reluctant to divest their positions even with the fall of LTC.

The explanation for the latter pattern obeys a psychological explanation. Even with the falling price people keep the faith that the asset will rise again, moreover, if they were to dump their coins they would do so at a loss... such reason, most decide to wait, and only a few dump their coins. For such reason, the Realized cap describes only a slight downtrend that seems not to be in line with the asset's fall.

MARKET CAP

The market cap alone does not give us much to see, as it moves in tandem with the price action, so to make the analysis more interesting I will link it to the Realized cap and interpret the signals from both together.

SHORT TERM (3 months)

_{MC: market cap, RC: realized cap. Image taken from: ^Source}

In this case, we can first observe that the market comes from a bearish period of consolidation. This is confirmed by observing the Market cap lower than the Realized cap. However, at the beginning of August, a bullish period begins which is also confirmed by the location of the indicators, Market cap above the realized cap.

LONG TERM (3 years)

_{MC: market cap, RC: realized cap. Image taken from: ^Source}

This chart is even more interesting because it shows us everything in perspective. Since the end of 2020, the LTC has been in frank growth, which goes hand in hand with the Market cap above the realized cap.

What this is telling us is that during this period holders have plenty of opportunities to profit. But on the other hand, the sustainability of the trend over time also indicates that a correction could occur. As indeed happened in early May.

At this point the market starts a bearish loss, where the realized cap becomes higher than the market cap, thus starting a period of accumulation prior to another bullish phase.

MVRV RATIO

SHORT TERM (3 months)

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Studying the MVRV is very interesting, as it can give you buy and sell signals as well as identify patterns.

For example in this case, at the beginning of July 2021, the price is in a kind of sideways movement, however, the MVRV starts to show lower highs: LH1 = 5.57% , LH2= 2.45%. LH3= -3.69% . At this point, it is already below 1%, which is a clear indication of an extended bearish period of the market.

After this bearish period, a lower threshold occurs which tells us that the downtrend has reached a bottom. This predicts a trend change from bearish to bullish, which is also a good buy signal.

Time proves him right, and next the MVRV starts to show higher highs HH1= -2.24%, HH2= 14.35%, HH3= 22.8%, HH4= 33.93%, HH5= 44.21%, HH6= 44.7% and higher lows HL1= 8. 43%, HL2=17.99%, HL3= 29.21%, HL4= 30.39% , HL5= 33.95%, all above 1%; which is a clear indication of a bullish market period with a strong trend.

Here something interesting happens again, during the uptrend, the MVRV produces an upper threshold at 44.21%, which to the untrained eye could mean a trend change, however, what happens is that the price corrects and then resumes the uptrend forming another HH at 44.7%.

This next higher high in the MVRV indicates the possibility of price peaking in the next few days, which is confirmed almost a month later.

This means that the MVRV can help us predict future price movements.

LONG TERM (3 years)

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Firstly at the end of September 2020, we see that at the beginning of an uptrend in price the MVRV is below 1%, signifying an accumulation zone that will later function as support for the price.

Then the MVRV starts to show higher and higher highs confirming the strength of the trend: HH1= 32.49%, HH2= 120%, HH3= 167%, HH4= 170%; this last point is an upper threshold which we can take as a sell signal as it predicts the beginning of a bearish phase in the price.

This bearish phase is confirmed by the MVRV which shows lower and lower highs, : LH1 = 130.82% , LH2= 99.41%, LH3= 46.42%, LH4= 30.78%.

In the middle of July the MVRV is below 1%. It is at this point that we encounter a lower threshold and a predicted support level at the end of 2020, at which point the price rebounds and a new bullish phase begins, accompanied by the MVRV surpassing the 1% line and forming higher highs.

In this case, we can see that both the upper threshold and the lower threshold functioned as a signal to predict a trend change due to an oversold or overbought asset.

3. Is MVRV ratio useful in predict a trend and take a position? How reliable are the upper threshold and lower threshold of the MVRV ratio and what does it signify? Under what condition the Realized cap will produce a steep downtrend? Explain with Examples/Screenshot?

I think I can answer the first and second question in this section at the same time.

The answer is YES!!!, because the MVRV gives us overbought and oversold signals in the form of upper threshold and lower threshold, and as we already know overbought and oversold signals are indications of a trend change.

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An upper threshold indicates that the uptrend has already reached its top, and that it is now time for the price to correct in a distribution period, therefore it is expected to start a downtrend, so traders can take this indicator as a sell signal.

However, this signal then needs to be accompanied with the MVRV forming lower and lower highs to confirm the trend change.

On the other hand, a lower threshold tells us that the downtrend has already reached its top, and that now the price has entered an accumulation phase, therefore it is expected to start an uptrend, so traders can take this indicator as a buy signal.

However, this signal then needs to be accompanied by the MVRV forming higher and higher highs to confirm the trend change.

On the other hand the confidence of both signals is not the same due to some factors.

In the case of the lower threshold (MVRV < 1%) it is a much more reliable signal of trend change as it indicates an accumulation zone where the asset collects the necessary liquidity to start a new bullish phase.

However the upper threshold is a less reliable signal as it does not always represent the end of an uptrend but a price correction as we will see, especially if the upper threshold MVRV is below 200%.

This effect is entirely psychological, since when a first peak occurs (UT1) a certain group of marginal traders sells their assets mistakenly believing that the uptrend came to an end. This naturally causes the price to correct, which can be taken by other traders as a buy signal... which in turn causes the main uptrend to resume.

In an asset behaving under Elliot waves, this can happen up to twice before reaching the final upper threshold, as is the case in this example.

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For this reason the upper threshold of the MVRV is less reliable for predicting a trend change.

Under what condition the Realized cap will produce a steep downtrend? Explain with Examples/Screenshot?

As already stated in class, even in bear markets the Realized cap shows a completely flat contour or failing that a gentle fall, a product of the faith that people may have in the asset.

So the only scenario where the Realized cap can produce a steep downtrend is if people lose all confidence in the currency and there is a massive sell-off in the asset.

This could occur as a result of an external factor that weakens the confidence or public image of the project or of the cryptocurrency itself, as was the case of Ripple (XRP) at the end of 2020, when it was sued by the SEC, the agency that controls the stock market in the United States. See this Article

These lawsuits undermined public confidence in Ripple, which translated as a steep downtrend in the Realized cap in early 2021 as shown in the chart below.

_{Image taken from: ^Source}

Note that this small bearish phase was very different from the bearish phase that occurred in May 2021 where the price fell but the Realized cap remained in a shallow downtrend. In fact, Ripple was one of the few cryptocurrencies that did not have a sustained bullish phase since the beginning of 2021 as a result of this problem with the law.

Conclusion

The knowledge of the Realized cap has proven to be a very valuable tool, as it shows us in a more specific way the true underlying value of an asset.

Through it, we have access to the MVRV indicator which is perfect for indicating trend changes in the fundamental study of an asset. On the other hand, it also allows us to observe certain patterns by comparing them are market cap and price action.

All these tools together further strengthen our knowledge and understanding of the internal processes that occur in a cryptocurrency, and therefore help us to make better decisions.