DeFi
How to effectively manage DeFi risks
Even though decentralized finance (DeFi) is on the right track in terms of growth and adoption, the space remains full of risks, uncertainty, and volatility. One of its biggest advantages over centralized finance is the availability and accessibility of financial data. Because transactions are public, blockchain provides a unique opportunity to understand market sentiment through data analysis.
This innovative perspective is known as on-chain analysis. Simply put, it is the practice of analyzing the fundamentals, utility, and transactional activity of a cryptocurrency and corresponding blockchains in order to predict future price action and a broader range of metrics. walk.
Iakov Levin is the founder and CEO of Midas.Investments, a CeDeFi (centralized decentralized finance) crypto-investment platform.
On-chain analytics provides a view of the digital financial system for better decision-making and helps answer critical questions: Who owns the majority of assets? Are holders of a specific token sitting on profits?
Why do we need on-chain analysis?
Any form of investment requires a thorough analysis of market sentiment and capital situation. Traditional business analysis always presents a challenge because market data is not always transparent.
On the other hand, the transparent nature of DeFi means that there is plenty of data accessible. However, for this data to be actionable, it must be refined, organized and transformed into understandable information.
The on-chain analysis approach fills this gap. It creates an effective practice for measuring the necessary data and metrics and potentially simplifying complex investment decisions.
Additionally, it can be a powerful practice for identifying protocols with high liquidity and security risks. We are only in the early stages of on-chain analysis. However, the emergence of more innovative data brokers and analytics solutions could enable next-generation on-chain analytics to bring more comprehensive visibility to the entire DeFi sector.
The negative side of on-chain analysis
It is important to remember that we should not rely solely on on-chain analysis. More often than not, this does not provide a complete picture of market transactions where we see the skeleton data of transactions without understanding their context. There is a risk that one cannot get the full picture of what is driving current market sentiment – and how long it might persist.
The crypto and DeFi spaces are highly strategic. Recently, we have seen tweets or announcements from influential public figures dramatically increasing specific tokens beyond their projected value, and small changes in regulation completely decimate a token’s floor price. These prospects are relatively common in the DeFi space, which cannot be predicted by on-chain analysis.
Focusing too granularly on micro-details can result in losing the larger strategic narrative. Even though such analytics effectively provide essential information about each transaction, they cannot provide broader context by linking each activity across the blockchain.
Nonetheless, these pitfalls of on-chain analytics may be resolved in the future when we see more and more wallets being tagged on exchanges, allowing investment decisions to be made in a much more balanced and efficient manner.
How to Use On-Chain Analytics Effectively
The most critical on-chain metrics that investors tend to rely on are liquidity indicators and how they change over time. On-chain analytics seeks to provide insights into how liquidity spreads from one protocol to another over time. For example, if a network experiences high liquidity, it can be predicted that certain protocols and associated tokens will lose value.
There are several different analysis tools, suitable for different levels of investors. The most basic is Nansen, which allows users to dig deeper into what’s happening in wallet addresses across the blockchain. Nansen helps identify token flows between major players, where money is moving and deposited, which non-fungible tokens (NFTs) are positioned for higher prices, and more.
Then there is Dune Dashboard, where users (usually advanced traders) can write SQL queries to identify and track required metrics and convert them into comprehensive visual charts. There are also other popular tools tailored to specific blockchains, such as Etherscan, Santiment, and Messari.
The Intense Demand for On-Chain Analytics and Its Future
On-chain analytics has become a powerful tool in recent years, especially for investment companies and venture capital funds. Many have built their own advanced on-chain analytics systems to identify deeper metrics and effectively manage their clients’ risk positions. Several startups have also entered the blockchain data analytics market, working as data brokers and providing actionable blockchain analytics data to major venture capitalists (VCs) and investors.
The future of on-chain analytics looks bright. This intense demand for on-chain analytics will continue to grow as Web3 services are expected to grow by 700% over the next five years. As more venture capital firms and hedge funds use these analytics to make sustainable decisions and more data brokers enter this space, the current on-chain analytics challenges will be raised through innovation.