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Hackernoon logoWhat Centralized Exchanges Tell Us About Crypto Investors by@jrodthoughts

What Centralized Exchanges Tell Us About Crypto Investors

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@jrodthoughtsJesus Rodriguez

Chief Scientist, Managing Partner at Invector Labs. CTO at IntoTheBlock. Angel Investor, Writer, Boa

When comes to trading, centralized exchange rule the crypto market. Based on some of the work we have done at聽IntoTheBlock, we believe around 40% of the daily volume in major cryptocurrencies is processed through centralized exchanges. Sadly, centralized exchanges are also one of the most difficult components to analyze in the crypto space and a regular source of poor/fake data.

However, if we are able to understand the behavior of crypto exchanges, they can become one of the most powerful and unique sources of intelligence for crypto assets.

At聽IntoTheBlock, we have been doing some creative machine learning work to understand the behavior of crypto exchanges. Our machine learning models are able to effectively identify the key elements of a crypto exchange and understanding their behavior.

That work has been fascinating from an intellectual standpoint but its rather a foundational element of a market intelligence strategy rather than a source of intelligence by itself.

By understanding the characteristics of centralized exchanges, we can develop unique signals and indicators that are optimized for crypto assets and have no equivalent in other asset classes.

Turning the Tables: A Unique Source of Intelligence About Crypto Assets

Centralized crypto exchanges are both an element of obfuscation but also a unique source of intelligence for crypto assets. The centralized architecture of exchange hide a lot decouple their order book activities from the underlying blockchains.

From that perspective, order book metrics are a more accurate source of intelligence to detect real time patterns in daily trading activity.

However, we now know that we can use machine learning methods to understand the internal topology and patterns of centralized crypto exchanges.

Combining the order book and blockchain data records of centralized crypto exchanges provide a very unique source of intelligence.

Think about it, how much would investor pay to obtain relevant data from the fund flow activity related to exchanges such as NASDAQ or NYSE? Using a data-first approach to understand the behavior of centralized crypto exchanges leads us on two complementary directions:

i.聽Order Book Data Fees:聽Contain relevant patterns about the behavior of traders in a specific exchange.

ii.聽Blockchain Data Fees:聽Provide relevant intelligence of flow of funds in and out of exchanges as well as complementary metrics.

While the first element is common in other type of public market exchanges, the latter is very unique to crypto. If anything, monitoring the blockchain footprint of exchanges has some similarities with the analytic techniques that are often used in dark pools to track the activity of individual investors. Combining order book and blockchain analytics provide an incredible source of intelligence about the behavior of crypto exchanges. Before we get into specific metrics or indicators, let鈥檚 do a quick recap about the architecture of centralized crypto exchanges.

A Quick Recap About Centralized Crypto Exchanges

In previous posts, we鈥檝e discussed some of the internals components of the architecture of centralized crypto exchanges. In essence, there are four key components that are relevant in the behavior of centralized crypto exchanges:

路聽Hot Wallets:聽Hot wallets are typically the main interaction point between external parties and an exchange. Exchanges use this type of wallets to make an asset available to trade.

路聽Cold Wallets:聽Exchanges use cold wallets as a secured storage of crypto-assets. This type of wallets typically hold larger amounts of assets that are not intended to be traded frequently.

路聽Deposit Addresses:聽Deposit addresses are, often temporary, on-chain addresses used to transfer funds into an exchange. The focus of this type of address is to facilitate user to exchange money flows.

路聽Withdrawal Addresses:聽Withdrawal addresses are, often temporary, on-chain addresses that are used to transfer funds out of the main exchange wallet. Sometimes withdrawal addresses can play a dual role as deposit addresses.

Some Fascinating Indicators About Centralized Crypto Exchanges

The interaction with public blockchains differentiate the behavior of centralized crypto exchanges from any other type of financial exchange in public markets. The combination of order book metrics and blockchain analysis yields very unique sources of intelligent that describe unique patterns of crypto assets. Here are some interesting ideas:

路聽Inflow-Outflow Volumes:聽Calculating the volume of inflows and outflows provides relevant metrics that could serve as predictors for large positions on a specific crypto assets. IntoTheBlock soon-to-be-available Inflows-Outflows signals tracks this trend very effectively.

路聽Exchange Liquidity:聽The difference between inflows and outflows provides a relevant sign of available liquidity for specific exchanges. Liquidity over time is an important measure of the ability of an exchange to fulfill orders.

路聽Cold Wallet Balances:聽Tracking the balances in cold wallets is also another measure of relevant liquidity as well as the proof of funds of specific exchanges.

路聽Exchange Liquidity Risk:聽Correlating the liquidity measure of an exchange with the recurrent spreads between bid and asks in order book is a relevant measure to track risks. Large liquidity levels indicate the ability of an exchange to fulfill orders versus potential levels of risks.

路聽Order-Book-Volume-Volatility Correlation:聽There is a well-documented relationship between the volume of a specific order book and volatility fluctuations. The main theoretical explanation for the relation is that the arrival of new information makes prices adjust to new equilibria over time.

路聽Token Listing Predictions:聽Large transfers about specific tokens to exchange deposit addresses could be a signal of a potential listing in the exchange. Listings typically result in short term spikes of a given token.

路聽Whale Activity Monitoring:聽Monitoring transfers from large token holder into exchange deposit addresses could.

路聽Smart Price Momentum:聽Smart price is a well established metrics of order book analytics that measures the spread between the bid and the asks over time correlated with the inverse volume of bid and ask orders.

路聽Deposit-Withdrawal Address Balance Momentum:聽An indicator that measures the ration on the balance of deposits and withdrawal addresses over time is a nice complement to the exchange inflow and outflow relationship and can measure the sentiment of investors in an exchange.

These are just some ideas of new indicators that can help to provide objective insights about the behavior of crypto investors in centralized crypto exchanges.

The ability to understand the blockchain architecture of an exchange provides a unique source of information to extract relevant patterns about the behavior of crypto investors as a group.

More importantly, centralized crypto exchange datasets serve as a natural complement to order book fees providing a cycle of information that has no equivalent in any other asset class.

(Disclaimer: The Author is the CTO at IntoTheBlock)

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@jrodthoughtsJesus Rodriguez

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Chief Scientist, Managing Partner at Invector Labs. CTO at IntoTheBlock. Angel Investor, Writer, Boa


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