As we continue with our Bear Market Tactics series, we start to get into the more technical side of reading and understanding blockchains.
So far in the series, we have covered how to read on-chain data and perform on-chain financial analysis to identify promising opportunities to start allocating capital with a dollar-cost averaging approach.
This week we will dive into how to use a blockchain explorer to track and understand transactions and look into other helpful information a blockchain can provide us.
While using a blockchain explorer isn’t necessarily an activity or tool that you use specifically during bear markets, these market downturns provide us with an opportunity to understand and master them.
What Is A Blockchain Explorer?
Transactions on a public blockchain are visible to everyone; however, reading this raw data is exceedingly complicated from a technical perspective. Just as Google made it possible to find specific web pages on the internet, a blockchain explorer does that for the transactions on their blockchain.
There are several block explorers to choose from, each with unique offerings, generally focused on a specific blockchain. This week we will concentrate on Bitcoin block explorers.
Due to Bitcoin’s simplicity, Bitcoin block explorers are generally relatively straightforward. The first thing to understand when it comes to reading Bitcoin transactions is that it works on a UTXO model.
Bitcoin’s Accounting Model
There are generally two types of accounting or record-keeping models in blockchain design: account-based and UTXO. Ethereum uses an account-based model, while Bitcoin uses the latter.
UTXO stands for “Unspent Transaction Output”. Satoshi, when designing Bitcoin, chose this model because it helped solve the double-spend problem.
You can think of UTXOs as cash in your wallet. Every UTXO represents a different note or coin that adds to the total amount in your wallet. If you had $100 in your wallet, it could be made up of one single $100 bill, two $ 50’s, or one $50, two $ 20’s and a $10 and so on. Despite the different values, they still add up to $100, and each is equally spendable, but how are UTXOs created in the first place?
Many analogies can be provided to understand UTXOs; however, Glassnode (who we use for our on-chain analysis) describe UTXOs as the equivalent to gold coins:
Although a unit of bitcoin is divisible, we should not think of bitcoin amounts like a dividable liquid, but instead as discrete quantities, like GOLD Coins.
Consider this analogy between UTXO and GOLD Coins where 1 BTC = 1-oz of gold:
- When one receives 1.5 bitcoin to an address, the owner now owns 1.5 bitcoin held in a UTXO. Using our analogy, this is the equivalent of “receiving a 1.5-oz GOLD Coin“.
Source: Glassnode Academy
- To spend 0.2-oz of the gold coin at a shop, the owner cannot simply break off a piece of the coin and pay only that piece. Instead, they must “Melt the entire 1.5-oz amount” by putting it into a Transaction (analogy is a “Melting Pot”).
- This process destroys the original 1.5-oz gold coin (the UTXO is destroyed), and mints a new set of gold coins with new denominations (UTXO creation). In this case, the transaction will create:
– one 0.2-oz gold coin —> paid to the shop owner
– one 1.299-oz gold coin —> returned to the original owner as change
– a small fee of 0.001-oz —> paid to the operator of the mint for their services (analogy is the Bitcoin miners)
– Total value is 0.2 + 1.299 + 0.001 = 1.5-oz
Source: Glassnode Academy
- With the transaction, the network can divide and “Mint” the gold coin into any set of arbitrary denominations of “New Coins” (analogy is newly created UTXOs) and send it to as many different addresses as is required.
- Bitcoin miners, who are the equivalent to operators of the melting and forging equipment, take a small fee for their services (the transaction fee).
While the UTXO model can be more complicated to grasp, it does provide several benefits over other models, including:
- it helps avoid the double-spend problem
- it improves privacy as users can use a new address for each transaction
- there is improved scalability as transactions can be processed in parallel
How To Use A Block Explorer
Now, with an understanding of the UTXO model, we can dive further into using a block explorer and reading blockchain data.
There are many block explorers to choose from; we use the explorer offered by blockchain.com. It is a free service that anyone can use and has an intuitive UI to visualise and interpret blockchain transactions.
When using a blockchain explorer, there are different metrics and levels of analysis you can do, from general network health to looking at individual blocks and transactions.
Analysing A Block and Its Transactions
Every single block has a sequence number associated with it, also known as its block height, one of the most recent blocks is block 744947.
You can obtain a lot of information from each block. As you can see from the above, you can ascertain the block hash, its timestamp, the number and value of transactions contained within it, the difficulty, the transaction fees and other information. This can be very handy when you want to understand the specifics of any block.
You can also now go and look at the individual transactions that have occurred within that block, and this is where the UTXO model is more apparent. Each has a unique transaction hash, making it possible to track any single transaction ever made on the Bitcoin network. Take the following transaction hash as an example:
If you look at the above information closely, you will see that the transaction was made on the 22nd of May 2010 at 20:16. The total amount spent in this transaction was 10 000 BTC; it is, in fact, the infamous Bitcoin pizza transaction. At today’s prices, this transaction is worth over $200 million.
You will also see the UTXO model working; there are 131 inputs that make up the total amount of 10 000 BTC. If you followed the link above, you would also notice that you can start tracking where the money was sent and follow a complete transaction history from then on. This block explorer has a handy feature as the red and green globes on the right-hand side tell us whether the bitcoin sent was spent or not after this transaction. If you do some digging, you will see that the 10 000 BTC were sent to another address (“spent”) after the transaction, but the address that received the mining reward still holds the 50 BTC.
We encourage you to go and use the above block explorer as it helps you understand exactly how transactions work on the Bitcoin network. However, there is still a lot more information one can gather from a block explorer besides transaction data.
Assessing Network Health
Block explorers can also provide vital information one can use to assess the network’s health, including hash rate and its distribution, the number of transactions, transaction volume, the mempool size, the difficulty of the network and average confirmation times to name a few. For a complete list, you can go here.
Under the Block Details page, some of the more important to pay attention to are the total number of transactions, which you want to see increasing over time. The other important metric to watch is the confirmation times; we have previously written about the difficulty adjustment and how that affects the time it takes for a miner to mine a block. Many factors affect confirmation times, such as total network activity, transaction fees and hash rate; however, as long as they stay consistent over time, you can see that the network is operating as designed.
Mining information can also be particularly useful to follow. Miners, after all, are one of the most critical participants in the Bitcoin ecosystem. You can assess the hash rate, which should increase over time. The hash rate can also be significantly affected by market conditions because when the market has a downturn, those miners with high operating costs are expected to capitulate.
Another interesting piece of information is that we can track the distribution of the mining hash rate.
While it may look like mining is super concentrated between four mining pools, you must remember that these pools are made up of a large variety of individual miners who contribute hash power to the pools to increase their chances of being rewarded. Most work on a pro-rata share basis minus the fee the pools charge. For most people, it can be a cost-effective and easy way to get into mining in the first place; however, it does lead to a degree of concentration risk.
There are many different metrics that are handy under network activity, including the number of unique addresses used, transactions per second, tracking UTXOs and other information.
One interesting metric is also watching the size of the mempool. The mempool is a record of all the transactions that have been submitted to the network but have yet to be added to a block. These are most often transactions that haven’t been submitted with a transaction fee high enough and serve as an excellent example of the free market nature of Bitcoin’s transactions and how you are required to pay (or “bid”) for the limited block space.
You will see that during periods of high activity on the blockchain (often coinciding with a bull run), there are a large number of transactions that sit in the mempool, waiting to be confirmed.
We have just mentioned some exciting metrics you can look at. We always recommend exploring these for yourself and understanding them in more depth. Blockchain analysis is a fascinating subject!
The ability to use a blockchain explorer is an important one in the world of blockchain. It allows you to track your transactions and understand more about the blockchain you are using. It can provide helpful information that allows you to assess the health of the network and ensure it is operating as designed. These pieces -of information are all necessary when it comes to deciding what blockchain to use if you plan on building on one or if you want to invest in its network token.
Next week we will cover an Ethereum block explorer and its account-based model. If you have any questions or have trouble using the network, please feel free to reach out and ask us questions. We always look forward to chatting with our readers. Otherwise, please feel free to share this article if you know anyone who is interested in learning more about using a block explorer.
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This is not financial advice. All opinions expressed here are our own. We encourage investors to do their own research before making any investments.