Why Nansen’s “Smart Money” analysis isn’t so smart

Inaccurate definition of Smart Money

Nansen defines Smart Money as the following:

crypto entities that trade or invest in a way that is considered experienced, well-informed, or “in the know.”

Upon deeper investigation, we realized their labeling of these so-called “Smart Money” entities is largely categorized by volume-based indicators, which we believe is an inaccurate signal when defining “Smart Money.”

In reality, wallets that exhibit large transaction volumes don’t always directly translate to being experienced, well-informed, or “in the know.”

Just because a wallet has a lot of volume, doesn’t mean they know what they’re doing in the markets.

Ineffective labeling

In addition to Institutions and VCs being labeled as “Smart Money,” other entities such as exchanges and smart contracts are added into the mix as well.

Unfortunately, this can lead to misinformation that wrongly indicates long/short signals.

Let’s go through some hypothetical situations to explain what we mean.

Case 1

Exchange addresses should not be labeled as Smart Money wallets.

When a large volume of tokens is transferred to an exchange, there is a high probability they will be sold.

In this example, since Nansen categorizes Exchanges as Smart Money, this large transfer is seen as a token inflow, which creates a bullish signal that can be misleading to investors.

Case 2

Misinterpreting an internal transaction between two wallets owned by a single entity.

When an unlabelled wallet address transfers tokens to a known Smart Money address, it is categorized as a token inflow, giving a bullish signal to investors. But in reality, the situation could be totally different – it could just simply be an internal transaction between 2 wallets owned by a single entity.

Case 3

Smart Contracts should not be labeled as Smart Money wallets.

When tokens are transferred to a Smart Contract, this is seen as a token outflow, giving a bearish signal to investors.

But, this is not always the case. It’s possible that a Smart Money wallet is simply depositing their tokens into a protocol like AAVE, in an effort to earn a yield on it. Instead, this could be a bullish signal because of the high confidence in token stability shown by the Smart Money wallet.

Misleading “Smart Money” signals

Nansen’s inaccurate “Smart Money” labeling sometimes causes misleading signals for their users – bullish signals when things are bearish, and bearish signals based on a nothing-event.

Here’s an example of what we’re talking about.

Let’s say a16z has 3 wallets: wallet A, wallet B, and wallet C. But due to Nansen’s labeling flaws, they only detected that wallet A and wallet B are part of a16z’s wallet network. So if a16z decides to move a large volume of tokens from wallet B (labeled as “Smart Money”) to wallet C (not labeled as “Smart Money”), Nansen will see this as a massive outflow of tokens from “Smart Money,” creating a bearish signal to its users – when in reality, they’re just simply transferring their assets internally.

By identifying areas of improvement in Nansen’s analysis of “Smart Money,” we developed a new parameter that’s more sensitive to market developments and offers deeper insights that lead to more accurate conclusions.

Introducing Elite Entity Cohorts – Web3’s most influential investors

What are the main differences between Elite Entity Cohorts and “Smart Money”?

1. Elite Entity Cohorts are composed of multiple data points.

Instead of using a single metric (volume) as a sole measure of importance, Elite Entity Cohorts are composed of 2 entities, each with its own characteristic that heavily influences token price:

• Top Holders
  • A collection of top wallet addresses currently holding the top 1% of tokens
• Top Movers
  • A collection of the top 1% of wallet addresses that produced the most token inflows and outflows in the past 30 days

2. Elite Entity Cohorts dynamically change with new market developments

In contrast to “Smart Money,” Elite Entity Cohorts are compiled using critical data points to generate more refined groups of wallet addresses to track.

Within a token ecosystem, there are constantly new buyers, new sellers, and new whales that emerge. And with these dynamics, static metrics like “Smart Money” quickly become outdated and ineffective. By incorporating Top Movers into the definition of Elite Entity Cohorts, we’re able to capture the dynamic nature of token ecosystems and constantly identify new groups of token holders that have the greatest influence on token price.

This results in more accurate insights into market situations which ultimately helps inform better investing decisions.

Why Elite Entity Cohorts have the edge on “Smart Money”

In the past, we believed that tracking “Smart Money” would give us an edge because they had insider information that helped them dominate the markets.

However, through further investigation into how “Smart Money” is defined (volume-based indicators), we found it difficult to observe any useful alpha or actionable insights from these particular groups of investors.

This is why we used a different approach to define Elite Entity Cohorts.

Alphalytics decided to focus primarily on market momentum (Top Movers) and price influencers (Top Holders) to identify Elite Entity Cohorts. And through numerous backtest experiments, we found that tracking the activity of Elite Entity Cohorts predicted price action with high accuracy.

If you’d like to learn about these backtest experiments, you can review our case studies here.

What do we look at when analyzing Elite Entity Cohorts?

Key metrics of Elite Entity Cohorts

• Transaction history
• Percentage ownership of circulating token supply
• Bull or short sentiment
• Paper hands or diamond hands