As the digital asset market matures, more and more professional investors are entering the market. As a result, new valuation methods – often borrowed from the traditional financial markets – are entering the cryptosphere.
In this guide, we will introduce the NVT Ratio and explain how it can be used to value digital assets, such as bitcoin.
What Is the NVT Ratio?
The NVT Ratio (Network Value to Transactions Ratio) is a digital asset valuation metric that takes the market capitalization of an asset and divides it by how much is being exchanged each day in USD. This metric can be used to gauge whether the price of a digital asset is currently overvalued or undervalued.
In NVT’s current iteration, a moving average is applied to the transactions to make the denominator of the equation less volatile. Smoothing out the results gives the world a legitimately useful, blockchain-specific indicator.
If the NVT ratio is above 150, it is in the overbought range, and it may be indicative of a market top. On the other end of the spectrum, if it is below 45, then it is in the oversold zone, and this could indicate a market bottom.
NVT = Bitcoin’s P/E Ratio
The relative value of a company’s stock price has long had to stand the test of the classic P/E ratio. This ratio is calculated by dividing the stock price by a company’s earnings per share. If the P/E ratio is high, it means the company is either in a growth phase or the stock is overvalued. NVT provides sets the stage for a similar analysis of bitcoin.
For example, when bitcoin was first ramping up between 2010 and late 2011, it’s NVT ratio was well above 150 for most of that time. As the initial growth stabilized, the NVT ratio started to correlate with price action because the initial growth phase had ended.
Although, it is virtually impossible to predict a bubble, there is a strong correlation between each major dip of BTC and NVT. During each of the four major dips, when the “bubble popped” NVT was above 150.
Again, this doesn’t necessarily mean that every time NVT hits 150, there’s a bubble. It could also be that bitcoin is experiencing a growth phase and continue to move higher.
A Smart Way to Use NVT
The NVT ratio can be a good tool for figuring out if a drop in price is a true crash or merely a consolidation.
When a digital currency is “hot,” there is usually a whirlwind of buying on the part of both veteran traders and those who are hopping on the bandwagon for the first time. In nearly every instance, the price drops after an initial surge.
Sometimes, that’s because the price is consolidating. Investors are grabbing profits and others are waiting for a better entry point. As the price hits the desired entry point, more investors pour in, and the move north is supported.
Other times, the market doesn’t see real value and what seemed like a passionate love affair ends up being a momentary infatuation. The price drops, investors keep selling, and the price continues to plummet.
If, on the NVT graph, the ratio stays within its normal range during the ups and downs of a price adjustment, the price is consolidating. However, if the NVT ratio spikes, transactions are not keeping up with the price. In that instance, the price plunge will likely continue.
Keep an Eye on the NVT Ratio
The next time the price of BTC drops significantly and then, does it’s typical dead cat bounce back up, you could check the NVT ratio.
If the NVT ratio is high while the price is “recovering,” you could look out for a possible drop lower because the transactions are not supporting the upward move in price. On the other hand, if NVT is in the normal range, it could signify that the move down was a consolidation, and the price may be poised to continue higher.
Although it is impossible to accurately foretell price action, the NVT ratio can provide helpful insights into why prices are moving as they are.
- Blockchain Valuation Metrics: A Working Guide for Investors
- Digital Asset Valuation: Metrics for Valuing Bitcoin, Altcoins, and Cryptocurrencies
- Bitcoin Valuation Spreadsheet: Economists Agree on $13,333.33 (With Downloadable Spreadsheet)
If you would like to learn more about how to trade bitcoin, subscribe to Bitcoin Market Journal today!