The NVT ratio or “Network Value to Transactions Ratio” is one of the new crypto-native investment tools. Investors use The NVT Ratio and the updated NVT Signal to spot crypto bubbles and buying opportunities.
The NVT ratio tracks the dollar value of transactions on the Bitcoin blockchain and measures this against its market value. The product is a P/E-like cryptocurrency investment ratio to track relative value and bitcoin market cycles.
The P/E Ratio of Cryptocurrencies
The NVT ratio is also known as the P/E (Price to Earnings) ratio of cryptocurrencies. It uses Transaction Volume (On-Chain) as a proxy for underlying value and measures this against market value – just like the P/E Ratio measures the stock price against earnings.
Another analogy that illustrates how to use Bitcoin NVT Ratio, is the comparison to a “Price-to-Sales” Ratio of payment companies. Online payment companies, being in the same industry, have relatively similar fixed costs. Here you can measure how much money is sent through PayPal (Sales) and make a ratio relative to its market value (Price). Compare this ratio between Paypal’s and the competitors, to get an idea of which one is the best investment in relative terms.
As you’ll see, you can do the same with NVT Ratio, when investing in cryptocurrencies.
With Bitcoin and other cryptocurrencies, we know how much money is sent through the network every day. With this data, we can do a ratio to the network value (or market cap), and measure relative value between cryptocurrencies, as in the PayPal case above.
Bitcoin NVT Ratio: How it Works
Two Inputs is used in Bitcoin’s NVT Ratio:
- Network Value / Valuation
- On-Chain Transaction Volume
The graph above shows how the two inputs tracks each other quite precisely.
The graph below shows Bitcoin’s NVT Ratio. The two inputs Network Value and Transaction Volume divided by each other. Imagine a situation where the two inputs track each other precisely. The NVT ratio chart below would show a straight red line, without fluctuations. Evidently, this is not the case.
When one deviates sufficiently from the other, the result is ups and downs on the graph.
This is how the NVT Ratio provides information about relative under and over valuation. When one input deviates too much from the other, or looses its “peg” by appreciating out of proportion to the other, it could be a signal of bubble territory, or buying opportunities.
Bitcoin Bubble Territory
- Bitcoin is in bubble territory when NVT ratio is 95 and above.
According to the NVT Ratio, Bitcoin was in bubble territory in 2013-14, as major price increases were followed by sharp drop in blockchain transaction volume.
As seen above, in Q1 and Q2 of 2018 we’ve seen patterns reminiscent of 2014. Large price increases and a subsequent drop in transaction volume, resulting in a massive increase in NVT Ratio. How Bitcoin comes out of this bubble territory, time will tell. Prices will fall further (Network Value) or we’ll see an increase in transaction throughput (Transactions) (Aug, 2018).
NVT Signal Ratio (NVTS): Improved Predictive Properties
NVT Signal Ratio (NVTS), is a derivative of the NVT Ratio. The NVT Signal Ratio aims to improve the predictive properties of the original NVT Ratio.
Data in the original NVT is smoothed by a 28-day (14 day backward, 14 day forward) moving average in both the numerator and denominator (Network Value / Transaction Volume).
Data in the NVT Signal Ratio is smoothed by a 90-day moving average, but only on the denominator (Transactions). The numerator (Network Value) is left responsive.
The result is an indicator more robust to market mania, by being conservative on the underlying value side (90-MA on Transactions), while tracking market movements in real terms.
Anatomy of a Bitcoin Moon
When Bitcoin moons, it attracts attention and hoards of new buyers comes storming in. This triggers an increase in transaction volume as buyers and exchanges transfer coins between bitcoin addresses on the blockchain.
An increasing price creates mainstream interest and increasing speculation, which also results in higher transaction volumes. The NVT proxy for underlying value increases (transactions in USD), although a large part of the volume may come from short term speculation.
As the proxy for underlying value is now inflated by short term speculation, the NVT Ratio is losing its predictive properties. As mentioned, the NVT Signal fixes this effect by introducing a 90-day moving average on transaction volume. The underlying value proxy is kept stable and immune to sudden market hysteria.
Bitcoin NVT Ratio vs NVT Signal
Let’s plot the NVTS and NVT Ratio against each other and check which is a better indicator.
The NVT Signal got the Bitcoin bubbles of 2013/2014 right. It reached a level 175, far beyond bubble territory, before the Bitcoin price dived again. Again, in the 2017 bubble, The NVT Signal seems precise in flashing the warning lights, just before price peak in December.
Meanwhile, the NVT ratio is laggy, mostly warning about market hangovers (High valuations and low on-chain economic activity).
Comparing Cryptocurrencies Using the NVT Ratio
Use the NVT or NVTS to find the best buy and compare the relative valuations of cryptocurrencies.
The NVT Ratio can also be used to compare how different cryptocurrencies are priced, in relation to how much value is sent over its blockchain. This chart is from coinmetrics.io. A high NVT Ratio means that the network is expensive in relation to how much value it moves. The chart below indicates that $BCH is relatively highly valued, compared to Bitcoin.
Crypto-native indicatiors are experimental. I use them primarely to know when not to buy. If you can manage not to buy tops or relative overvaluations, you’re off to a good start (as most people FOMO in a the later stages of bull cycles). Getting a great price is the next step.
More on the NVT Ratio and NVT Signal
- Go to the NVT Ratio category.
- Read this interview with NVT Ratio creator, Willy Woo.
- Listen to AntiREKT Podcast ep. w/ Willy Woo.