Traders and market analysts use hundreds of metrics to determine the value of stocks, currencies, and commodities. But when it comes to cryptocurrencies, things can be different. How could we analyze Bitcoin's Price-to-Earnings, for example?
When trading stocks, the traditional financial market uses the P/E indicator, or in Portuguese, Price/Profit Index, to calculate the stock's current price against its profit. With Bitcoin, it's not so simple. Happily, something similar is already in place for On-Chain Data analysis.
What is the NVT indicator?
Firstly introduced by Willy Woo in 2017, the NVT (Network Value to Transactions) indicator can be defined as the relation between network value and transactions. It's calculated as crypto market capitalization, divided by daily volume, traded and quoted in USD, throughout the network.
How does the NVT indicator work?
The NVT shows when Bitcoin's price is overbought, revealing large distances between market value and network usage that suggest speculative values and potential bubbles. Experienced traders analyze this information to create more accurate asset allocation strategies, making the NVT a fundamental indicator on the Bitcoin network.
How to calculate NVT?
The NVT of the Bitcoin network is calculated by dividing the Network Value by the daily value of the BTC traded on the network and quoted in USD. In other words, it is the equivalent of all Bitcoin in circulation, divided by the daily volume of Bitcoin traded on the network. Therefore, being technically an expression of inverse monetary speed.
NVT = Network Value/Daily volume of BTC on the network
How to use the NVT interface?
Several analysts suggest that Bitcoin is in a possible bubble when the NVT is equal to or greater than 95. For this value to be high, Bitcoin's market capitalization must exceed its volume of transactions substantially, indicating that the price is inflated without plausible justification. The same goes for unjustified asset devaluations.
The early years of the Bitcoin network were marked by a very sharp growth. This caused markets to overvalue the network despite its real financial movement.
In other words, we are seeing a network growing explosively, requiring an assessment based on future potential. This is very similar to what we see in the exponential growth phases of startups.
How to predict Bitcoin bubbles with the NVT indicator
Identifying a bubble before it pops is quite difficult. The NVT indicator can't determine if it is or not a bubble. Yet, it can be very helpful in identifying a market crash or consolidation after the price has peaked.
After a market assessment, we can determine if the price has consolidated or will follow a new trend. For example, during the first quarter of 2016, Ethereum's valuation grew to near 15 times, from $70 million to over $1 billion.
For those not used to the cryptocurrency market, it looked like a bubble. However, no crash followed, and its new assessment was sustained, with the NVT indicator confirming it was not a bubble.
Similarly, the NVT index can't predict a bubble with certainty, but it is very useful when discerning between a crash and a consolidation after the price has peaked. It can determine this relatively fast.
Is the NVT indicator worthwhile?
Like any indicator, the NVT provides valuable information that may impact your decision-making process.
As discussed earlier, its main purpose is to define if Bitcoin is overbought or oversold, potentially showing if it's time to sell or if it is time to buy, respectively.
What is the NVT Signal?
Now, that you know more about the NVT, let's talk a little about the NVT Signal indicator. Developed by Dimitry Kalichkin and derived from the NVT, this indicator refines data for predictive signals, anticipating new price peaks.
The NVT indicator data are leveled by a 28-day moving average, with 14 days behind and 14 days ahead, both in the numerator and in the denominator (Network Value / Daily BTC / USD transaction volume).
The NVT Signal indicator data are leveled by a 90-day moving average, but only in the denominator (Daily Bitcoin transaction volume on the network).
The result is a more robust indicator that tracks market movements, dividing the daily Network Value by 90 days moving average of the daily Bitcoin Volume on the network. Thus, being defined by the following equation:
NVTS = Network Value/ 90 days moving average
Using the NVT Signal indicator
While using the NVT Signal inside the Vector platform chart, price levels above 150 are in the overbought zone, indicating price spikes in the market. Price levels below 45 tend to be oversold.