Bitcoin blockchain activity does not support its current price

  • Network activity and prices are always correlated values that must grow at par.
  • The extremes of the value of the network relative to transactions (NVT) indicate price caps or bottoms.

After the arrival of Bitcoin (BTC), for brief moments, at USD 9,000 in the month of May, many analysts within the market began to question whether the increase in the leading cryptocurrency was organic or whether there had been an excess of speculation by the “fear of being left out” (FOMO). To determine unsustainable movements or financial bubbles within an asset such as Bitcoin, the ratio of the value of the network to what is traded within it could be the key to understanding the overall picture of the asset.

As Warren Buffett said, “Price is what you pay, and value is what you get.” In traditional markets, mainly on the stock market, the price/profit ratio (P/E index) is a tool used to establish a company’s value. It simplifies the work of investors in determining the market value of a stock compared to the company’s profits. That is, the P/E shows how willing traders are to pay for a share today, based on past or future earnings. A high P/E could mean that the price of a stock is overvalued based on a company’s profits and vice versa.

In theory, a company’s share should never cost more than it produces in profits since a particular company share would not back price growth. Exponential growth in this asset class without primary backing could denote excessive speculation within the markets, which would ultimately make the share price unsustainable.

Although Bitcoin is not a value, or at least not officially, this metric can be adapted and applied to a vast majority of today’s crypto actives. Using different tools, in conjunction with transactions within the network, it can be determined whether the latest movements in the BTC price and its associated capitalization have been on a par with its economic activity within its blockchain.

The table below shows a line (in red) representing the value of the network, which is nothing more than the market price multiplied by the supply of the currency, also known as the “market capitalization” value. Also shown is a blue line symbolizing the volume or value traded within the Bitcoin blockchain.

When the volume (blue line) does not exceed the value of the network (red line), the growth of the asset is not organic — source:

During upward trends, the volume of the network (blue line) exceeds the total value of the system (network value or market capitalization) because investors are willing to pay a higher price today, as a result of the expectations of future growth that the asset may have. It could then be said that the increase in prices is organically supported by increased economic activity within the blockchain.

In cases of a downward trend, the value of the network is usually above, until its economic activity is balanced and exceeds it (returning to the previous cycle). Currently, Bitcoin is in this position, the growth in the last quarter that led it to revalue close to 160%. Meanwhile there has been an increase in a network activity, but it has not been enough to exceed the value of this, suggesting that much of the rise described above is not organic, came from the speculation of an extremely optimistic sentiment around news such as Bakkt, Fidelity, the Facebook factor and the integration of the cryptocurrencies as a form of payment in AT&T. While it is true that this metric alone does not sentence BTC to correction, it does emphasize the impossibility of sustained long-term growth without an increase in network volumes.

As discussed above, both values can be presented in a relationship, which is called by analysts as the NVT or Network Value concerning transactions. This corresponds to the division of the value of the network between the amount that is processed within it or what is equal, the current supply of Bitcoin between the value in BTC transmitted through the chain of blocks, or volume.

NVT has been growing since January. Source TradingView.

The value of the 30-day Kalichkin NVT network (a variant of NVT) has been increasing since January, and is currently above 33, exceeding its previous peak seen in December 2013. An increasing NVT should be considered as a bearish indicator for the price, as it means a decrease in the economic activity of the network. Similarly, a sharp rise in NVT with a strong uptrend in price could suggest an overbought state and that the asset is currently overvalued according to its economic utility.

On the other hand, metrics visualize the value of an asset should not be used as a commercial tool by itself, because different variables are left out. The NVT does not take into account inflation or the use of transactions outside the chain, through second layer protocols such as the Lightning Network, which can affect the total value of the metric.

Similarly, and based on this tool, the probability that Bitcoin will perform a local maximum above USD 9,000, without first pausing network activity to grow, seems practically nil. It remains to be seen if the leading cryptocurrency by market capitalization can reach record values in the use of its economic activity.

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