Measuring Token Velocity: NVT Ratio

The NVT Ratio

The Network Value to Transactions (NVT) Ratio is viewed similarly to the stock market PE ratio, which can be used as a proxy to gauge over or under valuation of digital assets like Bitcoin. The NVT is calculated as Market Cap (Network Value) divided by the $USD transaction volume on the network.

The traditional “normal” range for NVT is between 20 and 100. However, using the NVT ratio smoothed with the 30 day moving average (MA), compresses the “normal” range between 10 and 30, i.e. beneath 10 is undervalued and above 30 is overvalued. For example, if Bitcoin’s NVT is greater than 30, investors may assume that the network valuation (Market Cap) is outpacing its underlying utility ($USD transacted on the network); and vice versa.

Neoclassical Crypto Economics

A long standing hypothesis for digital asset valuation is that increasing asset velocity has a negative price effect on network value. This notion is borrowed from the Neoclassical economic equation MV=PQ. This dynamic is the result of monetary assets’ utility being generated as both medium of exchange and store of value (slower velocity).

To illustrate, imagine the choice of holding $100 US dollars for one month or $100 Zimbabwean dollars. Which would you feel more confident in at the end of one month your purchasing power will still be $100? In theory, the desire to get rid of poor store of value currencies or digital assets, increases velocity, and negatively affects their Market Cap.

NVT Ratio = Network Velocity

In practice, the NVT ratio is mathematically identical to network velocity, using the MV=PQ equation. The chart below illustrates that Bitcoin’s historical overvaluation levels (high velocity years) have coincided with bear markets (2014–2015). Similarly, the bull market years (2013, 2016–2017) for Bitcoin showed NVT oscillating within the undervaluation to “normal” range (low velocity years).

Additionally, the chart below shows Bitcoin’s NVT/Velocity spiking in 2018, which makes sense given Bitcoin has lost ~50% of its value this year (high velocity year). Furthermore, the negative relationship between NVT/Velocity and Bitcoin’s Market Cap is verified by a correlation coefficient of -0.46 in 2018 and -0.09 since 2013.

*coinmetrics.io

Plausible Explanation?

One possible explanation is that the NVT ratio must always pay for the sins of past bull markets because they tend to skew towards extreme overvaluation and exuberance. For example:

• First: BTC begins falling which spikes NVT/Velocity, uncertainty grows, velocity increases again, and price drops further until the discrepancy between Market Cap and transaction volume ($USD) is closed.

*coinmetrics.io

• Second: NVT/Velocity begins decreasing as the gap between Market Cap and network transactions reverts to its long term mean.
• Third: Step 2 continually unfolds until a bottom is found, which is historically beneath 10, but closer to 5.
• Fourth: Once the bottom is found, the next bull market commences whereby NVT oscillates within “normal” ranges until valuations become “bubbly” and past sins must be purged once again.
• Fifth: Step 1 starts over again and NVT/Velocity begins to increase.
• Sixth: Rinse and repeat a la reflexivity.

Summary

It should be noted that at the end of 2017, Bitcoin’s NVT was near 5. In hindsight, that would have only been a good time to buy Bitcoin insofar as you sold it the first few days of January 2018 for a quick, but large profit. Unfortunately, investor psychology does not work that way and that buy signal would have cost investors a lot of money.

One caveat that we could insert for margin of safety, is that a potential buy signal near 5 should come off the back of a bear market rather than an already exuberant bull market.

DisclaimerNeither the author of this article, nor Pugilist Ventures, provide investment, financial, or legal advice. This cannot substitute for professional advice and independent factual verification. The content provided on this site is for informational purposes only and should not be construed as any kind of solicitation for investment in any investment opportunity.

Measuring Token Velocity: NVT Ratio was originally published in Hacker Noon on Medium, where people are continuing the conversation by highlighting and responding to this story.