Using NVT and NVTG in practice to value the most popular cryptocurrencies
Disclaimer: This article is not meant as investment advice. Use it to supplement your own thoughts and analysis.
If you haven’t read the prequel to this article, or find yourself needing more background information, check out this previous post. The intro to this article is a brief recap of what was covered there.
Abstract
Our work to bring fundamental ways to value crypto has led us to believe that ratio analysis could hold the keys to understanding a piece of the puzzle. Using new and improved ratio analysis methods based on network value, we find that Ethereum and Dogecoin (yes, really) have the most attractive valuations and that historically, Ethereum, Ethereum Classic, Bitcoin Cash, and Bitcoin Gold are under-priced.
Introduction
I’ve talked previously on the power of a digital asset’s network. After all, if we fundamentally view these as an addition to the internet to improve our ability as humans to interact, what better way would there be to value them by their ability so far to do that?
To tackle this, the Coinmetrics team proposed a ratio called Network Value to Transactions (NVT) to measure how useful a token has been. Dmitry Kalichkin revised this to make it more of a trading signal. And in this article, I improved on Kalichkin’s NVT to make it more receptive to the short-term nature of the crypto market.
In that article I also propose a new metric, Network Value to Transactions/Growth (NVTG) that I believe is a more accurate and complementary representation of how a digital asset’s network should be valued. If NVT is the P/E (technically, a cyclically adjusted P/E, or Schiller’s P/E) of the crypto world, NVTG is the Price-Earnings/Growth (PEG) ratio that these forward-looking and high-growth markets need. A lower value for both NVT and NVTG indicates a “better” deal for the value you are getting.
Previously, I only looked at NVTG in the context of Bitcoin. In this article, I will apply NVT combined with the new NVTG metric across 10 popular coins and explore how they can be used in conjunction as a relative indicator of valuation. But before we do, let’s take a step back and try to remember what P/E and PEG are used for in the stock market because that will guide our thoughts on these ratios. They are used to:
1) Compare similar assets against each other (a.k.a. relative valuation)
2) To discern and take advantage of historical trends
Analysis
I’ll start with a figure that summarizes the results regarding the first point, relative valuation. After that, I’ll dig deeper into the most interesting tokens to try and answer #2 based on historical data. Note that the figure below shows the 1-week average of the metrics (3/13/17 to 3/20/17). Data to build each metric was scraped from each coins’ blockchain.
Takeways:
· Coins like BTG, RDD, and VTC appear to have attractive values of usefulness relative to other tokens based on NVT. However, after factoring in network growth potential, they become significantly less valuable.
· BTC is priced more cheaply than BCH for transaction volume and especially when considering growth
· ETC and LTC are priced well for how often they are transacted on, and including the network size effect they become even better (especially LTC)
· DOGE is the most undervalued coin by NVT; factoring in network growth effects makes ETH just barely the most undervalued. How did this happen?? DOGE actually has one of the fastest and lowest transaction fees and prides itself on being able to be used for everyday transactions (making it a great coin to arbitrage). Such wow. Obligatory doggo:
Ok moving on to #2, analyzing historical trends. I’ll focus on the coins where factoring in network growth potential increased its value relative to the other coins: BCH, BTC, DASH, DOGE, ETC, ETH, and LTC. Results for the other three coins (BTG, RDD, and VTC) can be seen at the end in the summary table. All time frames end on 3/20/18. Thresholds were calculated for each coin by determining the optimal quartile number to reflect the elbow criterion. The blue NVT/NVTG line passing below the green line indicates a good buy opportunity and vice-versa for the red sell line. The area in the middle of the two lines indicates a hold period.
Bitcoin
· NVTG captures exactly how overpriced bitcoin was back in the 2013–2014 bubble, there were simply no users to justify its value
· By both metrics, bitcoin is very expensive right now although not as expensive as how it was in 2013–14
Ethereum
· NVT recognizes that Ethereum was overpriced in Summer 2017 as well as Winter 2017–18; however, NVTG points out that the growth in network value in the Winter made up for it
· By both metrics, Ethereum seems to be historically underpriced for its network value
Litecoin
· NVT shows that litecoin was overpriced in early 2017 and Winter 2017–18, but NVTG explains this through a similar trend as seen in ethereum in Winter 2017–18 as the price increase is compensated by a huge increase in network growth
· Using both metrics doesn’t give us a clear conviction either way, but it is apparent that litecoin has a huge network and the market might not be crediting it properly for that
Bitcoin Cash
· We only have 4 months of analyzable data after our moving average calculations, but we can see that both metrics correctly pointed out that bitcoin cash was overvalued in Winter 2017–2018
· By both metrics, Bitcoin Cash seems to be historically underpriced for its network value
Ethereum Classic
· Once again we are limited by data, but the metrics have done well at times in December 2017, January 2018, and February 2018 to determine when it was truly overpriced
· Ethereum Classic seems to be slightly underpriced by its network value according to NVTG, NVT is borderline
Dash
· Both metrics correctly show that Dash was overpriced Summer 2017 and Winter 2017–18
· Appears to be becoming a more attractive investment, but so far there is no mispricing based on historical trends
Dogecoin
· Both metrics correctly show that Dogecoin became overpriced Summer 2017 and Winter 2017–2018
· Trending down to become more underpriced, so far there is no indication to believe it is mispriced on a historical basis
Results Summary
Note that these values are only current as of 3/20/17. Using NVT and NVTG as hard relative metrics, ETH, ETC, and DOGE are the clear winners for network value (remember, a lower value means it is “better buy”). Out of these three ETH and ETC are the most underpriced based on their historical trends.
We will be trying to get these revised NVT and NVTG metrics published somewhere so that these can be used real-time without having to do all the scraping and computational work from scratch. I’ll link it in here when it happens.
Conclusion
Using both NVT and NVTG as crypto corollaries to P/E and PEG gives us very important fundamental insights to the value behind a digital asset’s network. Just like how P/E and PEG only considers a firm’s earnings and growth to be important in valuation, using NVT and NVTG neglects other vital aspects of a digital asset and should ideally be used in conjunction with other methods. However, just looking at the figures shows that these metrics are remarkably good at spotting bubbles. Lots of work could be done to get better at spotting good buy opportunities by optimizing thresholds for certain time periods (30-day or 90-day rolling window, for example).
