The relationship between Bitcoins Market Value and Transaction Volume
In the last article, we attempted to discover a correlation between the Bitcoin network’s hash rate, and the market price of Bitcoin. This time around, we will be analyzing a new metric to see how it affects Bitcoin’s price: the transactional volume of digital currencies.
The relationship we are trying to describe is, how much utility does Bitcoin create for its network participants, relative to the cost to acquire the asset. In conventional financial markets, this analogy can be likened to the P/E ratio, which measures how much an investor needs to spend on a security, in order to get one dollar back in the companies earnings.
In financial markets, a securities “utility” is the financial return it generates for its investors. However, crypto markets consist of decentralized networks, which are not companies and therefore do not generate revenue. As such, the utility they provide to its’ users is different. We can look at Metcalfe’s law, the formula used to value computer & telecommunication networks to determine what form of utility cryptocurrencies create. Since blockchains are decentralized networks, their utility is the amount of user activity, AKA the number of transactions. So to analyze the relationship between the networks value, and the number of transactions on the network we can use the ratio called ‘Kalichkin’s Network Value to Transactions Ratio’ (Kalichkin NVT).
Kalichkin NVT = Daily Network Value / 90day Moving Average Transaction Volume
Essentially, this formula is describing a cryptocurrencies monetary value, relative to how much it is currently being used. So when a NVT ratio is high, it is indicating that the network’s market value trumps the user utility that is being derived from the network. Using this metric, traders can determine if the asset is trading at sustainable levels, or if the price is artificially propped up by speculation AKA a ‘bubble’.
How to leverage the Kalichkin NVT ratio to make informed investments:
When investing in fiat markets, traders look at the P/E ratio to determine sound opportunities to get into the market. For P/E ratios, a lower ratio indicates that the price to purchase the stock is close to the stock’s actual earnings. Alternatively, a high ratio indicates that it costs more to buy the stock, then what the stock is generating in returns, so it is overvalued. The same logic can be applied to NVT ratios; when someone is looking to buy cryptocurrencies, they should want to see a high transaction volume vs market cap ratio. This indicates that there is a significant amount of transactions occurring on the network, so participants are getting utility from the network and the asset is trading at a justifiable price.
The figure above is a comparative chart detailing the Kalichkin NVT ratios of Bitcoin and Ethereum over a 90 day period. If we look at the beginning of November, BTC and ETH had Kalichkin NVT ratios of 27.97 and 42 respectively. When analyzing cryptocurrencies through the Kalichkin NVT ratio, anything within 10–30 is a safe buy, while assets below 10 are undervalued, and those trading above 30 are overvalued. Based off this we can see that Ethereum is over valued by 12 points, while Bitcoin is just within the threshold of being a safe buy. If we look at the end of the month, both NVT ratios have dropped off drastically with BTC’s now all the way at 17.36 and ETH’s now at 24.96, so based off the Kalichkin NVT ratio, both assets are in safe buy zones. November was one of the markets worst months in two years, so its not surprising that as both currencies loss a tremendous amount of market value, their Kalichkin NVT ratios underwent a proportionate correction. We can also use this metric to validate when cryptocurrencies were in a bubble, as evidenced by Ethereums overvalued Kalichkin NVT ratio. Since the market crash, the cryptocurrencies NVT ratio has clawed back into sustainable territory.
Although Bitcoin dominates the headlines for its unprecedented volatility, its original use-case was not as a storage of value, but as a medium of exchange. So with respect to the original ethos of Bitcoin, what matters is how much this asset is being used, not how much it is being traded for. When trying to find good opportunities to enter the market, users should adopt a holistic lens to analyze the market. Instead of just looking at cryptocurrencies market value and how much the asset is worth, look at transaction volume and metrics such as Kalichkin NVT ratio’s to determine if the transaction volume warrants such a high unit price, or if the market is just getting ahead of itself.
