What Is Bitcoin’s NVT Ratio? A Beginner's Guide

What Is Bitcoin's NVT Ratio? A Beginner's Guide

Price indicators are indispensable tools for market analysis. Some are more widely known than others, but a rich and varied indicator toolbox can help a trader, investor, or analyst open up new perspectives.

Read on to learn more about the Bitcoin NVT ratio, how it is calculated, and how its figures can be interpreted.

What Is the Bitcoin NVT Ratio?

The Bitcoin NVT Ratio (short for Network Value to Transaction Ratio) describes the relationship between Bitcoin's market capitalization, which is its network value, and the USD volume transmitted through the Bitcoin blockchain on any given day.

This indicator was first established by crypto researcher and analyst Willy Woo in 2017 as the "closest thing we have to a P/E ratio." The price-earnings (P/E) ratio is used in the equity markets to determine the relationship between the price of a stock and the company's earnings.

Bitcoin is, of course, not a company, so the P/E ratio is not applicable in its original form.

As such, Woo introduced a modified version by substituting the absent company earnings with daily transaction value as a way to quantify the asset's performance in real time.

Like the P/E ratio, Bitcoin's NVT ratio determines whether the cryptocurrency is overvalued or undervalued at any given moment.

Calculating the Bitcoin NVT Ratio

The Bitcoin NVT ratio is calculated by dividing the BTC's current market cap by the daily transaction value, which is the 24-hour USD volume transmitted through Bitcoin's blockchain during that time period.

Shown as a mathematical formula, it looks like this:

MCAP stands for market cap and DTV stands for daily transaction value.

Both variables can be found on any coin aggregator, making the ratio easy to calculate. However, it is important that both values are taken from a single source to ensure consistency.

The formula is very simple and may look even more familiar to those with a background in traditional finance. As the crypto answer to the P/E ratio, which has been used for almost a century on the S&P 500, for example, the metric is useful, simple, and well-established.

It's important to note that Bitcoin doesn't have earnings. Usually, companies with no earnings or those that are losing money cannot determine a P/E ratio since there is no denominator in that case.

Blockchain networks, however, have daily transaction volumes. This ensures that large networks such as Bitcoin have a denominator to derive the NVT ratio.

Interpreting the NVT Ratio: Here's How it Works

The NVT ratio is a very useful indicator of a coin's valuation.

A high NVT ratio, or an upward trend, suggests the asset might be overvalued. This happens when the market cap is significantly larger than the transaction volume, indicating the asset's price may be higher than what the daily transaction activity supports.

A higher ratio typically reflects strong investor confidence, but it doesn't always mean a market correction is imminent. Instead, it suggests that while prices could consolidate and prove the valuation to be reasonable, if the NVT ratio rises well beyond typical levels, a price correction could be on the horizon.

Conversely, a low NVT ratio, also called a downtrend, means network activity is outstripping its market cap, which shows the current price is lower than the asset's corresponding daily usage.

The market may be bottoming out at this point, which gives investors reason to believe it's headed toward an increase in price.

Finally, the third option is a sideways trend or an equilibrium, which means that the current market cap to transaction volume ratio is stable and sustainable. This is usually the case when a market trend is already established, while the first two options can signal a potential change in the market's direction.

Let's see this in action. The NVT ratio was notably low as Bitcoin approached what would be its all-time high on March 13, 2024. One week prior, Bitcoin's NVT ratio fell to 11.35; it dropped to 12.13 on March 13, highlighted on the graph below.

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This analysis points to the NVT ratio's utility as an indicator of Bitcoin's potential price movement. The low NVT ratio meant Bitcoin's utility was outstripping its market price, after which a price increase was expected to follow.

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Is the NVT Ratio a Reliable Bitcoin Indicator?

The NVT ratio can be beneficial in determining the current state of the market versus an asset's utility value. In other words, the NVT ratio's highs and lows can give reasonable cause to believe that a price could move a certain way.

There are also some variations to the NVT ratio that open up new possibilities in analysis.

One is the NVT signal, which uses a 90-day moving average in place of the daily transaction values. This shows the three-month market trend rather than a time-specific value.

An advanced NVT signal, often called the NVT Golden Cross, incorporates standard deviation bands. When the NVT ratio moves above these bands, it indicates that Bitcoin may be overbought, and when it moves below the bands, it suggests that Bitcoin may be oversold.

The ratio also has its inverse, calculated by dividing the on-chain transaction volume by the current value of the Bitcoin network. This is called velocity and shows how quickly the asset is moving through its network.

In conclusion, the NVT ratio can be a useful tool in recognizing whether BTC is currently over- or undervalued, which can shed some light on its future valuation. However, like any indicator, it shouldn't be taken in a vacuum or expected to serve as the holy grail of market analysis.

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