Increase your Bitcoin trading skills with these 3 on-chain metrics

Key takeaways

Among the top indicators, the most popular is the N/A ratio, which is useful in determining whether BTC is overvalued or undervalued. The MVRV ratio can provide insight into whether long-term investors are unwinding their positions or sitting tight with their BTC. Bitcoin Days Destroyed could serve as a confluence for a reversal in BTC’s long-term trend. Chain indicators should be used to supplement investment decisions and should not be the primary reason for action.

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Bitcoin’s on-chain data holds the key to understanding investor behavior. If interpreted correctly, the top indicators can give investors an edge to make investment decisions and improve their Bitcoin transactions.

In part two of our series on using Bitcoin’s on-chain metrics to record profits, Crypto Briefing offers readers insight into the NVT ratio, the MVRV ratio and Bitcoin Days Destroyed.

Click here to read part one of this series.

Understand the Metric

The basis of on-chain analytics is to use blockchain network data to dial in the sentiment of users for a particular cryptocurrency.

Although primarily used for Bitcoin, blockchain data can be used to gain insights for other mature networks such as Ethereum, Ripple, and Litecoin.

However, Altcoin on-chain analysis is beyond the scope of this article.

On-chain indicators are the simplest way to measure sentiment while maintaining accuracy. Although social media data holds weight in the discussion, it is very easy to skew this data for false positives.

Bitcoin’s most popular on-chain analysis, used by many analysts and investors, includes the NVT ratio, MVRV ratio and Bitcoin Days Destroyed.

These three indicators all track sentiment in different ways. Because of their different approaches, it is important to first understand these relationships and how to interpret them in order to get to grips with how on-chain indicators work.

Breaking down the Top Three Indicators

1. Network value to transactions (N/A) ratio

The NVT ratio for a given point in time is the market cap of Bitcoin divided by the dollar amount of BTC settled over the network.

If Bitcoin’s market cap were $150 billion and $2 billion of BTC was moved on the blockchain, the N/A ratio would be 75 ($150 billion/$2 billion).

Willy Woo, a pioneer of on-chain analysis, was trying to find the equivalent of the stock market’s price-to-earnings ratio when he created the N/A ratio.

$BTC is not in a bubble. Here is #bitcoin market cap to USD volume transferred ratio. The closest we have to a PE relationship. Article incoming. pic.twitter.com/OhZo9cExQV

— Willy Woo (@woonomic) February 24, 2017

For the uninitiated, the price-to-earnings ratio for a company is the market capitalization of a company divided by its total earnings after accounting for all expenses.

However, calling the N/A ratio the crypto equivalent of the PE ratio is inaccurate, as the transaction volume of the network is in no way earnings. If anything, it’s closer to the price-to-sales ratio, which is the market capitalization of a company divided by its total sales/revenues.

Semantics aside, the predictive power of the N/A relationship is evident during certain situations.

When users move coins, it is recorded on the Bitcoin blockchain. If this happens en masse, the denominator (dollar amount of BTC moved on the network) of the N/A equation increases, causing a slight reduction in the ratio.

At this point, if BTC is moved to exchanges to sell, it will cause price and market cap to drop. Since the N/A ratio equation now has a lower numerator (market cap) and a higher denominator (total transaction value), this causes the N/A to drop, bringing it close to a sell.

The core thesis of the NVT is to buy these dips after exuberant selling when the Bitcoin market is ready to recover.

For example, let’s say the N/A ratio is 75 ($150 billion market cap, $2 billion transaction volume in the chain in a day), and then investors slowly start moving their BTC, causing the transaction volume to rise from $2 billion to $4 billion . In this scenario, NRA reduces to 37.5 ($150 billion/$4 billion).

Now, if the BTC is moved to be sold on an exchange, it will affect the market cap. Assuming the market cap falls from $150 billion to $110 billion, the N/A ratio is now 27.5.

But if it is sold via an OTC desk, the market capitalization remains unchanged. However, the N/A ratio has continued to decline, which explains why market cap alone is not an accurate proxy to truly capture sentiment.

According to the indicator, there are “buy” and “sell” bands. These bands are dynamic and are adjusted based on historical prices.

If the N/A hits the “buy” band, it indicates that Bitcoin is currently undervalued and vice versa.

According to this chart, it becomes clear that the NVT has significant predictive power during periods of exuberant buying or selling.

2. Market value to realized value (MVRV) ratio

The MVRV relationship was conceptualized by Willy Woo’s partners at the erstwhile Adaptive Capital, Murad Mahmudov and David Puell.

MV, or market value, is the market capitalization of Bitcoin at a given time period. RV, or realized value, is a measure of each BTC valued at the market price when it was last moved.

Suppose Alice bought one BTC at $7,300 and Bob bought two BTC at $8,900. When the market price of BTC is $8,000, the market value of their cumulative holdings will be $24,000, but the realized value will be $25,100.

Mahmudov and Puell divided market value by realized value and found a natural range between 1 (where MV = RV) and 3.7 (where MV is 3.7 times higher than RV). Above 3.7, Bitcoin was overvalued; under 1 Bitcoin was undervalued.

When MVRV increases, it means that market cap is growing, but long-term investors with significant stacks of BTC are not yet taking profit on their investment. When MVRV reaches the overvalued threshold, investors start selling; increased realized value and decreasing market value.

The essence of realized value is to track each BTC and multiply it by the price of BTC when it was last moved. This creates a more realistic view of Bitcoin’s valuation, as the millions of lost coins are weighted at zero or a very low amount.

Besides highlighting lost coins, realized value also tracks the behavior of HODLers who buy and hold BTC for long periods of time.

Comparing this to market value provides insight into how long-term investors behave.

If MVRV increases in an uptrend, long-term investors still hold their positions. If MVRV declines in an uptrend, long-term investors take profit on their positions.

This serves as a good signal to take profit on BTC holdings.

3. Bitcoin days destroyed

Even in the early days, Bitcoiners understood that transaction volume alone was a misleading data point. A single entity can send the same 10 BTC back and forth from a few addresses to skew the data.

To combat this, a member on BitcoinTalk proposed a metric called “Bitcoin Days Destroyed”.

This tool provides a way to measure actual transaction volume growth, as well as a way to interpret what this transaction volume means.

Bitcoin Days Destroyed assigns a higher weight to coins that haven’t been moved in a long time.

For example, if someone buys 10 BTC on January 1, 2020 and moves it to their wallet on January 10, 2020, that would represent 1,000 Bitcoin Days Destroyed (10 days x 10 BTC).

Before selling much BTC, it must be moved from investor wallets to either an exchange or to an OTC desk. The Bitcoin Days Destroyed metric captures this.

Usually, there is a big spike in Bitcoin Days Destroyed after price makes a top or bottom.

Because of this, it is useful to identify a trend reversal by watching investor behavior.

On-chain data is a complementary tool

All three indicators described in this article index market sentiment using different sources of data.

Using on-chain analytics can add an edge to any investor’s toolkit. Although it is not recommended that investors rely on them as a primary reason for making investment decisions, the effectiveness of these indicators cannot be denied.

Profit-taking signals come earlier than the top, for example, so it is important to actively monitor the indicators in tandem with BTC price. During bubbles, Bitcoin tends to ignore data and ride a wave of irrational exuberance.

On-chain analytics have made their way beyond Bitcoin and into the broader cryptocurrency landscape, but limited data for most altcoins makes this toolkit less effective.

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