Bitcoin Valuation using Dynamic Range NVT Signal

NVT Signal, or Bitcoin’s “PE Ratio”, is one of the best metrics for identifying over-valuation. However, the drastically changing nature of the Bitcoin network, and movement off-chain, could make traditionally high NVT Signal values relatively less expensive in the future. Using a Dynamic Range NVT Signal allows for continued maturity in the Bitcoin network and ongoing identification of relative over- and under-valuation.

What is “NVT Signal?

NVT Signal (credit: to Willy Woo and Dmitry Kalichkin) is akin to a “PE ratio” for Bitcoin. It can be used to identify when Bitcoin is overbought (expensive) or oversold (cheap). It does this by calculating the ratio of Bitcoin’s market capitalization to its daily on-chain transaction value. The power of NVT is in its ability to put a price against the value that the Bitcoin Network delivers — secure, immutable transactions.

As defined by Dmitry, NVT Signal is calculated as follows:

NVT Signal = Circulating Market Cap / 90 Average On-Chain Transaction Value

However, just having the NVT Signal value isn’t enough. What level indicates Bitcoin is expensive or cheap?

In 2018, Willy Woo proposed NVT Signal values above 150 as overbought and under 45 as oversold. Historically, these figures worked well at identifying local peaks and troughs in Bitcoin’s Price. However, due to the changing nature of the Bitcoin network, a fixed fair value range of 45–150 may not be appropriate into the future.

Bitcoin is Constantly Evolving, and this Impacts its Fair Value

There are a number of reasons to believe that the fair value range of NVT Signal may not remain in a fixed band. The Bitcoin Network is constantly under development. Both via Bitcoin Core technical enhancements, and from the way Bitcoin’s surrounding infrastructure is engaged with and developed upon by the public. These developments significantly impact the transaction value transmitted on the Bitcoin network, and therefore alter the fair value of the NVT Signal.

What are some reasons why the fair value range of NVT Signal might change in the coming years?

NVT Signal’s fair value range might increase, because:

  • Bitcoin is only 10 years old. It’s likely that relatively “high” and relatively “low” NVT Signal values will change with time, as have PE ratios in the stock market over the last century. For example, there are relatively fewer businesses with PE ratios below 15 today than there were 50–100 years ago.
  • Increasing use of off-chain transactions. Some transactions are now made off-chain, including Liquid Network’s private side-chain which is used by many major exchanges such as BitFinex and BitMex. If the trend towards side-chains and private transactions continues, we can expect less-and-less transactions to be captured in the public on-chain data (reducing the relative value of the “T” in NVT). This could cause the fair value NVT range to increase with time.

NVT Signal’s fair value range might decrease, because:

  • Bitcoin is like a start-up. It’s extremely volatile and its mainstream adoption and long-term success is far from certain. As young businesses can have extremely high PE ratios (they are traded at high prices in anticipation of growth and high future earnings), Bitcoin too may currently have an inflated NVT Signal range (in anticipation of increased transaction values in the future). Therefore, as Bitcoin matures, its long-term NVT Signal value could stabilize lower.

Based on the above, we can expect long-term trends in the NVT Signal fair value range to ebb and flow as the use case and technology infrastructure of Bitcoin matures. In fact, we have arguably already seen this change. If you believe the 84% drop in Bitcoin’s price to $3,150 in December 2018 was the low in the current market cycle, and consequently represented an “oversold” NVT Signal valuation, you would not have identified this using a NVT Signal range of 45 and lower. In December 2018, NVT Signal (using Blockchain.info data) did not drop below 70.

Establishing a Dynamic Range for the NVT Signal’s Fair Value

For the above reasons, a dynamic range is proposed for the NVT Signal fair value, which can be used to identify when Bitcoin is overbought or oversold.

The following range is proposed for assessing Bitcoin’s Fair value with NVT Signal:

  • Overbought: NVT Signal > long-term mean +X * standard deviations
  • Oversold: NVT Signal < long-term mean — Y * standard deviations

The above calculations are proposed to be performed over a rolling 2-year historical “look-back” period. In other words, at any point in time, only the prior 2 years’ worth of data should be considered in assessing relative value. This is roughly half the time between Bitcoin Supply halvings. In the future (in say, 5 years’ time plus), a 2-year look-back period is unlikely to be a sufficient window. Nonetheless, it was chosen here to give an ample period for historical review (8 years out of bitcoin’s short 10-year life); and because doubling the horizon to 4 years did not provide any measurable difference in the end results below.

Because Bitcoin’s NVT Signal is skewed (it has historically experienced more extreme highs than extreme lows),“X” and “Y” cannot be the same value …unless you never want to buy bitcoin again, or consider that it has never been cheap in its entire lifetime.

Today, the following defaults are proposed. Due to the reasons outlined below, these parameters should probably be reviewed every 2–4 years:

  • Overbought: NVT Signal > 2-year mean +2.0 * standard deviations
  • Oversold: NVT Signal < 2-year mean — 0.5 * standard deviations

Overbought is set here to 2 standard deviations above the mean. For a normally distributed data-set, this would mean Bitcoin is overbought roughly 2.5% of the time in any two year period. Though it turns out to be a somewhat higher percentage of the time given Bitcoin’s NVT Signal has not been normally distributed.

Oversold is considered anything less than 0.5 standard deviations below mean. Again, this is due to the NVT Signal’s skewness. For example, in the last 10 years, Bitcoin has never had an NVT Signal below mean less 2 standard deviations. Using 0.5 captures the December 2018 low of $3,150 as “oversold”.

A benefit of using the Dynamic Range NVT Signal is its interoperability across data sources. It is a know fact that estimates of “transaction value” differ across data vendors, as outlined by CoinMetrics here. This is due to the way Bitcoin issues “change” for transactions. Data vendors have their own process for estimating the “real transaction value”, and often come up with greatly different figures. Nonetheless, using a Dynamic Range for fair valuation with NVT signal should yield the same result of relative over- or under-valuation across different data sources. A fixed fair value NVT Signal band will not. This is because of the relativity of the dynamic range to the data observed.

Bitcoin’s Dynamic Range NVT Signal Fair Value

Here are the results.

NVT Signal with Dynamic Range “Fair Value”

The white NVT Signal line turns red when it above the red overbought line, and green when below the green oversold line. The indicator fills red and green respectively to highlight these changes through time. As with traditional fixed band NVT Signal valuation, NVT Signal is generally more precise at identifying market tops than bottoms.

Based on the above default Dynamic Range settings, Bitcoin is currently fairly valued today and near “oversold” territory.

You can also check out the live indicator on TradingView here. If you don’t agree with any of the dynamic range settings used in this article, feel free to easily adjust them on TradingView and see the impact.

Considerations

The NVT Signal with a dynamic fair value range must be used with care.

As with all markets, an asset can remain “expensive” or “cheap” for extended periods or time and continue to get even more expensive or cheaper. This can be seen above during the 2015 -2016 period where NVT Signal spent much of the time ranging between 40 and 45. Arguably, this was the longest period of undervaluation (relative to actual use) in Bitcoin’s history.

As noted above, it is likely that a 2-year “look back period” for calculating mean and standard deviation will not be sufficient in the years to come. As Bitcoin matures and stabilizes (some time in the future), a longer “look back period” should probably be used. Further, with maturity Bitcoin’s NVT skewness may reduce, requiring adjustment in the “X” and “Y” values above. Nonetheless, to minimize the impact of over-fitting, it is recommended these parameters be reviewed no more than once every 2 years.

Finally, as Bitcoin ages, the validity of NVT Signal in general will need to be monitored. Particularly with respect to the potential for increasing use off-chain and private transactions which may diminish the validity of NVT.

Live Indicator on TradingView.

Disclaimer on Backtests

Any Backtest performance returns presented represent hypothetical returns and are meant to simulate how a strategy would have performed during the period shown had the strategy been implemented during that time. Backtested/simulated performance returns are hypothetical and do not reflect trading in actual accounts. Backtest returns are provided for informational purposes only to indicate historical performance had the strategy been implemented over the relevant time period. Backtested performance results have inherent limitations as to their relevance and use. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading, such as the ability to withstand losses or to adhere to a particular trading program in spite of trading losses, all of which can also adversely affect actual trading results. There are numerous other factors related to the markets in general and to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results, all of which can adversely affect actual trading results. Any and all of these factors mean that no representation is being made that strategies presented here will achieve performance similar to that shown, and in any case, past performance is no guarantee of future performance.

The Capriole Fund

The Capriole Fund has one goal: outperform Bitcoin.

We are open to professional investors, but the fund has limited spaces.

Share the Post:

One Response

  1. This was a very interesting article but I was unable to see any data in Trading view after the early part of January 2024, as all data after that was missing – can you please advise how I get access to latest data using the Trading View indicator.

Leave a Reply

Your email address will not be published. Required fields are marked *

Disclaimer

The information contained here is provided to you solely for informational purposes only. Opinions and projections included are provided as of the date of publication, may prove to be inaccurate, and are subject to change without notice. This information does not constitute an offering. Prospective investors should not treat these materials as advice regarding legal, tax, or investment matters. No recommendations are made to invest in Capriole Investments Limited nor any other investment. An offering may be made only by delivery of a confidential offering memorandum to appropriate investors. Past performance is no guarantee of future results. Investing in digital assets in general involves risk. Digital asset risks include, but are not limited to, exchange risk, legal risk, hacking risk, market risk, liquidity risk, trading risk and default risk. As with any investment, investing in digital assets could result in loss of investment. Additional digital asset risks are outlined at www.capriole.com/legal. Decisions or actions based on the information provided are at the reader’s own account and risk.

Related Posts

Update #52

Is the cycle top in? This issue, we will revisit the Bitcoin...

Charles Edwards

Update #51

Hash Ribbons is back. Perhaps the best long-term Bitcoin buy signal there...

Charles Edwards

Update #50

Is Bitcoin's longest winning streak finally coming to an end?...

Charles Edwards

Update #49

A dive on the forth Bitcoin Halving, Runes, Onchain valuations and macroeconomic...

Charles Edwards

Update #48

Welcome to Bitcoin price discovery, it's been a long time coming. With...

Charles Edwards

Update #47

The era of deep value is over. Bitcoin is fairly valued for...

Charles Edwards

Update #46

With the big Fidelity news, Bitcoin is finally being acknowledged in traditional...

Charles Edwards

Update #45

The brand names of these two behemoths in the traditional asset space...

Charles Edwards

Update #44

Today's Bitcoin ETF launch was the most successful launch in history and...

Charles Edwards

Update #43

ETF fever is coming to a head with approvals expected within the...

Charles Edwards

Update #42

Two major and positive events just unfolded in the Bitcoin space. According...

Charles Edwards

Update #41

Bitcoin is heating up, in both opportunity and across derivatives markets. And...

Charles Edwards

Issue #40

A new major trend has formed. We now have the biggest asset...

Charles Edwards

Issue #39

We have historically rare risk-asset signals appearing, amidst a period of Bitcoin's...

Charles Edwards

Issue #38

The last week has seen the biggest improvements across Bitcoin technicals and...

Charles Edwards

Issue #37

Bitcoin is pricing as a better-and-better inflation hedge. It is rapidly skewing...

Charles Edwards

Issue #36

The Fed is Building a War Chest. A macroeconomic deep dive to...

Charles Edwards

Issue #35

We are seeing some promising and rare structures form on Bitcoin which...

Charles Edwards

Issue #34

All else equal, Bitcoin is like a beach ball submerged underwater. Nonetheless,...

Charles Edwards

Issue #33

Last update technicals and fundamentals told us to be cautious with Bitcoin....

Charles Edwards

The Three Factor Model

90% of the S&P500 returns over the last half century can be...

Charles Edwards

Issue #32

Welcome to Capriole’s micro update #1. Where we consolidate the most important...

Charles Edwards

Issue #31

At $29K, Bitcoin’s on-chain fundamentals are not too hot and not too...

Charles Edwards

Issue #30

The failures of the Federal Reserve in managing the value of money...

Charles Edwards

Issue #29

This newsletter explores a taboo topic. The idea of the impossible, a...

Charles Edwards

Issue #28

Bitcoin’s deep value is slipping away and in its place a new...

Charles Edwards

Issue #27

We believe the 2020s will be the decade of hard money, much...

Charles Edwards

Why markets are not as overvalued as you might think.

Charles Edwards

Issue #26

The crypto world was shaken to the core in November as top...

Charles Edwards

Bitcoin Miner Sell Pressure

Charles Edwards

The Bitcoin Yardstick

Charles Edwards

Issue #25

We crack open the rarest of Bitcoin value metric readings you can...

Charles Edwards

Everything you need to know about yield curves

Charles Edwards

Issue #24

This month we deep dive into the macro and make the case...

Charles Edwards

SLRV Ribbons

Charles Edwards

Issue #23

Fear struck the market again with a blunt Fed speech. The broader...

Charles Edwards

Issue #22

This issue we deep dive into the many Bitcoin and macro metrics...

Charles Edwards

Issue #21

Today, we now find ourselves in a special juncture in the crypto...

Charles Edwards

The Digital Asset Thesis

Charles Edwards

The Capriole Macro Index

Charles Edwards

Issue #20

The S&P500 and Bitcoin showcased a strong recovery recently and today both...

Charles Edwards

Issue #19

Traditional markets have been taking a beating. Our February Newsletter and analysis...

Charles Edwards

Issue #18

The first quarter of 2022 is coming to a close. War in...

Ryan McCoy

Issue #17

For the past few months, Bitcoin has been driven by macro events...

Yassine Zrigui

Issue #16

Last month was mostly dominated by macro news much like December, namely...

Mick Herfkens

Capriole’s 2022 Market Outlook

A year ago, we published our “Christmas Special” newsletter. We wrote the...

Charles Edwards

Issue #15

If you have been around the cryptospace long enough, you have probably...

Ryan McCoy

Issue #14

Bitcoin started the month of November strong with a new all time...

Mick Herfkens

Issue #13

Bitcoin is up over 30% to date in October, reaching as high...

Charles Edwards

A Simple Metric to Identify Bitcoin Tops

Charles Edwards

Issue #12

Last issue, at $47K we noted some concerning metrics, but noted the...

Charles Edwards

Issue #11

Last issue we noted the improving fundamentals for Bitcoin...

Charles Edwards

Issue #10

Last issue we reviewed the China’s crypto exodus and argued why we...

Charles Edwards

Issue #9

These are unprecedented times. The Bitcoin network has just experienced the biggest...

Charles Edwards

Issue #8

Bitcoin is trading at more than 40% below the all-time high for...

Jan Uytenhout

Issue #7

Every month we write a short update on the market. We try...

Charles Edwards

Issue #6

Every month we write a short update on the market. Last issue,...

Jan Uytenhout

Issue #5

Every month we write a short update on the market. We try...

Charles Edwards

Issue #4

Every month we write a short update on the market. We try...

Jan Uytenhout

Issue #3

Every month we write a short update on the market. We try...

Charles Edwards

Issue #2

We try to release our newsletters when we see key opportunities. Today...

Jan Uytenhout

What is Money?

Charles Edwards

Issue #1

This newsletter provides our airplane view of the Bitcoin market. It summarises...

Charles Edwards

The Energy Standard

Charles Edwards

Bitcoin Energy-Value Equivalence

Charles Edwards

Bitcoin’s Production Cost

Charles Edwards

Hash Ribbons & Bitcoin Bottoms

Charles Edwards

Metcalfe’s Law Says Bitcoin is Overvalued

Charles Edwards

Bitcoin Valuation using Dynamic Range NVT Signal

Charles Edwards

The Next Resession

Charles Edwards

Bitcoin Bottom Fishing with Miner Capitulation

Charles Edwards