We know math might not be your strong suit so the thought of another ratio to keep track of might not be the best news we’ve heard. That said, for those avid investors, we’ve put together our steps for how to calculate Bitcoin’s MVRV ratio. This ratio was a newly proposed method for estimating a crypto asset’s real or “fair” value.
But before we get ahead of ourselves, we would like to remind you that this advice should not constitute investment advice. Rather, this is simply a guiding article to get you started.
If you have never heard of the MVRV ratio, you might be wondering what it is for. As we all know, bitcoin can be a volatile asset to own. It has delivered some spectacular returns in the past, as well as some spectacular crashes. But this is not necessarily a bad thing especially if you are a trader. As one article states, it is important to keep in mind that
Becoming a Successful Trader
“Successful trading is all about finding and capitalizing on market imbalances. Markets that are in balance cannot be exploited.”
But trying to gauge the price action of bitcoin is not an easy task. If you are a trader looking for an edge, you need a way to analyze the activity on the bitcoin network to get an idea of where the price is headed and when might be the best times to buy and sell. This is where the MVRV ratio might be of assistance. The MVRV ratio is a valuation metric that can help you gauge those market tops and bottoms. You can also use this value to analyze investor behavior. It is one more tool you can use in your trading arsenal.
Before we explain more about Bitcoin’s MVRV, let’s first explain how MVRV is calculated.
MVRV Ratio Defined
This ratio was originally created by Murad Magmudov and David Puell. This ratio is calculated by dividing the Market Cap (market value) of the asset by the Realised cap and can be stated more simply as:
Market Cap / Realised Cap = MVRV
This ratio is calculated on a daily basis.
Calculating Market Cap
But first things first, what are the market cap and realised cap values? Market cap or market value is the total market capitalization of bitcoin and can be calculated by multiplying the bitcoin trading price on exchanges by the number of bitcoins mined so far.
Market value = Price of Bitcoin x Bitcoins mined
Calculating Realized Value
The next value we would need to consider is the realized cap. Instead of using one current price for all of the mined coins, the realized cap takes into account the actual price paid for all coins in existence. It is calculated by taking the sum of the market value of the coins at the time they last moved on the blockchain i.e. when they were last sent from one wallet to the next.
To illustrate how this value would be calculated, we could calculate the realized value of just the coins in your position. You could do so by determining the average price you paid per coin in your wallet.
Let’s say your wallet looked something like this:
- 5 bitcoins at $4000 / each
- 10 bitcoins at $500 / each
- 1 bitcoin at $10,000 / each
If this is the case you could calculate the realized value of your bitcoins by using the following equation:
(5*$4000) + (10*$500) + (1*$10,000) = $35,000
35,000 / 16 = $2187.50
In other words, you paid an average of $2187.50 per bitcoin.
Doing this calculation for all bitcoins across the entire network would give us the realized cap for bitcoin. The realized cap is essentially an estimate of the total acquisition cost that users have spent to acquire their tokens.
This value helps us to eliminate some of the lost, unused, unclaimed coins as well as coins used for hodling from our total value calculations (market cap). It also strips out the short term market sentiment that would be reflected in the market value metric. It is therefore seen as a more “true” long term measure of the value of bitcoin. The market cap would move above or below this value depending on market sentiment at the time.
What Does the MVRV indicate?
If an asset’s current market value is higher than its realized value, i.e. MVRV ratio is above 1, it is determined to be an ‘overvalued’ asset. Whereas a value under 1 would indicate that the asset is “undervalued”.
However, in the case of Bitcoin’s MVRV, we see that 90% of the time, the MVRV of Bitcoin has been greater than 1. Interestingly, this does not mean that bitcoin was necessarily overvalued. Looking at price history charts, even when MVRV is over 1, Bitcoin’s price can still be quite far away from a global top, meaning its price may still have room to grow. By Bitcoin’s standard, any value over 3.7 is determined to be overvalued. And any value less than 1 is considered to be undervalued.
We can modify this ratio slightly to consider the deviation between the realized value and the market value by calculating the MVRV z-score. The z-score is a measure of the number of standard deviations above or below the mean. It gives us an idea of how far we have deviated from the mean which, in this case, is represented by the realized value.
Furthermore, this z-score can help us to better determine what is normal for a specific coin. We can calculate this by using the following formula:
MVRV Z-Score = (Market Cap – Realised Cap) / StdDev (Market Cap)
The Z-Score Explained
The Z-score is useful in pulling out the extremes in the data between market value and realized value. Without going into a detailed explanation of statistics, let’s just say that it has proven to be a very effective tool in identifying market tops with great accuracy. This point is well illustrated by having a look at the chart from Phemex below:
The z-score entering the pink zone indicates periods of where market value is moving unusually high above realized values. This usually signals the top of market cycles. Historically, Z-scores have been able to pick out the market high of each cycle to within two weeks.
Some interesting points to note on the graph are the parabolic spikes that have occurred before the prolonged downturns. Specifically, these have occurred in early 2013, late 2013, and late 2017. The spikes into the pink zone indicate that the market has reached a climax of euphoria.
When the z-score enters the green box, as indicated by a z-score below zero, it indicates that the market is undershooting bitcoin’s “real” value. As shown from the chart, buying during these times has historically produced great returns.
Bitcoin’s MVRV Z-Score in Action
A recent example of this occurred on March 13, 2020, during the coronavirus pandemic, when we saw the MVRV z-score dip below zero for the first time in 12 months. It indicated that the cryptocurrency was now undervalued and trading near a major bottom. It turned out to be a great opportunity to buy bitcoin. Bitcoin’s price on that day was $5017.83. It has since rebounded to a high of $9700.34 on May 31, 2020.
From a historical perspective, the MVRV z-score has been remarkably accurate in picking out the peaks and valleys within the price cycle of Bitcoin, and in helping us to consider the value of the investment.
Having said that though, it is just one metric and should be used in conjunction with others to increase confidence in our investment strategy. Using metrics such as this one helps us to think past the emotions of the crowd and consider the long term value of the coin since it is based on careful analysis.
Analyzing Bitcoin’s Action
There are two interesting factors to take into account when using indicators to analyze bitcoin’s action on the exchanges. One is that there is only just over a decade of historical data to back up your analysis. At times in the past, bitcoin’s behavior has defied analysts’ predictions. And it can be hard to predict how bitcoin will behave during a macro-financial crisis. As we’ve seen with the recent coronavirus pandemic in March 2020, bitcoin did not fare as well as expected. In just a three week period, the price plunged over 60%.
Another consideration is the effect of side chains on transaction volumes. Current metrics are based on the analysis of on-chain data, and they have worked well in the past. But exchanges like Bitcoin Liquid have now come into existence. This sidechain exchange allows large exchanges to transfer funds to each other off the main chain. Such transactions cannot be tracked using “traditional” blockchain analysis. Having said that though, some may argue that it may make the analysis clearer, as it will weed out more short term transactions, leaving a higher proportion of transactions from long term investors.
Let’s Get Calculating
We’ve just seen how the bitcoin MVRV has proven to be a useful tool in analyzing bitcoin’s price action and determining good entry and exit points. However, it is only one metric among many that are employed by expert traders to give them an edge. You can even compare it to the other metrics on your Hedgetrade dashboard. After all, anything that can give you added insight into this volatile coin can only help add to your confidence in trading bitcoin.
On the other hand, perhaps Bitcoin’s MVRV may have you feeling more confused than ever and has made Bitcoin seem more inaccessible than before. We agree that sometimes detailed technical analysis is best left to the experts. If this is the case, we want to assure you that you need not worry. With the Hedgetrade platform, you won’t need to do any fancy calculations before you invest. The only requirement? Looking up which investors you want to follow, and invest alongside them, as they share their expertise.
Sounds just a little bit easier if you ask us.