An Introduction to NVT & How Santiment’s Sansheets Has Brought its Value as a Lead Price Indicator to New Heights
A Simple Fundamental Model Proven to Work Better Than “Hodling”
With all of the strong market calls and opinions constantly showered upon us on social media in regards to what direction a crypto asset’s price is headed next, how nice would it be if each anonymous influencer, crypto expert, and Telegram/Discord server leader had a nice “accountability tracker” table like this next to their Twitter, Discord, or Telegram avatars based on their stance on the crypto markets over time?
Considering how much green there is next to their “Bullish” calls, and how much red there is next to their “Bearish” calls, you’d probably be quite impressed with this individual’s ability to predict the markets month after month. But as the caption indicates, these are actually backtest results for Santiment's newest Sansheets indicator over the past 43 months. I'll deep dive into this multi-layered NVT model based on token circulation and moving average thresholds. This will include how the surprisingly simple metric is calculated, what it can be used for, and why it considered to be a valid leading indicator for market direction.
What is NVT?
Many of you may have seen NVT mentioned on occasion since you began researching and following the ebbs and flows of the crypto markets. Also known as Network Value to Transactions Ratio, the metric provides us with insight into how to assign fair value to coins in an industry where doing so can be tediously difficult, and often virtually impossible. The idea behind the NVT theory is simple - if the value transferred on the network (transaction volume, or in our case token circulation) is too low relative to the network's valuation (market cap), then that asset should be considered overvalued and due for a correction. And vice versa - if the value transferred on the network is too high compared to its current valuation, NVT would deem the asset undervalued, and ripe for a breakout.
Drawing conclusions from a single metric regarding whether coins like Bitcoin (or a handful of other assets, like Ethereum) are over-inflated or under-inflated sounds presumptuous. But historical evidence has shown that it has performed surprisingly impressively as a leading indicator according to our trials and tests. While there is an argument that many fundamental metrics are best used to simply validate whether current price movements are justified, using NVT to its full extent can really open up doors for looking into the near future of the markets in an objective fashion.
To calculate NVT, you can simply take a dataset for Bitcoin or Ethereum’s market cap over a given time and divide it by its amount of transaction volume or token circulation over that same day. Even if we weren’t doing the math for you here, you don’t need to be a math wiz by any means to make your own model and do these calculations if you felt the need. We'll ensure you know how.
A simplistic overview of NVT's formula is an asset's network value over its daily transaction value. More specifically for Santiment, our version of calculating NVT is to take market cap divided by daily token circulation. With this calculation, your ratio will output a number that varies depending on the data source you pulled from. We recommend Santiment due to its reliability and ease in using Sansheets to get quick tables at your fingertips. As of this writing, Bitcoin's current NVT is 105.72. This outcome doesn't provide a whole lot of meaning as an isolated day. But comparing this outcome to other days over long periods of time for crypto assets, NVT begins to actually tell quite a story when you are able to find high ranges, low ranges, and meaningful averages of these outcomes over time. And again, don’t worry. We took care of finding these meaningful averages and ranges, which we'll show in our template. These metrics can also be found in tandem together on Sangraphs.
How Does Santiment’s NVT Template Work?
In our case, we chose to use token circulation over daily transaction volume due to its superior accuracy in predicting future price based on experimentation through our NVT model. Token circulation tracks the amount of unique active tokens that are exchanged on a given date, while transaction volume simply tracks the total amount of assets that were tracked across all network transactions on a given date. The difference between these two measurements are actually quite considerable, and the former is fairly universally accepted as the better approach for measuring economic activity in an asset.
We tested both methods ourselves, and according to the explanations of each metric on Santiment’s Github repository, we state: “Since Daily Transaction Volume gets rather noisy and easy to manipulate by transferring the same tokens through a couple of addresses over and over again, it’s not an ideal measure of a network’s economic activity. That’s why we calculate NVT using Daily Trx Volume, but also by using Daily Token Circulation instead, which filters out excess transactions and provides a cleaner overview of a blockchain’s daily transaction throughput.”
All of this being said, let's take a look at the model itself, using Bitcoin as our example template:
What you see in this chart is an array of colors, subtly fluctuating trendlines, and a familiar looking shape that resembles a zoomed out, monthly aggregated price line for Bitcoin. As odd or intimidating as it may seem at first glance, it’s actually a fairly minimalistic NVT chart. In short, red and orange colors mean the market is looking bearish based on token circulation as it aligns with BTC's market cap. Yellow-green and green colors mean the market is looking bullish. The higher the NVT is compared to other neighboring months, the more likely price will go down. The lower the NVT is compared to other neighboring months, the more likely price will go up. More on this later.
Using Santiment’s cutting edge platform, Sansheets, we pulled Santiment’s reliable and consistently updating crypto data into Google Sheets using their simple and freely available plugin in order to automate daily prices and NVT data since April 1, 2016. And since individual daily data going back multiple years would look like a blurred mess on a graph intended to fit on a computer monitor (among other reasons), we averaged all price and NVT data points and grouped them into months.
And what do we see? A reliably effective inverse correlation between NVT and price. In short, when NVT gets to its high range, this means that token circulation is low compared to its market cap (a no bueno sign). Alternatively, when NVT gets to its low range, this means that token circulation is high compared to its market cap (a bueno sign).
Crypto markets are still roughly just a decade old, and assets are constantly being overbought or oversold as traders tend to overreact with FUD and FOMO particularly coinciding with extreme price fluctuations. As a result, we utilize trend lines to adjust these high ranges and low ranges slightly over time in a fair, mathematically objective manner to dictate where NVT needs to be maintained to keep an asset’s price momentum up.
So with 2018 being such a down year for crypto, for example, NVT was naturally in the Bearish territory for the majority of the time. This caused our moving average lines to raise the range of what would be considered Bearish heading into 2019 (allowing more mathematical leniency), because the 2018 range was becoming the new Neutral. So when Bitcoin’s token circulation finally began picking up just slightly again in early 2019, it didn’t take as much picking up to get our NVT model back into Bullish territory this year as it would have needed to do vs. its respective market cap in, say, 2016 or 2017. This is demonstrated and highlighted by this image:
As we already showed at the beginning of this article with Bitcoin’s backtest table, following this template and owning BTC exclusively during Bullish months would net you an average of 25.49% returns on your investment every month that NVT is in this green range. Investing in a bearish month would lose you an average a much smaller, yet still significant 3.05% per month in this red range. Of course, this is based on a sample size of 9 Bullish months and 15 Bearish months out of the 43 total that are compiled in this analysis. Things could change and trend lines may need more precise interval settings as more future months reveal their significance. There are a few outlier months to acknowledge as it currently stands, as well (though an impressive very few). October 2017 and March 2019 are a couple examples.
Yep... NVT Works for Ethereum, Too
For comparison, here is Ethereum’s same template and backtest result table for its historical NVT since September, 2015 (when there was sufficient enough data and market liquidity for ETH to make accurate assessments about its NVT fluctuations):
There are a lot of telling stories throughout the history of Ethereum, and its token circulation vs. market cap paints a pretty nice picture for it in spite of the fact that its price is still fairly tied to the performance of Bitcoin as of this writing. But the backtest results on the right clearly show that following the colored signals leads to fairly predictable (thus, exciting) results. It’s worth noting that this backtest is two-pronged:
- 1) It measures the current month’s price direction to validate the movement it had since the month before it, and shows (through the 5 colored scale) whether a move up, down, or sideways was justified based on NVT’s measurements. So if a red NVT signal is given for the current month, and the average price of the current month is down 20% compared to the previous month, this correctly validates that token circulation is not keeping up with the market cap and is a major reason why price is currently falling.
- 2) It also measures the price direction of the following month to see how NVT shapes up as an all-important leading indicator. So if a bullish green signal is represented by the current month, and the average price of next month is 30% higher than the average price of the current month, it shows that the bullish signal correctly predicted a large, positive upward movement in price.
The multi-colored average percent column simply splits the average of these two to give a combined result for the most meaningful backtest results. You’ll notice that both the current month column and following month column don’t resemble a great deal of difference, so both measurements prove they have usefulness in this backtest analysis.
Is NVT the End-All, Be-All Indication for Future Price Movements?
If this lengthy article about our new NVT model is needlessly unconvincing and complex, we'll put it to you simply. Santiment is making available backtested charts for Bitcoin and Ethereum for our Pro subscribers. These charts objectively estimate each month's value in terms of NVT's output of it signaling Bearish (red), Semi-Bearish (orange), Neutral (yellow), Semi-Bullish (yellow-green), or Bullish (green) territory using historical NVT values.
It goes without saying that this is not a 100% reliable way to see into the future and know (without room for error) what direction the markets are headed. This is absolutely not investment advice and choosing to make trading decisions based on single-metric analysis like this is done at your own risk.
In a space where leading indicators are few and far to come by, however, we consider this NVT study to be serious progress for savvy traders and investors out there who are looking to gain an advantage with their trading strategies that supplement many analyses before making assessments. We will occasionally post screenshots of our NVT charts on our @santimentfeed handle and other platforms, but Santiment subscribers will be the only ones who can interactively get live looks at how the NVT signals are shaping up in real-time. Along with all of the other helpful tools we offer, consider these charts to be some pretty nice extra incentive.
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