The Network Spend Ratio (NSR) looks at the network size and compares it to price. It is the most important measure of value within crypto currencies.
Anything that measures the level of activity within the bitcoin network, is potentially useful information. A rising price reflects growing demand, as does the level of press comment or conversation on social media. Yet there’s nothing quite like going direct to source for information, and in that regard, the blockchain is a treasure trove. Everything that has ever happened, has been recorded, which is music to the ears of the analyst.
Extracting information from the blockchain enables us to count the transactions, and see their underlying value. That means we can measure how much money was transferred over the bitcoin network over time; not dissimilar to turnover for a company.
In the chart, the four series have been re-based to one at the beginning of 2013 and plotted on a log scale. It shows you that price, market cap and general spend* are highly correlated (unsurprisingly), yet the number of transactions less so. That number has been left behind.
*General spend is the combined on-chain transaction value measured in US dollars. This is the single most important metric in crypto analysis. This is a complex calculation because “change” is created in transactions, and ByteTree removes this to show the underlying transaction values. General spend takes the price and net spend at the time of each block to get an economic transaction value for that block. It is then added to all of the other blocks over the past rolling week, which eliminates the weekday bias (weekends are consistently weak). If general spend is rising, then the network is growing and vice versa. A growing 5 or 12 week general spend line would be a more stable measure of network growth than a single week. General spend is to a crypto analyst what sales/revenue/turnover is to an equity analyst, and it is measured in weeks.
In January 2013, the bitcoin network network hosted 275 thousand transactions per week, whereas now it hosts 1.7 million, having come close to 3 million in late 2017, at the price peak. With the bitcoin price starting 2013 at around $13, it is up around 300 times, when the number of transactions is up less than ten times. That’s still a high level of growth, but by implication, the Network to Transaction Ratio (NTR) has gone through the roof. And it has.
The network used to price each weekly transaction at $400 (network value or market cap was 275k transactions * $400 = $110 m). Today, each weekly transaction is priced at over $30,000. It’s a huge shift. Some believe the NTR is a useful valuation measure, but I’m not so sure. A useful valuation measure must have an anchor, it must be stable over time and be mean reverting. The NTR fails these tests. But still, it would make sense to own bitcoin when the NTR is rising, and be on your guard when it has been falling. But in that regard, it isn’t really telling you much more than price alone.
But what I do want to show you is a strong, and highly correlated link between the price and network spend. There is some circularity here as network spend is calculated using price, but “this is crypto”. The hype cycle sees new users, that transact, spend and tell their friends. The stronger that force is, the greater the network growth and the bitcoin price follows. This goes a long way to explaining bitcoin’s high volatility. Each cycle has seen more transactions and general spend than the last, and the intrinsic network value is building over time. And that is where we can find a more stable foundation to value bitcoin.
By using weekly spend, measured over 12 weeks, you get a reasonably stable measure of the network size, that is highly correlated to price over the longer term. That orange line rises during bull markets and falls during bear markets. To put that into perspective, the network spend was $21 million each week at the beginning of 2013. It grew to $1 billion by the end of 2013, only to fall back to $500 million by the end of 2014. In the subsequent bull market, that network surged to over $30 billion (late 2017), and a lesser $7 billion as I write. But that’s still seven times higher than the 2013 “bubble” peak.
I have calibrated the chart and the result shows a mean-reverting relationship around a constant. Mid 2014 was a bad time to buy because the network had already shrunk, yet the price was still high. Cue the collapse. A year later, by mid 2015, it was a fabulous time to buy bitcoin because the price was low while the network recovery was already well underway. And that is the most profitable time to buy. It doesn't come around too often, but when it does, now you’ll know what to do.
This can be seen on the Network to Spend Ratio (the network value divided by the weekly general spend). An NSR of 10 means that it takes ten weeks for the general spend to match the network value or market cap. A lower number ought to be cheap, and a higher number expensive. Well, nearly. Please allow me to explain.
You get some great signals, like the ones I just mentioned, plus the bull peak sell signals in mid and late 2013, and again in late 2017. But you get some terrible ones too. Imagine the general spend is falling and the price collapses. Bitcoin appears to be cheap, but the network is still contracting, and for that reason, you can get some bad signals, such as a cheap reading in February 2018. Although to be fair, the price had fallen from $19,000 to $6,000 and held there for another six months. Finally in November, when bitcoin finally broke $6,000, the NSR was 10, signalling caution. It wasn’t a great shock to those following the level of general spend which had carried on falling.
NSR is an extremely useful valuation tool, but be aware of the bigger picture. If the general spend is falling, there is no profitable way to invest on the long side. In that scenario, the best strategy is to get out of the way (or go short if you are that way inclined), and sit in cash.
And if you want to be really smart, then go long when the NSR is rising, and sit out of the market when it is falling. This simple strategy should succeed because it follows tried and tested investment principles. That is, it is value-orientated and cautions. Benjamin Graham would be proud.
(chart previously published has been deleted. I will republish in due course via the ByteTree.com blog)
Follow the NSR and many other metrics on https://bytetree.com/. The data set has been under construction since November 2013 (no typo). There’s much more coming that will help you to better understand the value of the crypto using data from the blockchain. And if you are looking for a crypto with a lower NSR, there’s always Litecoin. Caveat emptor.