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NVT Signal (NVTS) is a modified version of the NVT Ratio which uses a 90 day moving average of daily transfer volume as the denominator.
NVT Signal (NVTS) is a modified version of the original NVT Ratio and carries many similar interpretation properties. It uses a 90 day moving average of the daily transfer volume in the denominator instead of the raw daily transfer volume. The implementation of this moving average makes the ratio more responsive to real time over-extensions in price action as value (Market Cap) outpaces utility (90 day Transfer Volume).
Ratio values at either extreme tell analysts one of two things:
- A high NVT Signal (or uptrend) indicates that investors are pricing Bitcoin at a premium, as Market Cap growth outpaces on-chain Transfer Volume. High NVT Signal values have historically been periods to distribute BTC and often coincide with market tops.
- A low NVT Signal (or downtrend) indicates that investors are pricing Bitcoin at a discount, as on-chain Transfer Volume outpaces Market Cap growth. Low NVT Signal values have historically been periods to accumulate BTC and often coincide with market bottoms.
- A constant NVT Signal (or sideways trend) indicates that the current growth trend of both Market Cap and Transfer Volume are in equilibrium, suggesting the current market trend is sustainable. Such states are often reached during the early to mid phases of a bullish or bearish trend where the market direction is well established.
The chief concern with NVT Ratio is that while it tracks bullish/bearish trends fairly well, it lacks precision for identifying over-extensions in price action. Per the author Dmitry Kalichkin, the smoothing of transaction volume over 90 days made sense for the following reasons:
...cryptoassets exhibit reflexivity. In the short run, the price changes the fundamentals. In this case, transaction volume follows price.
So why does a longer period average result in a better indicator? Intuitively it makes sense. By definition, the role of Transaction Volume in the NVT denominator is to be a proxy for fundamental utility that users get from using the network. A longer smoothing period helps to get rid of the reflexivity effects described above — spikes in transaction volume that follow sharp price increase. These irregularities are speculation-driven and are bad descriptors of fundamental intrinsic utility of the network. When we remove these irregularities, we end up with a better proxy for fundamental value in NVT denominator, and, as a result, the new NVT ratio becomes a better descriptor of price level.
The evaluation and deeper understanding of NVT Signal can be developed via focusing on two distinct time periods:
- Regime 1: 2010 - Early 2018
- Regime 2: Early 2018 - Present
The key difference between these regimes is the upwards drift in NVT Ratio since early 2018. This drift can be attributed to many different things, such as off-chain flows (i.e. activity taking place on exchanges) experiencing a significant boom, an increase in BTC being held by low time-preference players (see Illiquid Supply), or even an uptake in layer 2 activity (i.e. Lightning Network).
Regime 1 provides a more appropriate example for both NVT Ratio and NVT Signal whilst Regime 2 is better analyzed via NVT Signal alone.
It will be evident in its application below that NVT Signal shows large spikes at market tops, and thus provides timely signals for exiting near Bitcoin macro tops. This differs from the original NVT Ratio and provides additional edge to users of both metrics.
- Red circles: Large bearish over-extensions in price action, which signals massive divergence between value and utility. Opportunities to sell during peak euphoria.
- Orange box: Bearish zone where value is consistently outpacing utility. Caution advised while these value prints are present.
- Green box: Bullish zone where utility is consistently outpacing value. Historically a positive expected value period to commence accumulating.
- Colour scheme rules for red circles, orange box, and green box above apply here as per the description in Regime 1.
- Blue circles: Large bullish over-extensions in price action, which signals massive divergence between value and utility. Opportunities to buy peak fear.
- Bitcoin NVT Signal bottoms have been sharper in Regime 2, which could be attributable to the expansion of derivative products within BTC markets.
Dmitry Kalichkin, February 2018