Our latest Bitcoin fundamentals analysis looks into the current trends after a difficult year for the cryptocurrency. Prices have been decreasing in Bitcoin since December of 2017. The price decline has slowed since the end of 2018 and analysts have been reporting mixed forecasts for future price prospects.
Some analysts believe the current increases and periods of consolidation are a temporary break from the overall bearish trend which will continue until prices reach much lower levels. Other analysts believe the price has seen its final capitulation in November and the current price action is representative of buyers accumulating and the starting an uptrend.
In this post, we delve into the fundamentals of Bitcoin to address whether the price of Bitcoin is likely to be overbought or oversold. Some of the fundamentals we delve into here include current network usage, the current state of mining on the network, ongoing development on the protocol, key analysis rations, and how all of these relate to price.
What is the Bitcoin network facilitating currently?
The number of transactions being processed has been gradually increasing over the past six months. In February of 2019, the number of confirmed transactions per day has mostly been between 300,000 and 350,000. The number of confirmed transactions being processed per day was approximately 200,000 this time last year.
The number and value of transactions are the best metrics for assessing the demand to use the network. As the market for Bitcoin is still at an extremely early stage – barely ten years old – much of the price movements are driven by speculative traders.
However, as the markets continues to mature, the price will more and more reflect the demand to use the network. This is why mature markets such as equities will adjust even if there is a slight change in expected earnings. The increase we have been seeing in the number of daily transactions over the past six months is a good sign for the demand of the network. But this may take some time to reflect itself in the price, which is mainly driven by speculative traders.
Given the decrease in price around February of 2018, the higher number of transactions still represents a lower total USD amount. Transactions taking place last year were transferring $1.5 billion in value. Even with the decreasing interest and prices, the network mostly processes over $500 million daily currently.
There was a spike to over $2.7 billion in mid-November of 2018, which corresponds to the time where price broke below a key technical level and a sharp sell-off took place. This spike in transaction value may correspond with traders moving funds to exchanges to convert into flat currency due to fear of further price declines.
What do the other metrics say about the Bitcoin network?
Despite prices decreasing, the hash rate of the cumulative miners on the network tripled from approximately 15 EH/s to 45 EH/s. Hash rate is often used as a measure of security of the network. An increase in the metric is driven by two factors. A greater number of ASICs mining on the bitcoin network and more efficient ASICs mining.
While transactions per day is a good metric to assess the demand for the network, hash rate is a good metric to assess the security in terms of procurement of the network. A network being supplied by a greater amount of hash rate is a more secure network and a more secure network will be more valuable.
However, with price being driven mainly by speculative investors due to the market remaining in an early stage, an increase in the hash rate is not always reflected by an increase in price. Prices in 2018 spent much of their time undergoing a correction from euphoric price increases which took place in the second half of 2017. With prices not increasing to reflect the increase in hash rate and the network being more secure, it may be indicating that we are still in the correction phase.
Recent research has also shown the Bitcoin network to be far more decentralized than in the past with no mining pool accounting for over 20% of the hash rate. The research compares the current mining distribution to the distribution in mid-2014 where the mining pool GHash.IO accounted for approximately 50% of the hash rate, bringing it close to being able to conduct a 51% attack.
Recent 51% attacks in cryptocurrencies such as Bitcoin Gold, Ethereum Classic, and Verge resulted in severe losses of confidence in the networks and corresponding price decreases. The current state of decentralization in the Bitcoin network makes it highly improbable that such a situation could happen in its network in the near-term.
Anything else exciting?
There have been a number of exciting developments taking place on the Bitcoin protocol so far in 2019. There are increased adoption and discussion taking place around the second layer bidirectional payment channel, the lightning network. Blockstream have also launched their sidechain Liquid, which is another alternative to address scalability issues on the Bitcoin blockchain.
Segwit is also seeing increased adoption which serves to make the use of block size more efficient. Lightning network and Liquid are still at a very early stage in terms of adoption and will require a lot of development improvements before being widely adopted. However, the lightning network holds big potential to have an impact on the future usage, adoption, and price of Bitcoin.It is still uncertain if and when the lightning network will make its impact, but it is worth noting that there is a lot of excitement about its development and progress.
Taking a deeper dive into the data
The above data demonstrate that despite prices decreasing, the Bitcoin network is still providing a vast amount of utility to users, and is secured by a large amount of hash power. There are also interesting developments taking place in the Bitcoin protocol itself and being built on top of Bitcoin.
But the key question remains: Has the price bottomed out or can it continue to decrease even with the data demonstrating network usage improvement? Price can always continue to decrease but a deeper dive into the data can help us assess whether the price is likely to have already bottomed out.
The MVRV ratio compares the market value of Bitcoin to it’s realized value. While the market value is calculated by multiplying the circulating supply of Bitcoin by the current market price, the realized value has an entirely different calculation.
The realized value is calculated by multiplying each unspent transaction output (UTXO) by the market price at the time and using the summation of these as the value. UTXO’s are essentially timestamps of when the last bitcoin moved. For example, if my wallet had 1 bitcoin and I received half a bitcoin in November of 2017 and half a bitcoin in November of 2018, this would mean I would have half a Bitcoin worth of UTXO’s for each. This is a useful calculation for a number of reasons. It accounts for cryptocurrencies which are in deep cold storage and those which have been lost by assigning them values at the time of their last movement.
Typically, when the MVRV ratio drops below one, this can be a strong signal that the market has capitulated as the market value at current prices is actually lower than the value which takes into accounts market prices at the time of all combined UTXO’s. The strength of MVRV as a signal can be seen on the below graph, where drops below 1 in the ratio have corresponded with prices bottoming. The latest significant price crash that took place in mid-November brought the ratio below 1. This does not mean that prices cannot drop further but it does mean prices are potentially at a discount in relation to fundamentals.
The fundamentals for Bitcoin indicate that the operating health of the network is stronger and more decentralized than ever. Transactions have been gradually increasing over the past six months indicating demand from consumers and the hash rate has tripled in 2018 indicating that the network is far more secure. With no mining pool accounting for more than 20% of the hash rate, the risk of a 51% attack is currently little to none.
There are exciting developments – such as the lightning network – taking place on the protocol, but it’s uncertain if and when these developments will have a material impact on price. All of these improved metrics have failed to correspond with an increase in price which strongly indicates that the market prices may still be correcting from the euphoric increases that took place in 2017.
However, when we analyse the MVRV ratio, there is a strong indication that the correction phase may be finishing and we could very well see an increase in price to reflect the improved fundamentals. Each time the MVRV ratio has dropped below 1, it has closely corresponded with a bottoming in price. The price declines which took place in mid-November of 2018 brought the ratio once again below 1 and we have since been seeing improved price action. The current price may very well be giving investors the opportunity to acquire Bitcoin at a discount.