Another year and another bubble in the cryptocurrency market. As I explained towards the end of a previous post the the cryptocurrency market is in the middle of another bubble of epic proportions. The chart above shows the price of bitcoin compared to the normalized average transaction rates (averaged over five days to smooth it out). Transactions here refer to transactions within the Bitcoin network, transactions that have to be validated by miners, this excludes transactions within centralized exchanges that typically use an order matching engine. The normalized average transaction rate was calculated by first calculating a moving average of daily transactions over a period of five days and finding the daily growth rate of the moving average. Afterwards starting from a value of 1 and multiplying cumulatively by calculated growth rates. The end result is what would the value of $1 be had it been invested in an asset whose value appreciated locked in step with the growth of its network, in this case the growth of the network is estimated using the average transactions over five days. The time period covers from August 28th, 2010 to July 14th, 2017. The data was obtained from Blockchain.info.
Impressive Network Growth
The purpose of calculating the normalized average transaction rate was to estimate how much has the network growth relative to the price of Bitcoin. As the chart shows above the average transaction rate, the orange line, has grown quite impressively. If it had been a security, $1 invested in August 28th, 2010 would be worth approximately $644 today. That’s an astounding 64,300% return over almost seven years or approximately 154% yearly return. While the price of Bitcoin has offered a similar rate of return one thing to note is the considerably lower volatility of the rate of growth of the network compared to the price of Bitcoin. The network has been steadily growing year over year despite the spikes and crashes of Bitcoin. Although there are other factors that also have to be considered when estimating the health of a blockchain project, such as the number of active wallets in the network, the average price of transaction fees, etc. the average transaction rate encapsulates the more important question of how much is it being used?
Bitcoin is in a Bubble
As is also obvious in the chart there’s a poignant discrepancy between the price of Bitcoin and its normalized average daily transactions. Starting in Februrary 2017 the price of Bitcoin started to grow at a much faster rate than the average transactions per day of the network. This spike happened as positive news coming from Japan and Korea made headlines increasing demand from speculators. It is quite obvious that the surge in prices is not justified by the growth of the network. A similar event happened towards the end of 2013. While many people blamed the collapse of Mt Gox for the crash of 2013 and now probably the potential fork as a result of segwit activation, it is clear that in both cases the stream of bad news only served to remind investors to come back to their senses regarding the price of Bitcoin relative to the size of its network.
Cryptocurrency Market ins in a Bubble
While my analysis is only applied to Bitcoin, it extends to the entire cryptocurrency market. The great majority of cryptocurrencies are valued in Bitcoin, therefore a surge in the price of Bitcoin means a surge in their prices as well. To make matters worse, the relatively small trading volumes in other cryptocurrencies make them more vulnerable to spikes and crashes of much larger proportions than what is being experienced in Bitcoin at the time. While there are other projects that are also priced independently of Bitcoin, such as Ethereum and Ripple which are also possible to analyze, it is not necessary to analyze them to conclude that they are also in bubble territory when looking at their price gains in the past two months. Ethereum and Ripple, despite having grown tremendously in terms of popularity, funding, expertise of their respective teams, and utility of their tokens, their networks are still much younger than Bitcoin’s with a smaller number of participants, yet their current market capitalizations have been increasingly nearing that of Bitcoin despite Bitcoin being in a bubble itself.
The Bubble is Crashing but Another will Come
As I write the cryptocurrency bubble seems to be bursting, with Bitcoin being more than $1000 away from its peak at $3000 and Ethereum under $180. Many people in the past have claimed every time a bubble bursts in the cryptocurrency market that it is the end of the cryptocurrency market. Do not be alarmed as you can see in the chart above that despite there have always been bubbles and bursts, Bitcoin’s network has kept growing, as has been the case for the most established cryptocurrencies in the market that offer something innovative. As I explained in a previous post, every time there’s a surge in speculators (usually due to some significant positive news) the price of cryptocurrencies may experience parabolic growth, but be aware that these price spikes are never sustainable as the growth of their networks do not justify such sudden price gains.