Understanding Bitcoin's Value with MVRV Z-Scores

2023-11-02 09:01:21

In the world of Bitcoin, one of the most common questions is, "What's the true worth of a Bitcoin?" Because Bitcoin's value is largely shaped by supply and demand, there's no simple answer to this question. To uncover the fair value of Bitcoin, you need to consider various factors. That's where the MVRV Z-score comes into play. Let's delve into the world of MVRV Z-scores to understand what they are and how they can help assess Bitcoin's value.

## The MVRV Z-Score Explained

The MVRV Z-score is a useful metric, often applied to Bitcoin, that sheds light on whether a cryptocurrency is currently overvalued or undervalued. MVRV stands for "market value to realized value," and it serves as an indicator of a cryptocurrency's fair value.

This metric finds its origins in the MVRV ratio, which was initially developed by Murad Mahmudov and David Puell in 2018. The original MVRV ratio compared a cryptocurrency's market value to its realized value. While it was great for tracking immediate price trends, it didn't offer much insight into the fair value of Bitcoin.

The MVRV Z-score, conceived by Awe & Wonder later in 2018, builds upon the MVRV metric by incorporating Z-scores, a statistical concept measuring how far a value deviates from the mean (average). However, instead of using the mean value, the MVRV Z-score replaces it with the realized value of Bitcoin.

Without delving too deep into the mathematics, the MVRV Z-score helps you see the difference between Bitcoin's current price and its historical average price. In essence, it allows you to gauge whether Bitcoin's present price is exceptional compared to its past values and price history. This metric plays a crucial role in answering the question of Bitcoin's true value.

## Calculating the MVRV Z-Score

While many websites provide MVRV Z-score charts, it's valuable to understand how to calculate it manually. Knowing the calculation process offers insight into how the metric functions.

The fundamental formula for the MVRV Z-score involves subtracting the realized value of Bitcoin from its market value and then dividing the result by the standard deviation. Here's how you can calculate it:

1. Obtain the market capitalization of Bitcoin, which is the total market value of all Bitcoins. You can calculate this by multiplying the price of Bitcoin by the number of Bitcoins in circulation.

1. Find the realized value of Bitcoin, which is the sum of the values of all Bitcoins based on when they last moved. This calculation can be a bit complex, but you can easily find this data online.

1. Subtract the realized value from the market capitalization.

1. Divide this result by the market capitalization obtained in the first step to arrive at the final MVRV Z-score.

## Utilizing the MVRV Z-Score

Since its inception, the MVRV Z-score has become a vital tool for Bitcoin investors. Why is it so valuable? It helps identify market trends and offers a more accurate perspective on Bitcoin's fair value.

The current MVRV Z-score provides insights into whether Bitcoin is overvalued or undervalued. When the score surpasses 6.9, it usually indicates that Bitcoin is overpriced. On many charts, this overvalued range is depicted as a red or pink "danger zone" that the MVRV Z-score occasionally enters. When the score falls below 0.1, it suggests that Bitcoin is undervalued relative to its fair value. Charts often represent this undervalued zone as a green "safety zone," signaling a good opportunity to buy Bitcoin.

The MVRV Z-score excels in identifying market momentum. Market trends are key in determining Bitcoin's value. Significant shifts in Bitcoin's fair value attract attention and lead to even more substantial changes. The MVRV Z-score effectively reveals this momentum, often providing early warnings about impending market shifts. Historically, when the weekly close displays an MVRV Z-score of > 5, there's a 94.36% chance of a reversal.

## Pros and Cons of the MVRV Z-Score

Like any metric, the MVRV Z-score has its advantages and disadvantages. It's a valuable tool for estimating Bitcoin's fair value, but it's not without limitations.

Here are some pros of the MVRV Z-score:

1. Simplicity: It's straightforward to calculate and interpret, making it accessible even to casual crypto enthusiasts.

1. Reliability: Using months of historical data, it's reliable for identifying significant market trends and can predict trends with up to 94% accuracy.

1. Momentum Indicator: It helps track market momentum, potentially signaling shifts before significant price changes occur.

1. Degree of Deviation: It not only informs you whether the market is overvalued or undervalued but also quantifies the extent of the deviation from fair value.

On the flip side, here are some cons to consider:

1. Weighted Past Data: Lower prices from Bitcoin's early history may receive more weight in the calculation, potentially affecting the results.

1. Market Awareness: As more people become aware of this metric, Bitcoin tends to react when the score reaches 6.9, regardless of other market trends.

1. Data Averaging: Some experts argue that using an average of the past four years of Bitcoin pricing data would be more accurate than averaging data from Bitcoin's entire history.

1. Limited Value Indicator: The MVRV Z-score doesn't provide a precise valuation of Bitcoin but simply indicates whether it's overvalued or undervalued.

## Is the MVRV Z-Score a Reliable Bitcoin Price Predictor?

While the MVRV Z-score won't give you the exact value of a Bitcoin, it can provide a reasonably accurate estimate of its fair value. Like any pricing indicator, its reliability has some variations. You can't sell the moment the score hits 6.9, as Bitcoin prices could still rise further. However, it offers a robust estimate of Bitcoin's fair value.

In addition to estimating fair value, the score is quite dependable in identifying potential shifts in the market. By examining its historical performance, it becomes evident that it accurately predicted price drops in April 2013, December 2013, and December 2018, one to two weeks before these market crashes occurred.

Compared to other indicators like the RSI, the MVRV Z-score provides additional information. Besides confirming whether a cryptocurrency is overvalued or undervalued, it quantifies the extent of that deviation. The pronounced peaks in the Z-score offer extra insight into market movement, aiding in forecasting Bitcoin's fair value in the future. Despite its added detail, this score remains user-friendly.

## In Conclusion

The MVRV Z-score is a valuable tool in the world of cryptocurrency. While it doesn't provide an exact valuation, it offers substantial insights into whether Bitcoin's fair value is higher or lower than its current market value. Like any crypto metric, it's most effective when used in conjunction with other data to gain a comprehensive understanding.

Ultimately, while indicators like the MVRV Z-score may provide some insight into cryptocurrency fair value, they should be taken with a grain of caution. With macroeconomic factors like government regulations and inflation at play, cryptocurrency prices can become highly volatile, potentially rendering such indicators and

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