A Practical Guide to Bitcoin Investment: Using Power Law Corridors, MVRV, etc. to Judge the Law of BTC Value
Editor's Note: This article comes fromChain News ChainNews (ID: chainnewscom)Editor's Note: This article comes from
Chain News ChainNews (ID: chainnewscom)
Chain News ChainNews (ID: chainnewscom)
The success of short-term quantitative trading strategies is based on the stability of unspecified variables in the market environment, while ignoring the analysis and use of on-chain data. Too much noise from the news, obsession with explaining the market, and capturing the fleeting α market hidden among multiple currencies consumes traders' energy and makes them lose their accumulation of valuable thinking.
"Rationality is the slave of passion", in the reflection of past trading experience, we propose a set of long-term trading methods that guide trading decisions with accurate indicators. This set of methods focuses on the regular and periodic discovery of historical data on and off the Bitcoin chain, rather than on interpretation.
The power-law corridor is our basic price model and the source of long-term trend judgment. It is the discovery of the law of historical prices (the result of the entire market game); operations such as opening positions and taking profits rely on on-chain and off-chain data indicators such as MVRV. Indicates the floating profit and loss level of the entire market; finally, we will reveal the reasons why we love Bitcoin by sorting out the shortcomings of other investment strategies such as fixed investment, one-time long-term holding and altcoin investment portfolio one by one.
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Fund Flow Theory, Reservoir Model and Growth of Derivatives Trading Volume
The root of the price change of trading goods lies in the inflow and outflow of capital.
The reservoir model is a very good illustration. If Bitcoin is compared to a reservoir, water is compared to capital, and the water in the reservoir is the liquidity of Bitcoin. The water level of the reservoir indicates the price of Bitcoin. . The cistern is connected to other larger pools outside through the capital flow pipeline A. The pipeline is bidirectional, sometimes injecting water into the cistern, and sometimes pumping water out. In addition, there is a water leakage port B below the water storage tank, which continuously leaks water outward.
Based on the model, the water level rises and falls in the following cases:
When the input capital of pipeline A is greater than the leakage capital of leakage port B, the water level of the reservoir will rise, that is, the price of Bitcoin will rise;
Under any other conditions, the water level in the reservoir decreases and the price of Bitcoin decreases.
In the cistern model, we added independent drains to indicate the relatively constant capital losses and outflows in the Bitcoin market, which have a significant impact on the price of Bitcoin during times when the capital input pipeline is relatively calm. Regarding capital leakage, the transaction fee of the trading platform is a good example. The trading platform generally charges a 0.2% handling fee for spot transactions. The seemingly inconspicuous ratio is magnified in multiple transactions. The platform receives service fees and uses them as the main source of income to pay for operating costs, and this part of capital flows out of Bitcoin from here.
The development of derivatives is a sign of the gradual maturity of the market, and traders have more flexible financial instruments. In our view, these "more flexible financial instruments" are the main factor driving the increase in capital leakage.
As the most important variety of derivatives, futures contracts (Futures) provide lower handling fees, higher leverage and more convenient short-selling methods on a spot basis. These changes have induced traders to gradually shift from spot trading to futures contract trading, and continuously increase the frequency of transactions, enlarge the transaction volume and leverage multiples. From a macro perspective, the increase in derivatives trading volume has provided trading platforms with higher fee income on the one hand, and widened the income gap between ordinary traders and elite traders on the other hand. Elite traders can obtain higher returns with the same capital cost through derivatives. From the perspective of cost, the cost of obtaining Bitcoin for elite traders is gradually decreasing, while the cost of ordinary traders is rising. Assuming that there is no external capital inflow, the capital distribution in the market will become more and more uneven, and it will tend to present the most classic "20-8 law", that is, 20% of the people control 80% of the wealth. Elite traders have a large number of bitcoins and low cost, which naturally generates a demand for selling. This part of capital will gradually flow out of the bitcoin pool, resulting in a decline in the price of the currency.
However, we don't need to be too pessimistic. Under the already bleak economic situation, governments of various countries continue to demonstrate the inability of modern governments to stimulate the economy through quantitative easing policies. Some mainstream financial institutions in the West have begun to regard Bitcoin as a weapon against inflation, and this reservoir is not a stagnant pool.
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MVRV and the Introduction of Average Cost Fluctuation Theory
Investment methods are inevitably built on assumptions.
Stock traders judge the price level through the company's profitability; crude oil futures investors judge the complex supply and demand relationship and geopolitical situation; value investors firmly believe that "intrinsic value" is the center around which the price fluctuations of investment products revolve.
Since Bitcoin is not an economy and a consumable, it is difficult for investors to judge its relative price by using familiar valuation methods. Willy Woo and Plan B borrowed the valuation methods and price models of traditional investment targets to develop indicators and models such as NVT and S2F. We gave up this idea and tried to find simple and effective indicators in different aspects of Bitcoin data. Metrics looked for in different data are orthogonal. We ideally believe that there will be the greatest win rate when they both signal buys, and we will continually backtest this assumption in the future.
The power-law corridor and the power-law fluctuation line are simply derived from the historical trend data of Bitcoin prices. The analysis theory of price trends has been fully mature in the traditional trading market and can be applied to any trading product. Our job is to introduce more data and look for indicators that are strongly related to price movements. Of course, these data mainly come from Bitcoin itself, that is, on-chain data.
Thanks to the design mechanism of Bitcoin itself, we can easily obtain the full ledger, which records the time, amount, participants and other information of each transaction of Bitcoin since the genesis block. Adding up each bitcoin with the bitcoin price at the time of its last transfer can easily obtain the sum of the cost of all currency holders, which is defined by Coinmetrics as RV (Realized Value), which is the realized market value of bitcoin. This concept corresponds to MV (Market Value), that is, the market value in the general sense (the current transaction price of Bitcoin multiplied by the amount that has been mined). The relative levels of MV and RV indicate the floating profit of the overall market.
MVRV fluctuates between 1 and 2 most of the time, and times less than 1 and greater than 4 effectively indicate the lowest and highest points in the entire trend.
The effectiveness of MVRV reveals naive average cost volatility, that is, price fluctuations around the average cost of the entire market. The cost of various roles in the entire market to obtain Bitcoin is not equal. Miners rely on low-cost mining to obtain Bitcoin, and then sell it in the secondary market to earn a spread; the cost of unlucky traders is frequent in the secondary market. increase in transactions; macroscopically, when the price of Bitcoin is lower than the average cost, any profit-making party will have less incentive to sell Bitcoin, and the market is more inclined to recover, and when the price of Bitcoin is 4 times the average cost, any Currency holders should understand that this kind of floating profit cannot be sustained for a long time, and smart traders can settle in time.
The average cost fluctuation theory describes the price center of the Bitcoin market and is our basic view on the cryptocurrency market.
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Power Law Fluctuation Lines: Backtesting Power Law Corridors
Many seemingly reasonable indicators are difficult to get rid of the suspicion of "after the fact". They use historical trends as known conditions to adjust the parameters of the indicators so that they can effectively indicate the rise and fall. Good indicators need to be verified through backtesting, especially over a long period of time and across cycles, to prove that his effectiveness is not lucky.
This article will conduct a backtest on the power-law corridor, traverse and record the difference between the actual transaction price of the day and the linear regression price after performing linear regression on all historical trend data before that day. Specifically, take October 29, 2013 as an example:
The pink line in the above figure is the price difference. We calculate the data of each day from July 29, 2010 to May 5, 2020 in the same way, and define this curve as a power law fluctuation line.
By observation, set thresholds of +0.5 and -0.5 on the curve, and mark the points outside the threshold.
The distribution of orange and green points in the figure is enough to prove the accuracy of judging the relative level of the currency price within the cycle through the power-law fluctuation line and the power-law corridor. In fact, the slope of the power-law corridor changes slightly every day, so the power-law fluctuation line has a better reference value. In addition, we can improve its sensitivity by adjusting the threshold of the power-law fluctuation line, but this is contrary to the starting point of the power-law corridor, that is, the power-law corridor is not used to guide short-term operations, so in this article we only set a vague threshold to verify the validity of the power-law corridor.
The static fluctuation line of the power-law corridor indicates that the upper rail of Bitcoin is gradually decreasing, and the lower rail is stable, while the trend presented on the dynamic fluctuation line is the opposite. This is contrary to our general view of "the larger the market value, the lower the volatility" is Consistent, but not able to effectively support it. It is currently difficult to draw conclusions about the relative direction of the upper and lower rails, because the number of cycles since Bitcoin's creation is still too small.
The indications of the Power Law Swing Line and the Power Law Corridor are not positive for the current price.
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Power Law Corridors: A Bitcoin Price Model
Traders spend their days doing the hardest thing in the world — predicting Bitcoin’s price movement. The methods are nothing more than the following:
Dude Stud, arbitrarily comparing Bitcoin with the market value of gold or other assets;
Theorists, who combine the rules of Bitcoin with economic models (such as S2F);
k-line drawing hands, qualitatively scavenging across an empty canvas with lines, shapes, and text labels of various colors.
We believe that traders' expectations and market performance are constantly interacting, so the currency price has a considerable range of uncertainty, and it is meaningless to predict the market subjectively and accurately. But in contrast, the historical trend of the currency price is the result of the game of all traders, and the rules discovered from it will be relatively stable. Therefore, we give up looking for narrative or theory that conforms to the historical trend, and regard all traders in the market as a whole, and use the simplest method to find inter-cycle laws.
Since the vertical axis is too large and the early price fluctuations are compressed, we adjust the vertical axis to logarithmic coordinates.
At this point, it can be observed that the curve has a good linearity in the logarithmic domain, but the slope is gradually decreasing. We also adjust the horizontal axis to logarithmic coordinates.
Perform linear regression on the above curve in the logarithmic domain, and obtain a straight line slope a=5.733, intercept b=-38.3, and R-square 0.9361.
So far, we have obtained the regression line from the real historical currency price as the central axis of the trend. In order to get the upper and lower rails of the trend, we will make the difference between the currency price and the regression line in the logarithmic domain.
From the difference graph, it can be clearly seen that there is a gradually descending upper track and a lower track parallel to the regression line. We obtain two straight lines through regression and translation respectively.
Putting the upper and lower rails together in the previous regression plot yields a clear power-law corridor.
The power law corridor is a simple law hidden in the historical trend of Bitcoin. It can provide guidance on the overall direction and provide a reference when the price is close to the upper and lower rails, but it cannot guide short-term trading because the width of the corridor (upper rail/lower rail) is too large. Wide (currently 10 times larger).
