Could it really be that simple?
It really is hard to value assets that don’t have an intrinsic value. Just ask any commodity strategist. This is why these guys typically develop models of supply and demand to assess the direction of commodity prices. But with cryptocurrencies, it seems even harder because not only do cryptocurrencies have any intrinsic value, their supply is fixed by an algorithm and the demand is the only true variable changing over time. Yet, demand for cryptocurrencies seems almost impossible to forecast.
But Erik Norland from CME Group seems to be on to something. He decided that instead of trying to forecast the end consumer demand for Bitcoin and other cryptocurrencies, it would be easier to look at the profits crypto miners make when verifying a transaction. The idea is simple. Every Bitcoin transaction needs to be verified to become part of the blockchain. The profit crypto miners earn per transaction changes over time. And if these profits per transaction increase, more miners start participating in the race to mine for new Bitcoins and the supply growth of Bitcoin temporarily accelerates. And whenever supply growth accelerates (even within the restrictive rules of Bitcoin) prices should go down.
The chart below shows the average profit per transaction for miners together with the price of Bitcoin. It isn’t a perfect relationship but whenever the profit per transaction spiked, Bitcoin prices dropped significantly. It isn’t a perfect indicator because sometimes, the price of Bitcoin started to drop while the profit per transaction still rose, but I simply looked at all the instances when the profit per transaction reached a new all-time high and then started to decline. From the all time high to the first low of profits per transaction, the average decline in Bitcoin prices was 29.3%. And the indicator was 77% accurate in signalling a Bitcoin drawdown.
Price of Bitcoin and profit per transaction for miners
Source: Bloomberg, Blockchain.com
On the other hand, if one had bought Bitcoin at these lows for profits per transaction and then held Bitcoin until the profits rose to new all-time highs, the average return for the investor would have been 2,753% (Median 345%) with an 87.5% success ratio.
Not a bad signal at all. Which makes me think if it really could be this easy to make money with cryptocurrencies?
The metric is interesting, but I find it problematic: profit per transaction is basically just a function of how many transactions there are: if there are many transactions then they become more expensive, i.e. transaction fees go up and miners make a greater profit. At parabolic peaks when Bitcoin price spikes by a factor of 5-10 a lot of that traffic comes from holders sending their coins to and from exchanges to either sell or after having FOMO-bought.
Sure, it's possible to say the added marginal hash-power increases the supply of Bitcoin temporarily, but I'd guess that it's a very minor factor: let's assume the block reward is 6.25 BTC/block every 10 minutes, which is about 900 BTC/day or 9,000 BTC over a 10-day period. If the hashrate increases by 5%, this will speed up block generation and add about 450 BTC to the supply over 10 days. That's a drop in the bucket, about 25-50 million USD or so.
I doubt that it's enough to crash the market sustainably as in a major top. The simpler explanation would be: transaction fees are correlated with the hype factor. And peak hype = peak price.
"Which makes me think if it really could be this easy to make money with cryptocurrencies?"
Its always easier after the fact -- the trick would have been to develop that thesis in 2013 or 17...