Litecoin is a remarkable cryptocurrency. Of the seven profiled on coinmetrics.io/mtv, its MTV ratio is among the steadiest (in our sample period of the last two years). Only bitcoin boasts a stabler market to transaction value. (Read our intro to MTV and a handy explainer.) As mentioned in our last article, useful fundamental ratios ought to generally be stable, so that price movements can be compared to the fundamental.
For a coin with a very predictable transaction load and volume, a massive price uptick would show clearly, and if not accompanied by a commensurate increase in transactions, this would lead to its MTV ratio expanding rapidly, signifying a more expensive valuation. However a coin with a volatile transaction load would not yield as pure an analysis. Thus litecoin’s steady MTV ratio is a very useful trait in assessing its price movements.
Its history does, however, contain one puzzling episode. Between mid-January and May 2017, Litecoin’s MTV skyrocketed to roughly five times its average.
“Makes sense,” you respond. “The numerator in MTV is market cap, so when it expanded rapidly in spring 2017, the MTV would also have increased.” Except the timing doesn’t quite work. Litecoin’s MTV peaked on the 13th of March, but its dramatic price pump didn’t begin until the 29th of March. In fact, when litecoin began its march from its long-term $4 range to $30, where it would consolidate, its MTV ratio actually reverted to its historical average. This means that the 7-fold increase in mcap was matched – exceeded – by an increase in transaction value.
The best explanation we can find is this: for whatever reason, in January-March 2017, LTC’s transaction volumes dropped while price stayed steady, causing MTV to climb. Its dramatic price increase (probably a result of speculation that it would embrace SegWit) in late March then catalyzed a dramatic increase in on-chain transactions, counteracting the price action and pushing MTV back down to its historical level. Since mid-May, Litecoin’s price has trended upwards from $30 to roughly $43 at the time of writing, even as its MTV has remained stubbornly fixed at around 10 (a fairly low or “cheap” valuation compared to most of its peers).
We combined MTV, price, and measures of transaction value and quantity onto one synchronized chart so these relationships can be visualized. (Note: we’re adding exchange volume data soon™, so we will be able to better unpack these relationships.)
You’ll notice that, contrary to what you might expect, the spiking price was actually accompanied by a declining MTV ratio. This is evidenced by the increasing number of on-chain transactions and their relatively larger size. Suffice to say that the currency was in a fairly vegetative state prior to the SegWit discussion and the spiking price jolted it into life.
What does this mean? Quite simply, this is (early and incomplete) evidence that transaction load follows price. This is a relationship we have noticed in a number of other cryptos over periods in which their market values appreciated rapidly. MTV would spike and then decline as transaction load caught up with price. Holders were suddenly incentivized to spend their coins, diversify, reinvest, and so on. And non-holders were motivated to buy on the news of the price action or the catalyst. There are three broad conclusions we can draw from this story, in order of importance:
- Cryptocurrencies exhibit reflexivity. Reflexivity is the idea popularized by the currency speculator George Soros which can be summarized as “the price changes the fundamental.” Put another way, causality is circular. Do price rises spur adoption and transaction volumes? Or does the demand for a currency power price increases? In this instance, changes in price clearly lead changes in the fundamental (on-chain volume). The existence of reflexivity means that the legacy finance approach to value – determining fundamental value and then comparing it to price and deciding whether the asset is fairly priced or not – may not be applicable here. Price changes drive buzz and attention, entice expenditure, drive merchant adoption, and make development funding and mining more viable. The price changes the fundamental. (Note: leaving Soros’ political views aside, he is clearly a remarkable trader and a lucid thinker, and we encourage everyone to read his description of how he came to discover reflexivity in the FT here.) The practical implications of the existence of reflexivity are both potent and potentially worrying, and we will lay these out in future posts.
- Market to Transaction Value is powerfully mean-reverting, so pay attention to trends. This tendency for MTV to normalize to its historical level means that temporary spikes may even out, but if you notice a long term trend, treat it seriously. Ethereum and Dash are coins that appear to be exhibiting functional breaks in their MTV ratios, having both come down to new lows recently and staying there. Is this evidence that they have reached a new level of adoption/usefulness and that their fundamental proposition has changed? Keep in mind that this is only a measure of standardized on-chain transaction values, so for something like ethereum, you may want to consider other measures.
- The better tech may not always win. Cryptoassets are a market with a high exposure to randomness. Small pieces of news that catch on and drive price increases occasionally end up powering positive feedback loops of adoption -> price rise -> adoption, etc. The right conditions are necessary, of course. Markets are still fairly inefficient, and information does not proliferate fairly or evenly. Thus a project with inferior tech that has better marketing and can take advantage of self-fulfilling prophecies and reflexive behavior may ultimately prevail over an obscure yet technically accomplished competitor.
A final note: I’m calling on-chain transaction volume a fundamental indicator of a cryptocurrency’s value, which some people may take issue with. However we see it as a useful proxy for actual usage (much better than exchange volume, which is easily faked), and since digital currencies are measured by their adoption and use, we think it’s a fair claim to make. Since network effects are so powerful in crypto, real-world usage of these currencies is a reliable an indicator as any. This is also why we’re restricting our MTV analysis to actual “currency-like” cryptoassets for now. Tokens connected to other services merit a different analysis.