What determines when a Bubble Bursts?

Buyers! Let's start here. The simplest explanation of when a Bubble bursts is when Buyers run dry. When there are no more buyers to purchase a commodity at the current price levels, we see a sharp, and volatile decline in price. And that is exactly what happened in 2013/2014 when Bitcoin's bubble burst. We had a Market Cap of around $13B but we just ran dry of anyone new to enter into this market to purchase at that price level.

In fact, looking at the data, the price of Bitcoin in November 2013 jumped 5x, above the $1000 level within less than 1 month. And then it just started dropping back down to Earth. This was happening when there really wasn't a market available to support it. With no new developments to justify the movement and really no technical methods to test it we came back down to earth over a number of grueling months.

And now we're again in the next phase of some incredible gains in 2017. Are we lacking buyers? Certainly not. Let's take a more detailed look to see if we can stay afloat during our current growth phase.

Measuring the "Health" of Crypto

As Crypto continues to gain acceptance and move upwards, the question of what is "healthy" growth continues to come up. Unlike the stock market, we do not have a long enough price history to truly extrapolate when there is under or overvaluation, or tools to understand what a bubble would look like in Crypto. We can only use analogies and comparisons to previous bubbles that have been witnessed in other industries of the past.

Moving averages, RSI levels, Elliott Wave Analysis, and other methods of technical analysis can help us better understand and possibly predict short term movements, but when we look at the larger picture, is there a way to understand if there are enough Buyers to maintain and continue to elevate the market up?

To understand this, let's look at the closest analogue, the Stock Market.

Using the stock market to help us understand a bubble scenario

In the stock market the P/E ratio (Price to Earnings) measures the Price of a stock and divides it by its Earnings. The purpose is to understand how much greater its perceived market value is to what it actually rakes in. This ratio is heavily relied upon and is a solid way to understand if a stock is "hot", overvalued, or undervalued and in need of correction in either direction.

However, Crypto doesn't really have a P/E ratio so to speak. But, it seems there may be a new metric that can guide us in the same way. Market Watch posted an article a few days back identifying a version of the P/E ratio in crypto. And it seems to hold up thus far.

The key is in understanding the relationship between (1) Market Cap and (2) Daily Transaction Volume. Let's first understand these terms and then show how they come together.

What does Market Cap tell us? A price is just a price unless there is reason for it to be "priced" that way.

Market Cap simply signals the current value placed on a commodity as a whole. By itself, it doesn't provide an inkling on the actual health of a commodity maintaining, growing, or shrinking from that value.

As an example, during 2013 when Bitcoin reached over $1000, the price looked amazing, but there was something underneath it that made that bubble pop. The key was Bitcoin had grown in price, but.. something else didn't balloon with it. And that's VOLUME. Let's understand Volume better and why it makes a difference in determining the Health of Cryptocurrencies

Why does Volume matter? Can an Eskimo sell a block of ice for $1 Million in a market of 2 persons?

At the height of Bitcoin's market cap in 2013/2014 we saw a day with a $200M daily transaction at the peak to hold up a $1000+ price in the figure above. In February 2017 when Bitcoin was at the same price again, the daily volume was roughly the same too. What's the difference? The average daily volume during the boom in 2013/2014 was around $50M whereas in February 2017 we were averaging around $150M on a daily basis.

That's 3X the average number of transactions at the same price level during two different time frames. And volume is part of the secret which allows the price to stay buoyant and to grow beyond it.

So, the more transactions that take place, the better the health of Crypto? Not necessarily. In an isolated setting, volume it tells us very little about the health of Crypto, just like Market Cap in isolation does very little for us.

The higher the Volume of transactions means more players are there, sure. And as long as it's kept in check, higher volumes can signal positive health. However, higher volumes can also become a nightmare for the health of the currency if it's happening when the market cap is declining indicating a sell off. So we can't assume high volume means a stable, or appreciating currency.

The Health Ratio: Our new P/E to Predict the next Crypto Bubble Burst (maybe)

You may now realize that Market Cap and Volume have an important relationship with one another. So let's put it all together. As with our case of 2013/2014 when Bitcoin rose to over $1000, the transaction volume (i.e. Buyers) just couldn't maintain its price. When no one is buying, sellers take over until a balance kicks in again. Wouldn't it be nice to be able to capture this phenomenon as a way to warn us of the current Health of the crypto space? Seems there is.

Chris Burniske, a blockchain analyst at ARK Invest, came up with a simple ratio. It simply divides the Market Cap by the Daily Transaction Volume. If the value is within a channel it can be considered healthy. If it's outside this channel then we may want to watch out. Let's showcase this ratio and see how it applies.

I'll refer to this as the M/V Ratio for simplicity here.
(1) The basic idea is we take the overall Bitcoin Market Cap which is

*USD $43.4B* (as of the writing of this article)

(2) Divide it by the daily transaction volume of

*USD $1.425B* (As of the writing of this article)

(3) Final M/V Ratio

$43.4B/$1.425B = *30.5*

What does the M/V of 30.5 mean and how does it tell us the health of Bitcoin? Let's use an example from 2013.

Understanding the M/V Ratio

In 2013, the price of Bitcoin reached well over $1000. However, as we covered earlier the price was rising but the volume wasn't rising as quickly. This pushed our M/V value up to around a value of 200.

That's 7X higher than today's M/V of 30.5.

This meant that we saw artificial hiking of price within the same circle of investors, but there weren't enough new buyers entering the market to keep the price at that level. From there it came crashing back down to manageable levels.

Chris believes that as long as we are playing around the M/V Ratio of 50 we're good.

Much higher means we're again lacking the volume to sustain the price gains. At the same time going much lower than 50 can also be problematic. It could mean there is a massive selloff happening as price plummets and volume increases to sell off the currency. So we don't want to go too far below 50.

In the meantime, we seem to be in a generally healthy M/V range, even with the usual volatility of huge gains and losses. But, no, it doesn't seem we're in a Hyper Bubble yet.

What do you think of the M/V Ratio?

Note: This is not investment advice. I am simply sharing my personal observations and analysis based on information available.

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