Bitcoin can be extremely volatile and unpredictable. The moment you think it’s about to trend upwards, it can completely drop in price. Many traders like to use technical analysis to predict price action in Bitcoin. Personally, I use technical analysis myself with my short-term trading portfolio. However, using the metrics we have already discussed in previous newsletters, plus many others, we can build a fundamental analysis case for a longer term direction in the current market cycle.
One of the best metrics to track Bitcoin tops is called Market Cap to Thermocap Ratio. As Glassnode defines it, “The Market Cap to Thermocap Ratio is simply defined as Market cap / Thermocap, and can be used to assess if the asset’s price is currently trading at a premium with respect to total security spend by miners. The ratio is adjusted to account for the increasing circulating supply over time.”
What is a market top?
All assets, whether its stocks or cryptocurrencies, go through market cycles. It starts with the accumulation phase where early adopters and investors begin to buy. Then the uptrend phase where buyers start to come in and the asset begins to increase in price until it hits its peak, known as the market top. Then there is the distribution phase as sellers take profits and the asset begins to trend downwards. Lastly, the downtrend phase when the asset begins to tumble down as most investors begin to lose faith in the uptrend and get out. Many things can happen between this long-term outlook but from a zoomed out view this is how market cycles work.
The black line of the above graph represents the price of Bitcoin. Each blue circle is the market top of the specific cycle in Bitcoins price history. The orange line is the Market Cap to Thermocap Ratio metric. It is clear that at every Bitcoin price top there was also a top in this metric.
How does Thermocap work?
As discussed in a previous article, miners are the entities that secure the network. In order to be a miner, infrastructure such as a facility, mining rigs, and energy must be purchased. In return, miners earn block rewards and transaction fees. There are good miners that have high profit margins and also others that take a loss. The mining industry as whole generally breaks even. Therefore, we can use the revenue generated by miners from the network to gauge the amount of money that has been invested/spent by miners into the infrastructure that secures the network. That is the Thermocap.
The ratio with market cap gives us an idea of the profitability of the network at any given time. The red zone tells us that it’s time to sell and the green zone tells us it’s time to buy.
A possible reason for this could be that as Bitcoin is becoming more valuable, eventually miners begin to sell more than usual to capitalize on the gains which creates a lot of sell pressure on Bitcoin causing a cascade of sells.
Keep an eye on this metric for the current uptrend phase of Bitcoin. This could mean the difference between selling way too early and making a lot more gains. It can also help you to not sell too late.