How to use MVRV Z-Score to determine if a cryptocurrency is potentially under or overvalued?
The MVRV Z-Score metric helps crypto investors figure out if the trade price of cryptocurrency is priced too high or too low compared to what people paid for it in the past.
To calculate the MVRV Z-Score, we need to know three important things first, namely Market Value (MV) and Realised Value (RV) Standard Deviation of Market Value.
Market Value (MV)
Market Value (MV) is equal to the multiplication of the current trade price of the crypto token by the total number of coins available for trading i.e. market circulation of the token. It represents the value that people in the market currently believe the coin holds.
Realised Value (RV)
Realised Value (RV) is calculated by multiplying the trade price at which each coin was last traded with the number of coins moved at that price. It shows the price at which each coin was originally acquired, giving a historical perspective on the value.
Standard Deviation of Market Value
The standard deviation of market value measures how much the market value of a cryptocurrency varies from its average. Here’s a simple example to understand it with proper clarity:
Step 1: Collect trade price data on the market value of the crypto token over a certain period e.g. Day 1: $100, Day 2: $120, Day 3: $110.
Step 2: Determine the Mean (Average) Market Value by adding all the market trade values we collected in the last step and dividing by the number of data points. For our calculated data we will get $(100 + 120 + 110) / 3 = $110.
Step 3: Now calculate the Variance of this data. For each market value, subtract the mean and square the result. This gives you the squared differences. Add up all these squared differences.
= [($(100 – 110)^2 + (120 – 110)^2 + (110 – 110)^2) / 3]
= [($(10)^2 + (10)^2 + (0)^2) / 3]
= [(100 + 100 + 0) / 3] = 66.67.
Step 4: Now find the Standard Deviation by taking the square root of the variance.
= √66.67 ≈ 8.16.
It means that on average, the market values deviate by about $8.16 from the mean market value of $110.
Main calculation
Now, to calculate MVRV Z-Score, just take the ratio of the difference between Market Value (MV) and Realised Value (RV) to the standard deviation of market value.
For this use the formula:
MVRV Z-Score = (MV – RV) / Standard Deviation of Market Value
Utilisation of score
If the MVRV Z-Score is high, it means the current price is much higher than what people previously paid, indicating the currency may be overpriced, with a risk of a price drop.
If the MVRV Z-Score is low, it suggests the current price is closer to or below historical prices, indicating the currency might be undervalued and could be a good buying opportunity.
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