A closely-watched bitcoin metric is flashing a buy signal that has historically led to huge gains – CNBC

Bitcoin could be poised for outsized gains if recent technical signals are to be believed.

Investors have been searching for a bottom to bitcoin since the cryptocurrency lost more than 60% of its value from the all-time high of nearly $69,000 it hit in November. Nearly $2 trillion has been wiped off the entire crypto market in recent months.

A measure of activity of bitcoin miners could give investors a clue as to where the digital currency is headed next.

Miners validate transactions on the bitcoin network using highly-specialized and power-intensive computers to solve complex mathematical puzzles. They are rewarded in bitcoin for their efforts. As more bitcoin is mined, solving these puzzles becomes more difficult.

During market slumps, a depressed bitcoin price can make it unprofitable for many miners to continue operations. They then sell some bitcoin to keep afloat. But they also turn off their mining rigs to save money.

That has happened in the latest market slump and can be demonstrated by "hash rate," a measure of computational power used to mine bitcoin. Since mid-May, when the market really started to sell-off, the 30-day average hash rate (a monthly average value) fell more than 7% and at one point saw a 10% dip. That signaled that miners were turning off their machines.

Hash rate, studied in various ways, is used by crypto investors to try to figure out when the market might bottom, because capitulation and a shakeout of the miners is often associated with the late stage of a bitcoin cycle.

"Historically speaking, capitulationin the mining market has tended to correspond strongly with overall market bottoms," Matthew Kimmell, digital asset analyst at CoinShares, told CNBC via email.

Following on from this, Charles Edwards, founder of quantitative crypto fund Capriole Investments, came up with the idea of "hash ribbons" in 2019 to identify buying opportunities for bitcoin.

When the 30-day moving average for hash rate dips below the 60-day moving average, this is called a bearish cross, and signals that miners are shutting down machines. Usually selling is associated with these events. As more miners are taken out of the market, the difficulty of mining bitcoin reduces because there is less competition.

Because of the reduced competition, more miners may re-enter the market and a recovery may occur.

"These 'capitulations' are painful events for miners within the ecosystem," Edwards told CNBC.

But using Edwards' method, when the 30-day moving average for hash rate crosses back above the 60-day moving average, the worst of the miner capitulation tends to be over.

When this happens along with the 10-day moving average price of bitcoin going above the 20-day moving average price, then this is when a "buy signal" flashes, according to Edwards.

He said those crosses occurred on Saturday.

In the past, buying bitcoin at these points would have yielded strong returns depending on how long you held the cryptocurrency for, according to Edwards.

For example, purchasing bitcoin at the buy signal of August 2016 would have given an investor a more than 3,000% return if held to the peak of December 2018, which was at the time when bitcoin hit a new record high.

More recently, buying during the recent buy signal in August 2021, would have yielded a more than 50% return if bitcoin was sold at the November 2021 record high.

"I created Hash Ribbons in 2019 as a way to identify when major Bitcoin mining capitulation had occurred, as once recovery resumes from these events, they typically markmajor Bitcoin price bottoms," Edwards said. "Historically, these have been great times to allocate into Bitcoin, with incredible returns."

Kimmell from CoinShares said that the logic behind the buy signal is that if the bitcoin price "tends to steadily outpace hashrate before a period of high price growth, then a trending rebound in hashrate," marked by the 30 day moving average for hash rate crossing above the 60 day moving average, it "may mean the rebound in bitcoin price has already begun."

"I find this metric should not be solely relied upon to make an investment decision, but can certainly be helpful if coupled with a suite of other metrics and qualitative evidence," he added.

CoinShares has put together a graph to show the correlation between hash rate and the bitcoin price. And it is split into areas where there is "gold rush" as bitcoin's price rises, and a subsequent inventory flush and miners' shakeout as the price declines.

In a chart provided to CNBC, CoinShares suggests that the market is currently in the shakeout period which typically precedes rebalancing and a rally in prices. Right now, according to the chart, the bitcoin price line is below the hash rate.

The graph shows the movement of bitcoin hash rate versus bitcoin price at different stages in the cycle.

CoinShares

But this could signal a bottom is near, according to Kimmell.

"It is impossible to say if we have reached full capitulation, however there is evidence we are in the phase of the mining cycle where capitulation most often occurs. Secondarily, if previous cycles carry predictive power, then yes, bitcoin price steadily outpacing hashrate would likely precede a period of high price growth," Kimmell said.

Vijay Ayyar, vice president of corporate development and international at crypto exchange Luno, holds a similar view.

"I think we have seen broad signs of capitulation given the events in the previous months. Hence it is likely we could have the beginnings of a bottom being formed. Usually bitcoin consolidates in a range for a whole which indicates accumulation, which is what we may be seeing," Ayyar told CNBC via text message.

Bitcoin has been trading in a tight range of around $18,000 to $25,000 since mid-June.

However, there are risks that these indicators do not prove as positive as they have been in the past because of the broader macroeconomic environment.

The current global economy is in a very different state versus previous cryptocurrency cycles. There is rampant inflation and rising interest rates globally, aspects which have not been present before.

Risk assets such as U.S. stocks, and in particular the Nasdaq, to which bitcoin is closely correlated, have seen a big sell-off this year.

"Of course all this is still based on historical similarity, and we are in a different macro environment," Ayyar said.

"The major risk remains the economy and inflation, but even then we are closer to an inflation peak than not, and hence this also shows that on risk assets we are closer to a bottom than not."

Read more:
A closely-watched bitcoin metric is flashing a buy signal that has historically led to huge gains - CNBC