Bitcoin Hash Ribbon, A Nearly Fail-Safe Bitcoin Buy Signal

Introduction

“Be fearful when others are greedy, and greedy when others are fearful.” This investment adage by Warren Buffet is well-known to many investors, but not necessarily practiced by all. In the crypto world, the Hash Ribbon is an indicator that embodies the principle of “being greedy when others are fearful,” utilizing signals of Bitcoin miners capitulating to find opportune moments to buy Bitcoin. Historically, this approach has been highly successful.

What is Bitcoin Mining and Hash Rate?

In the system designed by Bitcoin’s creator, Satoshi Nakamoto, miners use the computing power of mining machines to record transactions and maintain the Bitcoin network, a process known as “mining.” In return, they receive Bitcoin as a reward.

Approximately every 10 minutes, a new block is created on the Bitcoin blockchain, containing all transactions on the network during that time. However, only one miner can “mine” this block. In a competitive process, miners use their machines to perform hash calculations to solve a problem. The first miner to compute a hash value that meets the required criteria earns the right to package these transactions, mine the block, and receive a Bitcoin reward. For more details on mining, you can read another article titled “What is BTC Mining?”

Hash rate, or computing power, refers to the total number of hash calculations performed per second across the entire network. The Hash Ribbon indicator is derived from the hash rate.

Concept and Usage of Hash Ribbon

The Hash Ribbon was proposed by Charles Edwards, founder of digital asset management firm Capriole Investments, in 2019. It first appeared in two Medium articles he published that year, titled “Finding Bitcoin Bottoms Using Miner Capitulation” and “Hash Ribbons and Bitcoin Bottoms.”

The Hash Ribbon is a daily indicator, composed of the 30-day and 60-day simple moving averages (SMA) of the hash rate. Whenever the 30-day average crosses below the 60-day average, it enters a “capitulation” phase, indicating a decrease in miners’ on-chain activity and computing power. Many miners shut down their machines because the cost of mining exceeds the profits, leading to a gray signal on the indicator. During this time, the price of Bitcoin often experiences a significant drop or remains in a sideways trend.

When the 30-day average crosses above the 60-day average, it indicates that most miners are becoming active again, turning their machines back on, and increasing the overall network computing power. A solid green circle on the indicator marks the end of the miner capitulation phase.

The end of capitulation does not necessarily mean an immediate price increase. To buy at the most opportune time, investors should wait for the Bitcoin 10-day SMA to cross and close above the 20-day SMA, signaling that Bitcoin’s short-term trend is rising. The indicator will then show a blue “buy” signal, at which point investors can strategically buy and hold Bitcoin.

Image: Trading View

Image: Trading View

The graph shows that over the past 12 years, if investors had bought a large amount of Bitcoin following this signal, they would essentially be buying at the bottom before a rise, and would have received substantial returns. The table below compares the maximum decline and maximum rise of Bitcoin after each buy signal. The data from December 2011 to January 2019 is taken from an article by Charles Edwards.

It is evident from the table that, of the 16 known occurrences of the hash ribbon buy signal, only one instance in August 2022 was unsuccessful. Otherwise, this indicator has been quite accurate, including precisely predicting the bottom of the last bull market, allowing investors to make substantial gains.

The failure of the signal in August 2022 can be attributed to the sudden collapse of the FTX exchange. This black swan event caused the price of Bitcoin to plummet from around $21,400 to $15,400, marking the lowest point of the bear market that year.

December 2019 (indicated by the star in the table) can also be considered as another instance when the hash ribbon buy signal was affected by a black swan event. At that time, the price peaked only two months after the signal, resulting in the lowest returns in the table, mainly due to the impact of the novel coronavirus pandemic.

Global stock markets and the cryptocurrency market experienced significant declines from mid-February to mid-March 2020, with Bitcoin dropping 40% in a single day on March 12. If an investor had bought Bitcoin at around $7,200 at the end of December 2019, they would have seen a 46% increase before the crash. However, if they did not sell in time, the maximum paper loss could have been nearly 50%. Nevertheless, from a trading perspective, since the price of Bitcoin rose after the buy signal, this instance cannot be considered a complete failure.

However, it is clear that when a black swan event occurs, no indicator can be considered a panacea. Therefore, investors must always be vigilant and avoid rushing to go “all-in,” which could lead to significant losses.

Additionally, it is worth noting that in August 2023, when this article was written, another hash ribbon buy signal appeared. This time, the price of Bitcoin fell by about 20% after the signal, which is one of the largest declines following a signal. Although it is too early to declare this signal as a failure (as the indicator has not yet indicated the start of a new capitulation phase), the reliability of this signal is now highly questionable.

Can Hash Ribbons Be Applied to Cryptocurrencies Other Than Bitcoin?

Hash Ribbons are standardized based on Bitcoin, so when applied to other cryptocurrencies, the “buy” signals that appear on Bitcoin may not necessarily appear on others, as the SMA (Simple Moving Average) of cryptocurrency prices may not synchronize with Bitcoin. This could significantly reduce the effectiveness of the indicator compared to Bitcoin.

This article uses Litecoin (LTC) and Ethereum (ETH) as examples to illustrate the effectiveness of Hash Ribbons applied to these two cryptocurrencies. Like Bitcoin, Litecoin uses a Proof of Work (PoW) mining mechanism; whereas Ethereum, before transitioning to a Proof of Stake (PoS) mechanism last September, also used the PoW mechanism.

Litecoin

Similar to Bitcoin, the following four figures and one table show the times in Litecoin’s history when the Hash Ribbons indicated a “buy” signal, and the price situation after purchasing.

From the table, it can be observed that if we analyze using the same method as Bitcoin, the maximum increase in hash rate appeared at least twice, which was less than the maximum decrease. If we include the asterisk (*) in January 2023, where the maximum increase was only slightly higher than the maximum decrease, it can even be said that this indicator failed three times.

Moreover, the maximum decrease in Litecoin after a buy signal was significantly higher than that of Bitcoin, with several instances exceeding 10%, potentially causing investors to sell out after suffering unbearable paper losses. The most recent invalid signal in July 2023 can also be interpreted as the end of the speculation surrounding the third halving of Litecoin in early August, leading to a significant drop. After all, unlike Bitcoin, Litecoin does not have a clear narrative of significant price increases following halving events. After the second halving in 2019, it plummeted by about 70%.

Ethereum

Compared to Litecoin, the situation of Ethereum can be described as ‘worse.’ Compared to Litecoin and Bitcoin, Ethereum has the shortest time since its launch, with the first hash ribbon “buy” signal appearing only in January 2019. Applying the hash ribbon to Ethereum, the “second brother” of the crypto circle, there were three invalid buy signals out of just 11 times, and the average maximum drop was higher than both Bitcoin and Litecoin, while the average maximum increase was the lowest among the three.

It is worth noting that there have been two instances of failed buy signals for Ethereum before and after transitioning to the PoS mechanism, the most recent one being in July 2023.

Considerations for Using Hash Ribbons

In summary, since the hash ribbons were invented as an indicator for Bitcoin mining, their accuracy may decline when applied to other cryptocurrencies. For most altcoins that do not have a mining mechanism, the hash ribbons are basically of no reference value, as these cryptocurrencies have other more important factors affecting their price, such as collaboration with large corporations or listing on major exchanges. However, because Bitcoin is the “big brother,” its price fluctuations often impact other cryptocurrencies. So, if the hash ribbons are effective on altcoins, it is not necessarily due to the indicator’s accuracy.

Regarding Bitcoin, besides the occurrence of black swan events that can significantly reduce the effectiveness of hash ribbons, as most of the bitcoins have already been mined, the usefulness of this indicator may further decline in the future.

The total supply of Bitcoin is 21 million coins. According to CoinMarketCap data, about 19.45 million bitcoins are currently in circulation, leaving only 7.3% of bitcoins yet to be mined.

Currently, miners receive a reward of 6.25 bitcoins for each block mined, meaning that 6.25 new bitcoins enter circulation every 10 minutes. By the fourth halving period in April or May 2024, this reward will be halved to 3.125 bitcoins. This means that the proportion of new bitcoins entering the circulating market through mining will further decrease, and it is uncertain whether the indicator will remain effective. Therefore, hash ribbons should not be the only indicator used to decide whether to buy Bitcoin.

Additionally, since this is a daily indicator, it will only appear a few times a year, and even less frequently during a bull market - it is a rare occurrence that cannot be relied upon. Investors must pay regular attention while considering other indicators and candlestick patterns to make investment decisions.

Moreover, besides buying, it is equally important to sell Bitcoin at the right time. Hash ribbons only provide buying signals and do not offer guidance on when to sell Bitcoin, so investors must decide for themselves.