The world’s first cryptocurrency, Bitcoin, was created by an individual or group of individuals under the pseudonym Satoshi Nakamoto in 2009. The first block in the Bitcoin network was generated on January 3, 2009. Nine months later, cryptocurrency trading was launched for the first time on the New Liberty Standard exchange.
At the time, Bitcoin was the only digital asset and accounted for 100% of the cryptocurrency market capitalization. But later, altcoins (alternative cryptocurrencies to Bitcoin) appeared on the crypto market. Over time, the new tokens started to squeeze BTC, taking away its share of the digital asset market. The ratio of Bitcoin's market capitalization to that of altcoins is closely monitored by traders, who use this metric in identifying trends.
Today, with thousands of altcoins available on the market, Bitcoin is still the largest cryptocurrency by market capitalization. Given that all cryptocurrencies trade against Bitcoin, its dominance serves as a valuable indicator when trading different types of cryptocurrencies.
In this article, we will explain how to apply the Bitcoin dominance index chart in cryptocurrency trading.
What Is Bitcoin Dominance?
The Bitcoin Dominance Index is an index that shows the ratio of Bitcoin's capitalization in comparison to that of the rest of the cryptocurrency market. Bitcoin Dominance Index helps to determine the current trend on the market:
- When the index rises, altcoins become cheaper relative to Bitcoin, which means that capital flows into Bitcoin;
- When the index falls, altcoins become more expensive, meaning that capital flows into altcoins.
What is Bitcoin dominance today? As of March 2023, Bitcoin accounts for about 45,52% of the total crypto market capitalization.
BTC Dominance and Market Capitalization
Since Bitcoin's dominance index is the ratio of its market capitalization to all other cryptocurrencies, the indicator “Total market capitalization of cryptocurrencies” is used to calculate the index. This value of the index represents the sum of the market capitalization of all cryptocurrencies, including Bitcoin.
The formula for calculating Bitcoin's dominance goes like this:
BTC Dominance Index = (BTC capitalization / Total market capitalization of cryptocurrencies) * 100%
The year 2017 was particularly illustrative of how the Bitcoin dominance and total market capitalization of altcoins are interconnected. At that time, Bitcoin's dominance index, which had previously exceeded 90%, declined sharply due to the “ICO boom”. The appearance of new crypto-projects contributed to the decline of the dominance index until January 2018, when the index dropped to its historical low of 35.41%.
Factors Influencing BTC Dominance
There are several major factors affecting Bitcoin's dominance index.
The cryptocurrency industry evolves at a rapid pace, and from time to time there are pronounced trends in the market. This was the case, for example, with GameFi, NFT, and Metaverses, which attracted substantial investment. As a result, the tokens of the mentioned projects showed explosive growth. Every time, against such trends, Bitcoin's dominance showed a decline, partly because some investments flowed from BTC to the trending projects.
Bull or Bear Market
In order to identify the market sentiment impact on Bitcoin's dominance index, we first need to understand the market participants’ behavior. For example, in a bear market crypto investors tend to secure their assets by converting them into more reliable coins, such as BTC. This leads to an increase in Bitcoin's dominance.
In a bull market, we may see the opposite situation. Traders are tempted to move funds from BTC to more volatile assets in order to profit on the market growth. The Bitcoin dominance will show a decrease then.
On-Ramping via Stablecoins
On-ramping refers to the process of converting fiat currency into cryptocurrencies. With the emergence of stablecoins, many investors prefer them when exchanging fiat to crypto. Stablecoins are a great store of value in times of high volatility and can be easily traded to Bitcoin and other coins.
But stablecoins are not included into the Bitcoin dominance index. Therefore, Bitcoin dominance might decline due to the capital flows to stablecoins.
Emergence of New Coins
Every year, more than a dozen of highly promising crypto-projects are launched, not to mention hundreds of smaller projects. Sooner or later, they release their own coin or token, thus increasing the overall capitalization of altcoins. And that means that BTC's market share naturally decreases every year, even if none of the new projects takes away the capitalization of Bitcoin directly.
Bitcoin's Fluctuation in Price
The market capitalization of any cryptocurrency depends on its price and the number of coins. For BTC, its price is the main determiner of the market capitalization. Compared to the price, the number of bitcoins in circulation is not that important, as the figure is growing extremely slowly (inflation is about 1% per year). In fact, the market capitalization proportionally follows the movement of Bitcoin's price. Hence, the price has a direct impact on Bitcoin's dominance index.
However, it should be noted that Bitcoin market dominance does not increase simultaneously with the price growth. Another variable of the index, the altcoin capitalization, should also be taken into account.
Altcoins Fluctuation in Market Cap
There are currently more than 13,000 altcoins. Each of them has a dynamic price, making the calculation of the total capitalization of altcoins difficult, though still feasible.
Periods when altcoin prices grow and Bitcoin prices decline are called an altcoin season or an alt season. Typically, the capital flow into 75% of the top 50 altcoins faster than Bitcoin within the last 90 days marks the start of the alt season.
As practice shows, true alt seasons are rare and short-lived. When investors lock in profits, thereby increasing the number of bitcoins in their portfolios, altcoin prices decline as a result of the sharp sell-off. The dominance of BTC at this point grows again.
Using BTC Dominance in Trading
The Wyckoff method is the basis of modern technical analysis. This type of financial analysis allows you to understand market movements and predict future prices behavior. It consists of several elements that connect into a coherent strategy.
Originally developed for use in traditional markets, the Wyckoff method has firmly established itself as an integral part of cryptocurrency market analysis. That said, the method does not work well on overly volatile assets with small capitalization. It is best suited for such major assets as Bitcoin.
The price charts can be divided into sections according to the so-called Wyckoff Price Cycle, which consists of four main sections: accumulation, uptrend (or “price increase”), distribution and downtrend (or “price decrease”).
Traders often use this method to identify the strongest trend. Below are a few scenarios for using the Wyckoff method.
Using BTC Dominance to Spot Altcoin Season
As it was mentioned above, there is such a concept as “altcoin season”. It is characterized by capital flows from BTC to altcoins, reflected in the decline of the Bitcoin dominance vs altcoins index. So according to Wyckoff's method, the movement of funds from BTC to altcoins is cyclical.
Thus, traders seeking to earn on the rise of altcoins, track the Bitcoin Dominance Index. As soon as they see that Bitcoin's dominance has reached a local maximum, traders open positions in popular cryptocurrencies in anticipation of an altcoin season, following the logic of Wyckoff's method.
Using BTC Dominance With Current Bitcoin Price
The same principle used to predict altcoin season can be used as an additional indicator when building your trading strategy. For example:
- A rise in the price and dominance of BTC could indicate a potential bullish trend in the bitcoin market;
- BTC's rising price and falling dominance may indicate a potential bullish trend in the altcoin market;
- BTC's falling price and rising dominance could indicate a potential bearish trend in the altcoin market;
- BTC's falling price and dominance could indicate a potential bearish trend in the entire cryptocurrency market.
However, it is worth remembering that these factors cannot predict market trends on their own and should be used as an addition to other indicators.
How to Trade Crypto Using BTC Dominance
In general, when applied correctly, the Bitcoin dominance indicator can become a useful tool in assessing the cryptocurrency market and predicting future trends.
Strategy 1: Using BTC Dominance to Determine the Strongest Trend
The Bitcoin Dominance Index allows us to determine the asset with the best potential for investment — BTC or altcoins.
First, identify the trend of the BTC dominance index for a certain period of time. For example, you can use the index chart on the Tradingview website. Then identify the Bitcoin price trend over a similar time frame.
You can then use the table below as a guide.
Once you identify the signal from the table, use other technical indicators for further detailed analysis.
Strategy 2: Trading the Extreme High and Low Readings
Another useful strategy is to trade as soon as the ratio reaches extremes. When the index ratio approaches its historical levels, there is a high probability that it will reverse. The logic behind this approach is that by the time the index reaches its historical low, a significant portion of capital has already flowed into altcoins. Therefore, there is a high potential for growth in the value of BTC.
The table below shows the possible scenarios.
It should be noted that the Bitcoin dominance index very rarely reaches its historical highs and lows. Therefore, when the ratio does reach extreme levels, it can be the strongest signal for trading.
The Bitcoin dominance index can also be used for risk management. For example, if the value of BTC declines but its dominance increases, it can indicate a potential bear market for altcoins. In such a case, investors whose portfolios largely consist of altcoins should stay alert and even consider selling some altcoins.
Is Bitcoin Dominance a Reliable Indicator?
The Bitcoin Dominance Index reflects the mood of the market, so it can be used by traders and investors to identify upcoming trends. However, the current BTC dominance is only one of many possible market indicators.
The index helps the investors to predict the direction of the market and decide where it is better to direct money: in BTC or altcoins. If the share of BTC is decreasing, investors are investing in other coins. If it is growing, then money is directed to BTC.
However, from around 2020, at the time of BTC corrections, investors are no longer transferring money into fiat. Instead, they are investing money in stablecoins, which dilutes the share of BTC in total market capitalization.
It is highly probable that in the future, the BTC dominance will decrease even more. In that case, the index may become obsolete, as the price of altcoins will no longer depend much on the BTC price.
Bitcoin dominance is an important indicator used to determine which assets are worth buying, Bitcoin or alternative coins. Using the index in conjunction with other indicators, investors increase their chances of predicting the future trend on the cryptocurrency market.
However, many investors consider this index a controversial indicator. They believe it was more relevant in the past, when there were very few cryptocurrencies and no stablecoins. And with the observed gradual but steady decline in the share of BTC on the market, this index may finally stop working.
*This communication is intended as strictly informational, and nothing herein constitutes an offer or a recommendation to buy, sell, or retain any specific product, security or investment, or to utilise or refrain from utilising any particular service. The use of the products and services referred to herein may be subject to certain limitations in specific jurisdictions. This communication does not constitute and shall under no circumstances be deemed to constitute investment advice. This communication is not intended to constitute a public offering of securities within the meaning of any applicable legislation.