Digital scarcity continues to drive Bitcoin adoption. If you don’t know what that means yet, just imagine an asset that will only ever have 21 million in supply, because said supply is controlled by inalterable computer code. That’s the foundation of Bitcoin’s bull-case for 2020 and beyond, that most new investors have adopted, but the fact is, it’s been Bitcoin’s key value proposition since the beginning.
Now, what makes things different for crypto’s leading asset is that its’ current rally is being driven by institutions who continue to consider whether it may become the world’s first provably scarce super-currency. This theory, in turn, also goes hand-in-hand with the idea that Bitcoin also may be becoming the world’s most powerful inflation hedge, which we’ve discussed at length in past posts.
Despite all of this, however, even the newest iterations of Bitcoin’s value proposition boil down to the same thing. The digital gold narrative is finally reaching over to legacy financial institutions and catching their attention.
To truly understand why it has such staying power, it’s essential to become familiar with how its’ digital scarcity can possibly lead to supply shocks. Through starting with what key on-chain metrics say about Bitcoin’s recent performance, you’ll find it easy to decide whether Bitcoin’s in one, and what it could mean for Bitcoin’s future value.
What is a supply shock and how does it apply to Bitcoin?
Before we get there, it’s necessary to define a supply shock in the context of Bitcoin.
Generally, a supply shock is when a rapid increase in demand outpaces the issuance of an asset and causes the available supply of it to begin to dry up. In the context of Bitcoin, this would mean that Bitcoin buys are rapidly outpacing both its’ issuance via the block reward (6.25 bitcoins per block) and the available Bitcoins across all crypto exchanges, brokers, and other services that facilitate Bitcoin purchases.
Because the Bitcoin network experiences 50% reductions in its block reward(halvings) every four years, supply shocks are said to be “built-in” to it over-time as long as demand continually increases in tandem with these “halvings.”
Why 2020 May Have Kickstarted a Significant Bitcoin Supply Shock
Last month, Pantera Capital reported that Paypal alone was already buying more than 100% of newly-issued Bitcoin, judging by trading volume on itBit, which is the exchange that Paypal uses to facilitate its’ crypto purchases.
As you can see above, itBit’s volume spiked majorly near the close of October 2020, which is when Paypal opened its’ crypto services to its’ user base. Since then, it has continued on a significant uptrend. If you add in the fact that only one of MicroStrategy’s most recent bitcoin purchases accounted for the number of newly issued bitcoins in a month, then the likelihood of an incoming or already present supply shock seems even stronger. Still, looking at institutional bitcoin purchases vs. its’ overall issuance is only the tip of the iceberg in this respect.
What On-Chain Metrics Have Said About Bitcoin + A Supply Shock
Arguably even more compelling than the above are “HODLer” metrics.
Generally, these refer to all of the measures that track or help to track bitcoins that are held over the long-term versus those that are traded in the short-term. Using these metrics, together with what we’ve mentioned above, it’s easier to get a fuller picture of whether Bitcoin’s available supply is really drying up enough to engender a supply shock.
Though many HOLDer metrics exist, for our purposes, we’ve chosen to start with: Coin Days Destroyed(CDD), Binary Adjusted Bitcoin Days Destroyed (BABDD), Average Spent Output Lifespan(ASOL), and HODL Waves, with others interspersed between them to provide better context for Bitcoin’s recent movements.
Coin Days Destroyed (CDD)
Coin Days Destroyed, or “Bitcoin Days Destroyed,” is the ratio of bitcoins bought in a past transactional period to how long those bitcoins have currently remained static or held. Generally, the CDD is considered to be the oldest Bitcoin metric and tends to be used to bolster the case of whether more bitcoins are being held or spent. Related to this, it’s also usually used to help determine whether Bitcoin’s circulating supply is considerably decreasing or remaining relatively constant. Below, you can see the CDD in action.
Since October 2020 when the current institutionally-driven Bitcoin rally kicked-off, what on-chain data shows is that the measure overall “destroyed days” has been falling to a level reminiscent of before Square and Paypal entered the fray. When such a drop occurs, it’s generally held to indicate that the buying, selling, and trading of bitcoins is outpacing the “HODLing” of them. At face value, this may appear to stand in stark contrast to the idea that hodlers could be helping to drive the current bull market. In truth, however, simple “coin days destroyed” is not the most accurate metric, especially on its own. This is because, its’ data often becomes skewed by variables such as exchanges moving more bitcoins on-chain to fund their operations and it fails to accurately account for the creation of new bitcoin days by newly minted bitcoins.
In summary, as a metric, the CDD is just a baseline that was begging for improvement, which Hans Hauge did, when he created Binary Adjusted Bitcoin Days Destroyed(BABDD).
How do Binary Adjusted Bitcoin Days Destroyed Work?
By taking the data from Coin Days Destroyed and dividing it by Bitcoin’s current circulating supply, Hauge was able to put together a more accurate representation of the fluctuations between the time that bitcoins are held and how much of the overall hodler supply is being destroyed over time. Generally, the BABDD works well because it leaves out movements like exchanges transferring funds between their own wallets, to better account for the rises and falls in Bitcoin’s supply over time. Below, you can see the BABDD playing out in practice with historical data from June 2020, just after the last halving.
In this chart, the Adjusted Bitcoin Days Destroyed are represented by the red and green lines. When green lines are present, that indicates the more “HODLer-owned” bitcoins aren’t being destroyed than on average. On the other hand, when red lines are presents, the opposite is held to be true.
In other words, a growth in red lines means that more hodlers are selling.
Overall, what the BABDD tells us about the time period represented above is that shortly after this year’s halving, we entered a period in which the bulk of market participants were buying and HODLing, which tracks with investor behavior following each past halving.
What’s the advantage of the BABDD metric?
Overall, because of how the BABDD zeroes in on investor behavior while leaving out data such as exchanges transferring funds between their own wallets, it has less of a chance of being influenced by inconsequential market movements.
Using the BABDD today, you’ll find it easier to track which of these groups is truly winning out. If, for example, it appears to show that hodlers control the market over a prolonged period, then that adds strength to the possibility of a supply-shock. With all of this, however, it’s important to remember that no metric can completely accurately predict the future. As we’ve said several times before, with Bitcoin, nothing’s ever for certain. Even so, the more metrics you have in your toolset, the easier you’ll find it to grow as a cryptocurrency trader or investor.
Average Spent Output Lifespan (ASOL)
With that being said, the next metric on our list is the Average Spent Output Lifespan (ASOL), which provides investors with an average number of days that Bitcoins have been held on to before they’re spent, within almost any given time period. Together with the CDD and the BABDD, it can be used to create an even more precise measure of whether or not bitcoin investors and traders are trending towards “HODLing.”
In the chart above, the yellow line represents the “average age of coins being transacted” or how long the bitcoins in circulation have been held, in aggregate. When juxtaposed with Bitcoin’s price growth leading up to September of last year, what this data appears to tell us is that as last year’s bull market began to take shape, progressively more long-term investors began to sell their coins. After zooming in on the period between June-November 2020, however, it’s easy to see that this upward trend didn’t last forever.
Instead, by November 30th, sell-offs by long-term holders began to decrease. Since this wasn’t completely in line with a dip in Bitcoin’s price, it’s easy to question why such a movement occurred. Truthfully, the answer seem to lie in the direction of hodlers once again.
According to Glassnode, over the course of Bitcoin’s history, long-term “hodlers” tend to sell their bitcoins “before and during” bull-runs. So, it is possible that when such behavior is spotted, it can be used to point to a bull run’s continuance, though as with all metrics, it’s best not to do so alone.
So why does the ASOL matter?
What the ASOL helps us to do is track “hodler” behavior specifically. Together with the CDD and the BABDD, you have the start of an efficient toolset for determining both whether hodlers rule and whether or not Bitcoin’s circulating supply may be drying up in a significant fashion.
So, all in all, is Bitcoin in a supply shock?
Let’s go back to our CDD chart from above.
Using it, it’s easy to see that on-chain metrics seem to indicate a supply shock. Coin Days Destroyed are continuing to trend downward, which means that all of the above metrics are generally pointing towards investors and traders looking to the long-term.
In fact, as you can see in this chart, leading up to today, the CDD is at its’ lowest level since the bull run kickstarted on October 17th of last year. Using this together with current Bitcoin’s liquid vs. illiquid supply, as measured by a 7-day moving average, a relatively strong case can be made that we’re in the midst of a supply shock or at least, beginning to enter one.
On December 29th, 2020, Glassnode reported that on-chain metrics indicated Bitcoin’s supply was 78% illiquid, with their founder, Rafael Schultze-Kraft, pointing out that Bitcoin’s true circulating supply was also much lower than the often-cited 18.6 million. As you may already know, this is because most Bitcoin market data providers fail to account for lost as well as otherwise inaccessible bitcoins when reporting its circulating supply. At that time, Schultze-Kraft went on to say that “if many bitcoins are illiquid, a supply-side crisis emerges.”
Taking these points into account, we can then look at the current market data above and see that Bitcoin’s illiquidity has been trending further upward over the course of January. While in late December, Bitcoin’s illiquid supply as 14.5 million, it can now be estimated at about 16–16.1 million, given the above chart.
After dividing that number by the total number of bitcoins in existence (18.6 million), we end up with just over 86% of existing bitcoins as “illiquid.” This doesn’t mean 86% of bitcoins are lost or currently inaccessible in some other fashion. It does, however, appear to show that 86% of existing bitcoins are either being held by “hodlers,” or lost/inaccessible for now.
All in all, our conclusions have been made with Glassnode’s methodology, which is discussed further on their blog.
Bitcoin’s Road Ahead
Suffice it to say for now that considering Bitcoin’s rising illiquidity and its’ sinking Coin Days Destroyed as well as other related metrics, it appears clear that crypto’s leading asset is either in or entering a significant supply shock. Whether or not this is corroborated with further on-chain data over time remains to be seen. In any case, as you continue on your Bitcoin journey, through using all of the above metrics, you’ll find yourself with quite a useful toolset for tracking all of Bitcoin’s current and future market movements.
Right now, Bitcoin’s seen as a safe haven from difficulties that investors are experiencing and expect to be experiencing in other, more traditional markets. Consequently, as 2021 rolls on, the resurgence of the global economy will play a key factor in whether or not all of the trends above continue to point to a supply shock. If they do continue in spite of new growth across traditional assets and markets, then the question of a supply shock will have been answered with near-certainty.
If history indicates anything for certain, it’s that in the end, Bitcoin tends to eschew all predictions in favor of carving its own path. Wherever that path goes, we’re here to guide you along the way. If you’re interested in continuing to take your Bitcoin journey with us, then stick around with this blog. The ultimate goal of all of our Bitcoin-related content has always been to give you all of the necessary information so that you can confidently make your own judgments on Bitcoin’s value.
In our next post in this series, we’ll dig deeper into the possibility of Bitcoin as an inflation hedge (macro hedge). Until then, remember that we’re here to help you. If you have any thoughts or questions about this post as well as others, reach out to us any time here, on Twitter, or on our website!