Measuring the conviction of Bitcoin holders with a reserve risk

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The following is taken from a recent edition of Deep Dive, Bitcoin Magazine’s high-end market newsletter. To be among the first to receive this and other on-chain bitcoin market analysis straight to your inbox, subscribe now.

In today’s daily dive we will take a deep look at reserve risk.

Source: Glassnode

Reserve risk is a metric founded by Hans Hauge, and it is a cyclical market indicator that aims to quantify the risk / return of bitcoin allocation based on the conviction of long-term holders. Simply put, reserve risk is a relationship between the current price of bitcoin and the conviction of long-term holders. The current price can be seen as an incentive to sell, and the conviction of long-term holders / investors can be quantified as the opportunity cost of not selling.

We will describe and quantify these metrics in more detail later in the article.

Here’s an excerpt from Glassnode Insights:

“The general principles underlying reserve risk are as follows:

Each coin that is not spent accumulates coin-days that quantify how long it has been dormant. It is a good tool to measure the conviction of strong HODLers. As the price increases, the incentive to sell and earn those profits also increases. As a result, we usually see HODLers spending their coins as the bull markets move higher. Stronger hands will resist the temptation to sell and this collective action creates an “opportunity cost”. Everyday HODLers actively decide NOT to sell increases the cumulative unspent “opportunity cost” (referred to as HODL banking). The reserve risk takes the ratio between the current price (incentive to sell) and this cumulative “opportunity cost” (HODL bank). In other words, Reserve Risk compares the incentive to sell to the force of HODLers who resisted the temptation. “

Reserve risk is low when HODLer’s conviction is high (unspent opportunity cost is high and rising) and price is low.

Reserve risk is high when HODLer’s conviction is low (unspent opportunity cost is low) and price is high.

Calculation of reserve risk

As shown in the chart above, reserve risk is defined as the “price” divided by the “HODL bank”. While the price obviously doesn’t need an explanation, what is HODL bank and what signal does it provide?

As stated earlier, reserve risk is a relationship between the incentive to sell and the opportunity cost of not selling. HODL bank quantifies this “opportunity cost of not selling”.

Days of parts destroyed

In previous daily dives, we covered Parts Destroyed Days (CDD) as a chain metric, so we won’t cover it in detail here, but readers can find additional CDD information here.

Essentially, with the full transparency of the Bitcoin blockchain, one can see how many days each coin has been held and / or spent. When there is a large number of CDDs on a given day, it shows that old coins are being spent / changing hands. Additionally, if we divide the CDD by the circulating supply, we can normalize the metric for increasing circulating supply over time.

While the standalone supply-adjusted CDD metric itself doesn’t provide much of a signal, if it does, it does serve as a key input for reserve risk, and here’s how:

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