Reserve Risk
Reserve Risk is a cyclical indicator that tracks the risk-reward balance relative to the confidence and conviction of long-term holders. It provides a long-term cyclical oscillator that models the ratio between the current price (incentive to sell) and the conviction of long term investors (opportunity cost of not selling).
The general principles that underpin Reserve Risk are as follows:
Every coin that is not spent accumulates coin-days which quantify how long it has been dormant. This is good tool for measuring the conviction of strong hand HODLers.
As price increases, the incentive to sell and realise these profits also increases. As a result, we typically see HODLers spending their coins as Bull Markets progress.
Stronger hands will resist the temptation to sell and this collective action builds up an 'opportunity cost'. Every day HODLers actively decide NOT to sell increases the cumulative unspent 'opportunity cost' (called the HODL bank).
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 strength of HODLers who have resisted the temptation.
The Reserve Risk oscillator can be seen to oscillate in line with the macro bull/bear market cycles. It has well defined peaks in line with blow-off tops, and lengthy periods of relative undervaluation during bear market bottoms and into early bull markets.
In general, Reserve Risk can be considered in the following framework:
Reserve Risk is Low when HODLer conviction is high, unspent opportunity cost is increasing, and price is low and thus, there is an attractive risk/reward to invest.
Low Reserve Risk may signal relative undervaluation and this process can be a lengthy and prolonged event. Accumulation of unspent opportunity cost takes time and coin maturity and thus Reserve Risk 'bottoms' often encapsulate late bear markets through to early bull markets.
Reserve Risk is High when HODLer conviction is low, unspent opportunity cost is decreasing,
and price is high and thus, risk/reward is unattractive at that time.
High Reserve Risk may signal relative Overvaluation and this process is often a short lived and rapid event. Higher prices create a compounding influence of increases incentive to sell, higher realised profits and make it attractive to spend older with long lifespans. Thus Reserve Risk 'rallies' often encapsulate mid to late bull markets and reverse rapidly after blow-off tops.
Reserve Risk is calculated by taking the ratio between Price and HODL Bank. The derivation of Reserve Risk requires a number of calculation steps from the source metric of Supply-Adjusted CDD. For full documentation of the metric construction, please review the author's original paper.
Step 1: Calculate Value of Coin-days Destroyed (VOCDD)
Calculation of Reserve Risk starts with a derivative of the Supply-Adjusted CDD metric called VOCDD which calculates the USD value of all Supply-Adjusted CDD each day.
Step 2: Calculate HODL Bank
Each day a coin is held, the owner defers the ability to exchange it for its cash value. This deferred opportunity cost represents the conviction of HODLers and can be considered the aggregate 'unspent opportunity cost'. We quantify this by considering the difference between the current price (incentive to sell) and the median VOCDD (actual spending) giving us the remaining unspent 'opportunity cost'.
Note: we take the median of VOCDD to filter out transaction anomalies that may not be economically meaningful such as exchanges internally consolidating large coin balances.
This is the underlying principle of the HODL Bank metric which represents the cumulative unspent opportunity cost of the market holding the asset. HODL Bank is calculated as the lifetime cumulative sum of the daily difference between price and the median VOCDD.
Step 3: Calculate Reserve Risk
Reserve Risk is then calculated by taking the ratio between current price (incentive to sell) and HODL Bank (cumulative unspent opportunity cost).
Reserve Risk is a powerful cyclical indicator that in considers the global conviction to hold the asset relative to current price (the incentive to realise profits). Aside from direct impact of price (the numerator), the principles underpinning Reserve Risk build on the foundation of the HODL Bank metric (the denominator).
By baking in cumulative unspent opportunity cost as the denominator, over time, the weight of long-term holder conviction increases as coin dormancy increases. This results in two observations:
Periods of undervaluation are relatively long and often encapsulate the second half of bear markets and continue through to the first half of bull markets.
A Reserve Risk ratio below 0.0026 is empirically presented as an area of undervaluation based on historical performance.
Periods of overvaluation are often short and sharp, due to the compounding effects of higher prices and the subsequent incentive for long term holders to realise profits and spend old coins.
A Reserve Risk ratio above 0.0200 is presented as an empirical area of overvaluation based on historical observations and often occur only briefly at global market blow-off tops.
Note that the Reserve Risk ratio is subject to exponential changes in magnitude due to having price in the numerator. As such, this typically necessitates visualisation on a logarithmic scale.
Decreasing Price will first and foremost have an out-sized downwards influence on Reserve Risk being in the numerator of the ratio. Bearish markets therefore will depress the Reserve Risk metric. Red zones in chart below show where price is the dominant downwards influence on Reserve Risk.
High or Increasing HODL Bank will reduce Reserve Risk in a more subtle manner, a result of having a larger term in the denominator. This implies that higher prices are required to create sufficient incentive for HODLers to sell under the assumptions of the Reserve Risk metric.
When an asset is under accumulation and/or held for long periods of time, the collective unspent opportunity cost will begin to build up as fewer coin days are destroyed. This increases the magnitude of the HODL Bank metric resulting in a 'heavier' denominator and a higher implied global confidence. This will exert downwards influence on Reserve Risk.
Yellow zones in the chart below show where price trades sideways and HODL Bank is the dominant influence on a decreasing Reserve Risk.
This type of market behaviour is common in late bear markets through to early bull markets as smart money investors accumulate relatively cheap coins.
Increasing Price will have an out-sized upwards influence on Reserve Risk being in the numerator of the ratio. Bullish markets will therefore will increase the Reserve Risk metric.
Low or Decreasing HODL Bank will increase Reserve Risk in an exponential manner as a result of a smaller term in the denominator which typically occurs alongside higher prices (larger numerator). This implies that prices are sufficient for HODLers to realise profits and spent accumulated opportunity cost.
Upwards influence via decreasing HODL Bank can be expected as more coins are spent back into the economy destroying accumulated coin lifespans, specifically the spending of unique coins and in high volume. This increases the total CDD at higher prices, increasing the median VOCDD and thus decreasing HODL Bank. Given this behaviour typically occurs at elevated prices, both the CDD and price inputs to VOCDD will have a compounding effect on increasing Reserve Risk.
Unlike downwards changes in Reserve Risk which can be lengthy, slow and prolonged events, the influence of price on the upwards trajectory of Reserve Risk can be exponential and rapid in nature for the following reasons:
Higher price increases the numerator leads to a direct increase in Reserve Risk.
Higher prices create more sellers as every HODLer has a price at which the incentive to sell is sufficient to begin realising profits.
Higher prices increases median VOCDD as the USD value of each coin day destroyed is compounded by a higher price multiple.
Selling old coins increases CDD as coins held by long term holders with long accumulated lifespans are spent back into the economy.
This type of spending behaviour is common in mid to late bull markets as smart money investors divest and sell relatively expensive coins shown in green zones on the chart below.
​Hans Hauge (May 2019)
Hans Hauge - Introducing Binary Adjusted BDD, VOCD and Reserve Risk: An Exploration of Bitcoin Days Destroyed​
