Average Coin Dormancy (Dormancy) describes the average number of days that each spent coin had remained dormant before it was moved.
Dormancy considers the total volume of coin-days destroyed and divides by the total coin volume transacted to give an average spent lifespan on a per unit coin basis (i.e. spent lifespan per 1 BTC).
Dormancy is a derivative of Coin Days Destroyed (CDD) however is functionally similar to Average Spent Outputs Lifespan (ASOL) and has a similar interpretation. Where ASOL measures the average lifespan on a per transaction basis (spent output) , Dormancy measures the average lifespan normalised on a per unit coin basis.
High dormancy values mean that, on average, coins spent that day had been held for longer periods of time in an illiquid state and may be being spent back into liquid circulation.
Low dormancy values mean the coins being spent that day have are relatively young, signalling that older coins are generally remaining unspent, and on-chain volume is characteristic of more day-to-day traffic.
Average Coin Dormancy is calculated by dividing the number of coin days destroyed in a given day by the on-chain volume of that day.
Dormancy has similar properties to the ASOL metric in that it measures an average spent lifespan for coins moved that day. Dormancy differs from ASOL however in that it considers lifespan on a per unit coin basis (rather than per transaction basis for ASOL). As a result, Dormancy carries a more distinct signature for different market cycles (e.g. subsequent halving cycles) and also for different market structures (bull, bear markets).
The metric creators describe Dormancy as a gauge in what the smart money is doing in the market and whether they are generally in a state of accumulation or distribution. We typically make the assumption that older coins (with higher lifespans) are held by long term holders with strong fundamental knowledge and high conviction in the asset. These entities will change their spending behaviour depending on the current market cycle.
"Accumulation describes the act of smart money (last-resort buyers) taking cheap coins from dumb money (panic sellers), while distribution describes the act of smart money (old hands) releasing expensive coins into the hands of dumb money (bag holders). Accumulation occurs at market bottoms and distribution occurs at market tops." - Smith and Puell, Bitcoin Average Dormancy
Dormancy values tend to describe each phase of market character differently and are often distinct for each market cycle. As a result, we can generally characterise Dormancy interpretation as follows:
High dormancy values may indicate a state of distribution or realising profits by smart money, long term holders (HODLers selling to new entrants). This may indicate previously dormant coins are being spent back into circulation with a proportional effect on liquid supply.
Low dormancy values may indicate a state of increased long term holder conviction as HODLers acquire younger coins off the market, or at the very least stop spending their old coins.
Dormancy trend direction may be used to identify and distinguish between different market structures (related to the chart below).
Bullish markets (green): Profits are realised by long term holders leading to an uptrend in dormancy over the market cycle.
Bearish markets (red): Reduced long term holder spending and a general reduction in on-chain volume as interest in the asset wanes. This leads to a downtrend trend in Dormancy.
Late bear / Early bull / Re-accumulation (blue): Coins are accumulated by smart money investors and transferred to cold storage where they begin to mature. This leads to sideways and relatively low Dormancy as few old coins are spent.
Given market cycles can continue for multi-year periods, and Dormancy is best deployed for observing changes in long term holder spending behaviour, long period moving averages like the 90-day are useful to improve indicator signals. The chart below presents these market cycles alongside the 7-day (orange) and 90-day (blue) moving averages of Dormancy to demonstrate.
Note also how the lower bound values of Dormancy increase gradually over time, a phenomena that shifts approximately in line with each halving cycle. This is a result of greater aggregate lifespan accumulated by the total supply over time. The Supply-Adjusted Dormancy metric accounts for this phenomena by adjusting Dormancy proportional to the increase in circulating supply over time.
The chart below is shown in log-scale to demonstrate clearly this rising lower bound with each cycle.
Scale: linear or log
Moving Averages: 7-day, 30-day and 90-day
Supply-Adjusted Dormancy accounts for the impact of time on the Dormancy metric. Since coin days are accumulated over time, the potential lower-bound lifespan increases for all coins over time. As such, adjusting for supply (an increase in the number of coins in circulation over time) in the denominator provides a more proportional view of dormancy over the history of a market.
Reginald D. Smith (February 2018)
Reginald D. Smith - Bitcoin Average Dormancy: A Measure of Turnover and Trading Activity