What is Bitcoin Days Destroyed?
Updated: Jul 22, 2020
When investing in any security, the volume traded is an important factor to consider. Why?
1. Higher volumes give more credibility to the security as it means that more investors are interested in trading it. Low volumes mean that the security is not mainstream yet.
2. A jump in price accompanied by a jump in volumes is indicative of genuine widespread investor interest. A jump in price without an accompanying jump in volumes may simply mean that a lack of liquidity pushed up the price on the back of few trades.
But what about a situation where volumes are artificially increased?
Bitcoin is still at its infancy compared to fiat currencies. It is trying to build credibility. Malicious entities can transfer bitcoins back and forth and increase volumes to give the appearance of investor interest and thus build credibility of the digital currency.
Bitcoin Days Destroyed (BDD) could be the solution to keep such practices at bay. This metric was first considered in 2011. BDD gives a more realistic sense of interest in the security by removing the impact of short term speculative transactions and transactions designed to trick others into believing that there’s more interest than there actually is.
BDD gives more importance to coins that have been held longer.
BDD= Number of bitcoins transferred * Number of days those bitcoins were held before this transfer
Let’s say that Pam bought 100 bitcoin 7 days ago and sold it to Jim.
Number of bitcoins transferred= 100
Number of days those bitcoins were held before this transfer= 7
Let’s assume that Pam and Jim are trying to give the impression that there’s more interest in bitcoin than there actually is and so: On Day 1, Pam transfers 100 bitcoins to Jim. On Day 2, Jim transfers 100 bitcoins back to Pam. On Day 3 Pam transfers 100 bitcoins to Jim and so on for 7 days.
Looking at the data, in early 2018, there was a jump in bitcoin transactions but a relatively low level of BDD indicating that the trading came from short term traders and not long term investors. In late 2018 there was another jump in bitcoin volumes. This time it was accompanied by a jump in BDD indicating that market participants were long term investors.
In the second situation, transaction volumes would have gone up but the BDD would have remained the same.
There are some obvious issues with this measurement:
An excess emphasis is placed on single transactions where a holder transfers bitcoins from one wallet to another owned by herself. In Jan’20, Bitfinex transferred $1.1bn worth of bitcoin from one address to another. This could have been done for any number of operational reasons and was therefore not a sign of economic activity. In Jun’20, a private bitcoin wallet (not associated with any exchange) transferred almost $1bn worth of bitcoin to another address. It is not known is both addresses are controlled but the same entity but in case they are, the transaction doesn’t indicate economic activity.
BDD is not giving sufficient value to businesses with rapid turnover in bitcoin and instead gives greater importance to those using bitcoins as a store of value or even hoarding. This is likely to disappoint Satoshi Nakamoto who’s ultimate aim was to replace fiat currency with a decentralized currency and not create just another asset class.
BDD does not factor in volumes that take place off-chain. But then again, neither does the volumes of transactions metric.