Understanding Investor Behavior Through Supply Shock

Louis Sykes
January 26, 2022

One of the most underappreciated elements about Bitcoin is the transparency of transactions. This enables us to gain deep insights into the behavior of investors and users of the network.

The growing industry of on-chain analysis looks to address the concerns of those who wish to categorize, cluster, and ultimately analyze entity behavior to find increasingly reliable and actionable signals.

Blockchain mechanisms mean analysts and traders have access to a wide array of data that isn't possible to replicate in traditional asset classes, like stocks, commodities, and bonds.

One of the key metrics we've found to be of tremendous value is quantifying investor supply and demand through the use of supply shock.

In today's note, we'll outline how we use this data to supplement our traditional price work and technical analysis.

The Various Bitcoin Supply Shocks

  • Exchange Supply Shock
    • The coins that are held in cold storage compared to those that are available to be bought on exchanges.
  • Illiquid Supply Shock
    • The coins held by investors with little sell history compared to those held by speculative hands.
  • Liquid Supply Shock
    • Similar to the illiquid supply shock, with a greater emphasis placed on speculative entities.
  • Long Term Holder Supply Shock
    • The number of coins that haven't moved in over 155 days compared to more active and speculative coins.

Exchange Supply Shock

The Exchange Supply Shock runs a ratio of coins held in cold storage that are not readily available to be bought through an exchange to the coins that are currently held in exchange wallets.

Spot investors prefer to keep self custody of their coins through private cold storage as opposed to holding them on exchanges, mitigating counterparty risk (e.g., Mt. Gox).

When we see net withdrawals out of exchanges and into cold storage, it suggests investors are buying coins and transferring them to cold storage to HODL and accumulate.

Meanwhile, coins entering exchanges is a quantifiable measure to investor selling intent.

Below is Bitcoin's Exchange Supply Shock.

As you can see, net exchange flows have a tendency to lead price; we highlighted a few notable examples in recent years by the red and green zones.

Illiquid Supply Shock

The Illiquid Supply Shock takes into account Glassnode's sophisticated clustering of entities by their spending habits and liquidity.

By Glassnode's standards, there are three types of entities:

  • Illiquid
    • Sells less than 1 BTC for every 4 BTC bought.
  • Liquid
    • Sells between 1 and 3 BTC for every 4 BTC bought.
  • Highly Liquid
    • Sells more than 3 BTC for every 4 BTC bought.

Bitcoin's Illiquid Supply Shock compares the number of coins held by illiquid entities to that of liquid and highly liquid entities.

By Glassnode's estimations, nearly 80% of all Bitcoin is held by these illiquid holders with little sell history. Supply shock is a considerable driver of price, and this metric captures it nicely.

It's pictured below.

Liquid Supply Shock

The Liquid Supply Shock is similar to the aforementioned metric, in that it compares the number of coins held by illiquid and liquid entities to those held by highly liquid entities.

This generates a similar result but places slightly more emphasis on speculative hands over HODLers.

Bitcoin's Liquid Supply Shock is pictured below.

Long Term Holder Supply Shock

As the name would suggest, the Long Term Holder Supply Shock generates a structural oscillator view of the market that effectively communicates the supply dynamics underpinning the entire market.

It's calculated by dividing the number of coins that haven't moved (been sold) in over 155-days to the rest. Glassnode has shown that if coins are held over this 155-day threshold, it's more than likely going to continue to be held as a long-term position.

As seen below, this gives us an effective way to see whether investors are in a regime of accumulation or distribution.

Ethereum Supply Shocks

This same analysis can also be done on Ethereum.

Pictured below is the Ethereum Exchange Supply Shock. It's calculated the same way as Bitcoin: by evaluating the coins in cold storage compared to coins held on exchanges and readily available to be bought.

We can also run a calculation of Ethereum's Supply Shock against Bitcoin's.

The end result is we're comparing investors' relative buying of ETH against BTC, which can help aid in a directional conviction to the ETHBTC relationship. This can provide value from an asset allocation standpoint.

Considerations and Credit

As with any data set, supply shock is one of many inputs in our weight of the evidence approach.

Additionally, a caveat to supply shock is that Glassnode's liquidity metrics experience notable levels of drift for recent data points.

Entity-adjusted metrics, such as the inputs behind the Illiquid and Liquid Supply Shocks, rely on machine learning processes that result in giving overly bullish signals.

We'll be working on this internally to adjust for this drift.

All data was supplied by Glassnode.

Acknowledgments to Willy Woo and Glassnode for popularizing the study of Bitcoin Supply Shock.

For those interested in diving deeper into these metrics, we recommend the following Glassnode reports:

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Thanks for reading, and please let us know if you have any questions!

Allstarcharts Team

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