Dorit Ron and Adi Shamir (R&S) of The Weizmann Institute of Science wrote a paper Quantitative Analysis of the Full Bitbcoin Transaction Graph that has received allot of attention in the Bitcoin community and some press coverage. One of the paper’s main claims is that vast majority of bitcoins are not “in circulation”.
Here is our first surprising discovery, which is related to the
question of whether most bitcoins are stored or spent. The total number of BTC’s in the system is linear in the number of blocks. Each block is associated with the generation of 50 new BTC’s and thus there are 9,000,050 BTC’s in our address graph (generated from the 180,001 blocks between block number zero and block number 180,000). If we sum up the amounts accumulated at the 609,270 addresses which only receive and never send any BTC’s, we see that they contain 7,019,100 BTC’s, which are almost 78% of all existing BTC’s.
By itself, this is uninteresting. It is part of the Bitcoin protocol that 100% of the input to a tx must be assigned to its output, so when the former is not commensurable with the latter, the spender generates a new address to which the remainder is paid (i.e., he pays himself the “change”). Also, it is recommended practice that you generate a new address for every tx where you are payee. For both of these reasons, at any given point in time most bitcoin will be in an address that has never spent. In fact, if the recommended practice were universally followed, 100% of coin would be in such an address.
However, 76.5% of these 78% (i.e., 59.7% of all the coins in the
system) are “old coins”, defined as bitcoins received at some address more than three months before the cut off date (May 13th 2012), which were not followed by any outgoing transactions from that address after they were received… This is strong evidence that the majority of bitcoins are not circulating in the system… Note that the total number of bitcoins participating in all the transactions since the establishment of the system (except for the actual minting operations) is 423,287,950 BTC’s, and thus each coin which is in circulation had to be moved a large number of times to account for this total flow.
Now this is more interesting. That about 60% of bitcoins have been dormant for at least the three months prior to the study’s cut off date is consistent with the thesis that the majority of coin is not held for the purposes of conducting transactions but rather held as a store-of-value. But lets put aside the theoretical preconceptions for the moment. In this post I want to help tighten-up some concepts so that we can actually start testing some monetary theories on Bitcoin.
What is bitcoin velocity?
The velocity of a currency is basically the number of times a currency unit changes hands over a given interval of time. Conventionally, this interval is taken to be a calendar quarter because economists estimate money velocity as quarterly GDP divided by the average money supply over the quarter. Their calculation is indirect, because there is no centralized record of all fiat transactions in a given currency, but that transaction history is implied in the GDP stats. Bitcoin has the opposite problem: there is no GDP calculation for Bitcoin (yet!), but we do have a complete transaction log in the form of the blockchain. So calculating Bitcoin velocity should be straight forward.
We can make a back-of-envelope calculation right now. We’ll estimate the average (quarterly) Bitcoin velocity over the same time window studied in the paper, Jan 2009 to mid-May 2012 (13.5 quarters).
According to R&S the sum of all transactions (excluding minted coins) for the period is 423,287,950. As money growth over this period is linear and the first block starts at 50 and the last block is 9 million, the average money supply is 4,500,00. Divide the former by the latter and multiply by and you get a quarterly money velocity for bitcoin of just under 7.
Is that high or low? As a benchmark, look at US M1 money velocity, which we can get from the St. Louis Fed. The average quarterly US money velocity over the same period was about 8 (it’s currently about 6.9), and this has been on a downward trend since 2008.
We should really work these numbers into a timeseries, but the average is at least in line with USD velocity numbers, which in itself should cast some doubt on the level of economic activity that gets done in bitcoins. But we should also note that the numerator in our rough calculation includes change, which should be subtracted out; paying yourself doesn’t exactly count as coin “changing hands”. Devising an estimator for this is a task for a rainy day, but suffice it to say that our velocity estimate of is biased upwards.
The “Shadow” Bitcoin system
There is however an offsetting factor that may even bias velocity estimates downward: the Shadow Bitcoin system. Exchanges like MtGox, on-line wallets like, and some other bitcoin services allow transfers of coin between their users. The service holds coin in many addresses that are in effect “client” accounts, and transfers between such accounts are recorded only by the third party’s servers, not the bitcoin blockchain.
So despite the fact that a transfer of bitcoin takes place within a trusted third party, presumably such transfers should still be included in the velocity figure, but we have no way of knowing directly what these volumes are. I am going to set this question aside in this post.
How should we measure “dormant” coins?
Velocity is a basic concept in monetary economics and is easy to calculate. But the key statistic in the R&S paper is the percentage of “old coins”. This is a related but different concept.
If every address spends its entire balance 7 times over the quarter, velocity is 7. But if two addresses ping 1 BTC between each other 64 million times over the quarter whilst the remaining 8,999,999 coins aren’t spent at all, velocity is still 7. But in the first case there are no “old coins”, in the latter case all but two are “old coins”. Let’s call this concept dormancy.
Dormancy is related to velocity. If bitcoin money velocity is 7, that means that on average a coin sits inside an account for about 13 days before it is spent. If dormancy is not commensurate with velocity, then the distribution of dormancy across the money supply is going to be very wide. For example, an “old coin” is defined by R&S as one that hasn’t been spent in more than 90 days. So if about 60% of bitcoins are old coins, then the remaining 40% of coins have a velocity of at least 17.5, so on average each of those coins is dormant for no more than 5 days.
One of the problems with defining “dormant coin” as coin in an address that has not spent or received any coin in the last three months is that a single tx at an address–no matter how small–will put the entire balance of the address outside the set of dormant coins. This identification rule seems to be a lower limit estimate of dormant coin rather than a definition of it.
Any anyway, “dormant coin” is a binary attribute and rests on some arbitrary cut off based on duration, when what we are really interested in is the duration itself. So instead of measuring percentage of dormant coins, we should instead measure a coin’s dormancy: the time passed since the coin was last spent.
How do we measure the dormancy of a coin? Strictly speaking, this is nonsense, as coin input into a transaction is fungible. So dormancy is actually a property of a bitcoin address rather than a bitcoin (or some fraction thereof). We can define it as the weighted average of time since coin was paid into the address.
For example, if a new address A is created and 10BTC is paid into it at noon on Monday, the dormancy of A is 0. At noon on Tuesday, the dormancy of A is 1 (taking a day as the unit of time), by Wednesday it is 2. But suppose another 20BTC is paid into A on Wednesday. Dormancy goes down to 2/3 (the coins with dormancy=2 are now only 1/3rd of the address balance and the other 2/3 coin have zero dormancy). By noon on Thursday, dormancy is now 1 2/3.
In other words, an account’s dormancy increases by 1 every 24hrs when there is no activity in the address. Whenever R coins are paid into an address, dormancy is reduced by the factor , where B is the address balance after the coins are paid in. Whenever coins are spent by an address, its dormancy is unchanged (dormancy is a property of the remaining coins). But spends reduce the address balance, so subsequent coins received will reduce dormancy even more.
So what this definition gives us is a distribution of dormancies over every address in the blockchain at a given point in time. The dormancy of the Bitcoin network at a given point in time is simply the weighted-average of the account dormancies, where the weight for an address is its balance.