I don't KNOW which is "correct" but I prefer the first method. Determining the area is much more difficult, and to me the term off-center seems to imply "how far off it is from being centered?", not "what percentage of the design is still showing?" or "what percentage of the planchet is unstruck?". A coin where the edge of the design is at the center of the coin is "50% of the diameter off of being centered" or "Off of being centered by an amount equal to 50% of the diameter".
I talked to Fred Weinberg at the Denver ANA Show last week and here is what he said: Method 1 (above) is correct. Measure the unstruck portion through the center of the coin. Divide that by the diameter and multiply by 100%. Sorry for muddying the water but somewhere along the line someone told me the correct way was Method #2. I will start a new thread to clearly explain how to calculate the percentage off center for coins.
Calculating the "unstruck" portion of the planchet does nothing more than tell you how much of the coins design is missing and as such does not address how much "Off Center" the planchet was while being struck. Having said that, I truly believe that NGC just might use method 2 since I've seen some 10% Off Center NGC graded coins which are closer to 5% off center. I've also seen some wild percentages regarding incomplete planchets from NGC as well.