What is the Bitcoin Stock-To-Flow-Model?
10 Jan 2021
Have you heard about the Bitcoin Stock to Flow model?
If you haven't, then you should know that it is an exciting but also extremely controversial topic related to predicting the future BTC price.
While one side believes it's the "Holy Grail" of mathematical models around Bitcoin's valuation, critics of the Stock to Flow argue that it is very far from being precise and shouldn't be used to predict future BTC movements.
We have created this article to dissolve the confusion around the Bitcoin Stock to Flow model, explaining how it works as well as its potential use-cases and limitations.
What Is the Bitcoin Stock to Flow Model?
The Bitcoin Stock to Flow (SF) model represents a way to measure the scarcity of assets – more specifically commodities like gold and silver – which is now applied to BTC.
For a better understanding, let's see how the Stock to Flow model works for a commodity like gold.
In its traditional form, the Stock to Flow model is used to calculate the abundance of a resource or a commodity (gold, in our example), taking the total supply ever created and the asset's annual production into account.
According to the World Gold Council's estimates, around 197,576 tonnes of gold had been mined by the end of 2019, with annual production between 2,500 and 3,000 tonnes.
Now, to calculate the SF model, we have to divide gold's total supply (stock) with the yearly production (flow), which gives us:
197,576 / 2,750 = 71.85
For clarification, we took the average of gold's annual production (2,750) into account in the above example.
As a result of the calculation, the Stock to Flow model shows us how much newly mined gold enters the market each year compared to the asset's total supply.
Based on our example, it takes an estimated 72 years to produce the same amount of the commodity as is currently in the market.
As a rule of thumb, the higher the SF, the fewer new gold bars are minted each year compared to the total supply.
For that reason, a high Stock to Flow ratio could signal a long-term value increase for an asset, in theory, indicating that the instrument is not only scarce but also that it will take a long time to produce the remaining supply.
How Does the Bitcoin Stock to Flow Model Work?
Since Bitcoin is often seen as a store of value similar to commodities like gold and silver, the Stock to Flow model has been applied to the digital asset by a user called PlanB, who published an article on Medium about the topic in 2019.
It actually makes sense to apply the Stock to Flow model to Bitcoin. Unlike commodities where we only have estimates about the stock and the flow, BTC's supply changes are recorded transparently on the blockchain.
While Bitcoin has its maximum supply capped at 21 million coins, its supply issuance is programmed on the protocol level, making it predictable.
As part of a deflationary mechanism, the number of BTC created with every newly mined block is halved every 210,000 blocks (roughly every four years) during the Bitcoin Halvening event.
During the last Halvening in May 2020, block rewards have been cut from 12.5 BTC to 6.25 BTC.
According to Blockchain.com's stats, 18.595 million BTC have ever beeen created with an annual flow of 328,500 BTC (6.25 BTC is mined roughly every 10 minutes until the next Halvening event).
As a result, the Bitcoin Stock to Flow ratio equals 56.60, meaning it would take nearly 57 years to mine the current total BTC supply (without taking the maximum cap and Halvening into account).
In addition to calculating BTC's SF, PlanB also compared the Bitcoin Stock to Flow model with the BTC price to (potentially) predict the digital asset's future value changes.
By taking a look at a chart based on the author's calculations, we can see that the BTC price more or less followed the 365-day average of the Bitcoin Stock to Flow model. In fact, it has been quite precise in the period between April 2020 and January 2021.
Limitations and Criticism of the Model
While the Bitcoin Stock to Flow ratio may show some correlation with BTC from a historical perspective, the model clearly has some limitations in predicting future value changes for the digital asset.
For example, the model only takes Bitcoin's supply into account but not the demand for the cryptocurrency.
Supply and demand are the two major factors for determining the price of an asset. For that reason, despite the fact that BTC's SF climbs higher every four years during Halvening events, its price will decrease significantly if a huge drop in demand occurs.
Furthermore, the Bitcoin Stock to Flow model doesn't take the following factors into account that could have an influence on the asset's price:
- Black Swan events: In the economy, Black Swan events represent unpredictable episodes with severe impacts, especially on an asset's price. In Bitcoin's case, a Black Swan could be caused by a major regulatory crackdown that effectively bans people from buying and selling the cryptocurrency. As a result of such a theoretical scenario, the BTC price could take a significant hit.
- Volatility: While Bitcoin's volatility has decreased significantly over the years, the cryptocurrency is still subject to heavy price swings. After a major value drop during a highly volatile period, many investors may panic-sell their holdings, liquidating traders' long positions and resulting in a significant downtrend for the BTC price.
Some critics take things even further. Nico Cordeiro, Chief Investment Officer at Strix Leviathan, compares using the Bitcoin Stock to Flow model to reveal future price changes to predicting financial outcomes based on astrology.
The Importance of Doing Your Research and Drawing Your Own Conclusions
The Bitcoin Stock to Flow model is a rather controversial topic in the crypto community.
Whether or not the model works in practice, it's crucial not to base an important investment decision solely on Stock to Flow's Bitcoin price predictions.
Markets are complex and many factors play into price discovery. It's therefore impossible for anyone (for humans as well as mathematical models and algorithms) to precisely predict future long-term price changes of an asset.
However, the Bitcoin Stock to Flow model can be a useful tool to gain a sense of Bitcoin's scarcity and to foster long-term thinking, beyond momentary price swings.
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