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Understanding The Bitcoin Stock-to-Flow Model

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The price of Bitcoin (BTC) is quite a rollercoaster ride. This year alone, the original crypto has bounced around from a high of $47,000 to trading at just above $20,000 nowadays.

Where will Bitcoin go next? That’s a very tough question, and one of the most common ways of answering it is by consulting the stock-to-flow model.

Bitcoin’s built-in digital scarcity makes it similar in certain ways to commodities like gold or silver. In theory, that makes stock-to-flow a good fit for forecasting Bitcoin prices.

What Is Stock to Flow?

The stock-to-flow model is commonly used to price commodities. As its name suggests, the model assesses two attributes: stock and flow.

Stock is the total existing supply of a commodity. Flow is the new supply of the commodity that is created each year. Comparing these two attributes helps you assess the commodity’s relative abundance.

Let’s take gold as an example. Approximately 187,000 metric tonnes of gold have been mined in history—this is the stock of gold. It’s virtually impossible to destroy gold, so most of this stock is still around.

Now let’s look at how much gold is mined annually. Around 3,000 tonnes of gold is mined each year, according to the World Gold Council. This comprises the flow side of the model.

Divide the stock by the flow to get gold’s stock-to-flow ratio. The equation looks a little something like this:

187,000 / 3,000 = 62.3

That ratio means it takes approximately 62 years to acquire the total amount of gold currently in existence. The higher the stock-to-flow ratio, the more scarce the commodity.

How Is the Stock-to-Flow Model Used for Bitcoin?

One of Bitcoin’s most notable features is that the precise amount of new supply that comes into circulation each year is already known.

This means that Bitcoin’s stock-to-flow can be modeled with surprising accuracy, as opposed to other commodities like gold, which rely on less precise mining or supply estimates.

The total supply of Bitcoin will be 21 million coins, of which nearly 19.2 million have already been mined. New Bitcoins are created as miners validate transactions on the blockchain, following a predetermined schedule. The final Bitcoin should be put into circulation sometime in 2140.

Miners are currently rewarded with 6.25 BTC per block. With a block mined every 10 minutes, that translates to an annual flow of 328,500 BTC.

This means the current Bitcoin stock-to-flow ratio looks like this:

19,171,050 / 328,500 = 58.35

Incidentally, this is similar to the 62 years we calculated earlier for gold. Let’s take a closer look at how Bitcoin’s stock-to-flow ratio compares to other commodities like gold and silver:

The supply of Bitcoin will not be released linearly. Bitcoin undergoes a so-called halving every four years when the amount of Bitcoins released to miners for validating a block of transactions is halved.

The most recent halving occurred in May 2020, and the next halving is expected in 2024. When the next halving occurs, a block reward for Bitcoin will become 3.125 BTC. This means that Bitcoin’s flow will also halve—consequently, its stock-to-flow ratio should double.

Is the Bitcoin Stock-to-Flow Ratio a Good Model?

The stock-to-flow model’s predictive ability for Bitcoin has proven accuracy over the years.

As Bitcoin rocketed upward during the pandemic, the model gained much traction online due to its past accuracy.

There was a divergence between Bitcoin’s price and the stock-to-flow model in 2011 and 2013, before Bitcoin’s emergence into mainstream investing. But between 2015 and late 2021, the model predicted Bitcoin’s price accurately.

With Bitcoin straddling all-time highs in November 2021 at around $69,000, the model remained on course. That was until crypto hit a wall, dampening BTC price growth and diverging from stock to flow.

One of the model’s key flaws is that it doesn’t consider volatility and Bitcoin’s vulnerability to price swings. Investors panic during highly volatile periods, causing significant declines in BTC prices.

During the crypto winter, the stock-to-flow model failed to predict Bitcoin prices accurately.

The model predicts a Bitcoin price north of $100,000 in 2022, which is significantly higher than we have seen so far, with Bitcoin currently trading around the $20,000 mark.

This has led many to decry the stock-to-flow model as broken. Ethereum founder Vitalik Buterin is among the critics, even going as far as to declare it “harmful.”

“Stock-to-flow is really not looking good now,” said Buterin in a June 2022 tweet. “I know it’s impolite to gloat and all that, but I think financial models that give people a false sense of certainty and predestination that number-will-go-up are harmful and deserve all the mockery they get.”

Variables That Disrupt Stock to Flow

In retrospect, many of the supporters of the stock-to-flow model overlooked certain aspects of its predictive ability.

For instance, the years 2020 and 2021 were highly unusual years when more money was created than at any point in history, and financial asset values across all markets rose sharply.

The Covid-19 pandemic and its accompanying fiscal stimulus were the biggest drivers behind Bitcoin’s ascent. But the pandemic was also a total “black swan” event, and therefore attributing Bitcoin’s growth to supply-side dynamics, as the S2F does, now appears a reach.

Many other variables ultimately decide Bitcoin’s price.

Commodities like gold and silver have been around for thousands of years and have built up a long history of price data, perceived value and a place in the monetary and societal sphere. On the other hand, Bitcoin remains a highly experimental technology that is only 14 years old.

Forecasting the price of an asset that is so unprecedented on the world stage is a very difficult task. With Bitcoin nowhere near the levels predicted in the model, believers are seeing heavy losses.

Other Bitcoin Forecasting Models

The difficulty of forecasting the price of Bitcoin hasn’t stopped the rise of other models.

People bullish on Bitcoin’s store-of-value properties point to the market cap of gold, which some claim to be a counter-cyclical inflation hedge, as a good benchmark for Bitcoin. If Bitcoin rose to be worth the same as the current market cap of gold, $11.3 trillion, BTC would be worth $540,000.

Other methodologies for forecasting BTC prices:

  • The Elliot Wave Theory. Others use technical analysis, with the most common method for Bitcoin modeling being the Elliot Wave Theory. This method assumes that the market goes through predictable bull and bear cycles based on crowd psychology.
  • The Fulcrum Index. Greg Foss, who worked in the credit markets his whole career, produced a thesis even more aggressive than the stock-to-flow model. Foss’ Fulcrum Index model assumes Bitcoin can be seen as insurance on worldwide sovereign debt. Using credit default swaps, Foss places the fair value of Bitcoin between $108,000 and $160,000, although this is a long-term assessment of Bitcoin’s intrinsic value and less of a forward-looking price predictor.
  • Greater Fool Theory. Others take a more straightforward approach, insisting that Bitcoin will go to zero because it has no inherent value. These naysayers declare Bitcoin has appreciated due to the Greater Fool Theory, a finance mantra that says the price of overvalued assets rises only because people purchase them in the hope that they can sell them at a higher price to an even “greater fool.”

Time will tell whether any of these models turn out to be accurate long term. In the interim, the enigma of Bitcoin’s pricing has proven to be a difficult nut to crack.

Read More: Understanding The Bitcoin Stock-to-Flow Model

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