Bitcoin Stock-to-Flow Model: Will Scarcity Help Retain BTC’s Long-Term Value?

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The cryptocurrency market is in its infancy and experiencing high growth. Due to its novelty, investors and traders have been looking for long-term valuation models to determine the appropriate prices for Bitcoin and other cryptos. Since Bitcoin’s total supply is limited and predicted to be mined out by 2140, one can’t help but wonder if Bitcoin’s price will continue to rise due to its absolute scarcity. One such quantitative model called the stock-to-flow model measures the Bitcoin value and predicting Bitcoin’s price over an extended period. 

We’ll look at what the stock-to-flow model is and make a comparison between the stock-to-flow of both Bitcoin and gold. Then, we’ll unpack a model that incorporates the stock-to-flow ratio for Bitcoin and predicts its price. Lastly, we’ll discuss some problems that may prevent this model from being an accurate predictor of Bitcoin’s future.

What Is the Stock-to-Flow Model? 

Stock-to-flow is an investment model that measures an asset’s current stock against the rate of production or the total amount mined over the course of a year. Stock-to-flow is used to compare the relative abundance or scarcity of a particular resource.

In theory, if a resource is more scarce — for instance, precious metals such as gold, silver or platinum — then it’s likely to be a better store of value, meaning that it should retain its value and purchasing power over the long term. Beyond natural resources, other commodities such as real estate, stocks and bonds have traditionally been used as stores of value, too.

Source: Medium — Bitcoin modeling with scarcity.

Though traditionally used as a way to compare various established resources, stock-to-flow has been adapted as a way to valuate Bitcoin, the first scarce digital resource that’s believed to be a store of value.

Valuing Bitcoin using the stock-to-flow model began with a pseudonymous author, PlanB. In his article, Modeling Bitcoin Value with Scarcity, the author explains how the flow model makes sense for an asset like Bitcoin through the highlights of the statistically significant relationship between the circulating scarcity and its impact on price.

PlanB argues that Bitcoin can be valued as a scarce resource because it contains “unforgeable costliness.” To mine and produce new Bitcoins, massive amounts of electricity are required at a considerable monetary cost. The author argues that these properties push Bitcoin into a group of scarce assets that can be relatively valued using the stock-to-flow model.

This is different from valuating traditional fiat currency because centralized authorities can decide to create more fiat. Fiat currency isn’t scarce and is theoretically available in unlimited supply. Bitcoin, however, has over $18 million of existing supply out of the capped circulating supply of 21 million, which will be mined by 2140.

When Bitcoin Becomes Increasingly Scarce

The protocol behind Bitcoin is written such that no more Bitcoins will be mined or created once those 21 million have been brought into existence.

Due to the open-source code of Bitcoin, we know that Bitcoin’s rate of production is always decreasing. Every 210,000 blocks, or about every four years, the network goes through a halving process. This means the amount of Bitcoin a miner receives as a reward for validating a block is cut in half. This halving process entails that the production of new Bitcoin becomes smaller every four years.

This has a fairly immediate impact on the Bitcoin value, as the stock-to-flow ratio increases at each halving — creating an even scarcer resource.  

Calculating the Stock-to-Flow Ratio

The stock-to-flow ratio is a straightforward calculation.

Formula

Stock-to-Flow (SF) Ratio = stock ÷ flow

In this case, stock represents the current availability of the resource. Using gold as an example, its stock would include how much gold has already been mined

The flow would represent the new gold being mined. Generally, the stock-to-flow ratio is measured on a 12-month basis. Therefore, its flow would represent how much mining is expected to take place over the next 12 months.

For Bitcoin, stock would include the amount of Bitcoin which has already been mined to date, and flow would refer to the amount of Bitcoin being mined over the next 12 months.

Since Bitcoin’s code is open-source, anyone who can read computer code can see how Bitcoin works. As a result, we know exactly how much Bitcoin exists at this moment. Additionally, we know when, and how much, new Bitcoin is created — identifying the supply scarcity.

Total Bitcoin Circulating Supply
Source: Blockchain.com

Currently, over 18 million Bitcoins have been mined. The average time for the production of a new block in the Bitcoin blockchain takes around 10 minutes. As an incentive for the mining efforts, miners are rewarded 6.25 BTC whenever they add a new block of transactions into the blockchain. 

This means that 6.25 BTC are created every 10 minutes.  

That’s 37.5 BTC (6.25/10 minutes × 60 minutes/hour) created every hour, and 900 BTC (37.5/hour x 24 hours/day) created daily.

Therefore, the current annual flow of Bitcoin is 900/day x 365.25 days per year = 328,725 BTC.

As of fall 2021, the circulating supply of BTC was 18.8 million. There is a flow of 0.33 million bitcoins (328,725 ÷ 1,000,000).

This gives Bitcoin a current stock-to-flow ratio of 18.8 million ÷ 0.33 million = 57.

Decreased Flow Due to Bitcoin Halving

Every four years, the number of bitcoins mined is halved. At the time of this writing, a miner receives 6.25 bitcoins as a reward for mining each block. When the next halving occurs in 2024, the mining reward will be reduced to 3.125, which means the rate of new Bitcoin being created after that time will be reduced by 50%.

This inevitably and consistently reduces the flow portion of the ratio. When you reduce the denominator of a ratio, it increases the total value of the ratio.

As a result, Bitcoin’s SF ratio will increase significantly at the next halving in 2024, driving it to a ratio of nearly 120.

What Happens if the Ratio Is Low?

A low stock-to-flow ratio suggests there’s a lot of new production relative to the current stock available. This implies the inflation of the resource is likely to be strong. When a product is heavily inflated, the price to buy that product lowers significantly.

Fortunately for Bitcoin, its S2F ratio is unlikely to shrink. This is because the numerator of the ratio is steadily increasing each year. The denominator of the ratio will shrink every four years. As a result, the resulting S2F ratio continues to grow.

Gold vs. Bitcoin Stock-to-Flow Models: The Differences

There are several fundamental differences between the SF ratios of gold and Bitcoin.

The current SF ratio for gold is near 62.

Current gold stock = 185,000 tons

New gold flow = 3,000 tons

SF Ratio = 62

As you recall, the current SF ratio for Bitcoin is near 57.

The similarity of these SF ratios indicates the scarcity of these two resources, meaning that they’re excellent stores of value.

Though these ratios are relatively close together, there is a notable difference: Gold’s SF ratio has fluctuated over the past 100 years.  

Source: ingoldwetrust.report

Since 1900, gold’s SF ratio has bounced between 45 and 90. This is largely a result of the production rate increasing and decreasing over time based on market conditions.

On the other hand, Bitcoin’s mining schedule is systematic and known in advance. Production of new Bitcoin will decrease by 50% every four years. This means that Bitcoin’s SF ratio accelerates with each four-year halving.

The next Bitcoin halving is estimated to take place in 2024. Once it occurs, the SF ratio for Bitcoin will increase, as noted, to approximately 120.

Bitcoin’s increasing SF ratio will accurately indicate more scarcity, which in turn will imply a higher value.

Using the Bitcoin Stock-to-Flow Model for Price Prediction

PlanB researched this stock-to-flow ratio and ran a regression analysis against Bitcoin’s price history. In other words, he researched how the price and stock-to-flow model overlapped to see if there was any correlation.

His findings were remarkable. He discovered that Bitcoin’s price was modeling — and closely following — a formula that included Bitcoin’s stock-to-flow ratio.

Model Price Formula

Model Price (USD): e-1.84 × SF3.3

When you inspect this formula, the only variable is the stock-to-flow ratio. (The letter e represents Euler’s number.) Technically, this ratio increases slightly every day as new Bitcoin is added to the stock. It is this small increase in the daily SF ratio which drives the model price higher.

Then, every four years, the SF ratio makes a drastic jump. When you graph this formula, it looks something like this:

The chart above takes the model price formula and smoothes it out by applying a 463-day simple moving average.

Notice the scale of pricing on the left-hand side. After each halving, the model price for Bitcoin jumps higher by an order of magnitude, then settles into a sideways consolidation.

As the SF ratio jumps, the model price for Bitcoin jumps, too. This illustrates how the scarcity of a valuable product has an impact on its price.

Now, let’s overlay the actual price of Bitcoin since its inception.

Stock to flow model Bitcoin live chart.

The overlap is quite impressive, as the price of Bitcoin has tracked the model fairly well. In its early days, there was limited trading, and access to Bitcoin was very difficult to obtain.

Now, several crypto exchanges have come online, making the acquisition and trading of Bitcoin much easier.

One thing to notice when reviewing the chart above is that price doesn’t precisely follow the model. There are times when the price overshoots the model to the upside. Then, the price will undershoot the model to the low side.

Some traders compare the price of Bitcoin to its model to determine if Bitcoin is overvalued and expensive, or undervalued and cheap.

Currently, the model suggests the price of Bitcoin should be around $107K. At the time of this writing, on Oct. 19, Bitcoin is trading near $62K, which is almost half of its modeled price. As a result of this discrepancy, some traders may conclude that the price of Bitcoin is extremely undervalued and cheap.

On the chart above, the orange line shows the actual price deviation from the model price. When the orange line is above the green line, it shows the actual price is above the model price. When the orange line is below the green line, the actual price is underperforming relative to the model.

Traders may interpret this to mean that the model has worked in the past, but is starting to break down as a predictor of price. The recent underperformance has placed Bitcoin the farthest below the model price in its history. Ultimately, it’s up to you to do your own research and arrive at your own conclusion.

Problems with the Bitcoin Stock-to-Flow Model

The Bitcoin SF model has done a fantastic job of describing Bitcoin’s past price history and demonstrating why Bitcoin has been valued at high prices relative to 10 years ago. Will the model last forever? Will this model accurately forecast the price of Bitcoin years into the future?

Let’s unpack a couple of blind spots that may break the model, making it a poor predictor of future price action. 

Problem 1: Demand for Bitcoin

Bitcoin’s issuance schedule and relative scarcity aren’t the only reasons for its rise in price. Demand also plays a factor in the network’s value.

Consider that there are several blockchain platforms, such as Litecoin and Cardano with similar structures and issuance schedules. These blockchains’ currencies have scarcity with limited supply and decreasing production schedules. However, their SF models don’t accurately forecast prices for these blockchains. 

The prices of these cryptocurrencies don’t match the SF model because the demand to buy into those blockchains is significantly lower than that for the original Bitcoin. Therefore, if events were to unfold that negatively affect the demand for Bitcoin, then the value of Bitcoin would decouple from the SF valuation model.

Problem 2: Gold’s Stock-to-Flow Doesn’t Drive Its Price

As a result of Bitcoin’s periodic halving, its stock-to-flow ratio regularly jumps. It’s reasonable to assume that a contracting supply would fuel Bitcoin’s dramatic price increase.

Intuitively, this makes sense. We experienced a little bit of a supply shortage during the pandemic in March 2020 when this important commodity suddenly became scarce. As rumors swirled about a potential TP shortage, people began to buy it up — even if they didn’t need it. That additional demand further exacerbated the shortage.

However, it was the short supply that fueled an increase in demand. If a simple supply cut and the SF ratio were great price predictors, then gold analysts would be using them all the time.

The reality is that non-professional investors didn’t begin to hear about the concept of stock-to-flow ratio until PlanB’s research burst onto the scene.

According to Voima, the price of gold is uncorrelated to its SF ratio:

Leaning on the long history of gold suggests that stock-to-flow is not an accurate predictor of price for it. Therefore, it can be argued that stock-to-flow is not a predictor for the value of Bitcoin, either.

Problem 3: SF Ratio Doesn’t Explain Price for Other Cryptos

If the stock-to-flow ratio were the most important driver in a cryptocurrency’s value, then why not create another crypto that’s scarce, and halves every month? The reason this hasn’t happened is that the SF ratio isn’t the main driver of a cryptocurrency’s value.

We can also lean on current examples like Bitcoin Cash or Litecoin, which are replicas of Bitcoin but do not enjoy the same valuations.

Problem 4: Buying Power Needs to Grow Exponentially

Consistent with the stock-to-flow price model, Bitcoin’s price grows by an order of magnitude with each halving. A large challenge facing Bitcoin’s ability to keep up with this model is that there needs to be exponential growth in new demand for Bitcoin.  

We can learn from a network such as Facebook that there comes a saturation point where exponential growth is no longer sustainable. The same will happen someday to Bitcoin. Right now, there are more people and institutions who aren’t invested in Bitcoin than those who are.  

Therefore, adding more people and institutions to the Bitcoin network is easy because there’s a large pool for whom Bitcoin ownership is new.

Once the majority have bought into Bitcoin, there’s going to be a smaller supply of people and institutional money to grow the network.  

For example, MicroStrategy was the first public company to make Bitcoin a part of its treasury plan. Above is a chart that shows the historical purchases of Bitcoin by MicroStrategy. There are likely more stories like MicroStrategy’s that will come out in the future. However, there will come a time when fewer institutions will make Bitcoin a part of their treasury plan.

That reduction in institutional demand will decouple Bitcoin from the SF model.

Closing Thoughts

The current stock-to-flow ratios of Bitcoin suggest that it’s an increasingly rare resource. The stock-to-flow model shows a market relative of Bitcoin’s current price is almost half of the model price, suggesting Bitcoin is actually relatively cheap.  

However, it can be argued that the Bitcoin valuation through the stock-to-flow model will not last forever. The historical relationship and Bitcoin’s volatility need to be considered for more reliable accuracy. It is thus possible that Bitcoin is decoupling, and that the model’s validity is breaking down.

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