What is Bitcoin's Stock-to-Flow Model?

What is Bitcoin's Stock-to-Flow Model?

When it comes to Bitcoin price prediction tools, many people will think of the name “Plan B”, a Dutch institutional investor with knowledge of law and quantitative finance, owner of @100trillionUSD on Twitter with over 1.1 million followers and the creator of the famous Bitcoin's Stock-to-Flow (S2F) model in 2019. However, Bitcoin's Stock-to-Flow model is the first model that has attempted to apply the Stock-to-Flow ratio or Bitcoin rarity to  predict the price. This model is popular because Bitcoin’s prices have been relatively in accordance with the model’s predictions. To be able to apply Bitcoin's Stock-to-Flow model for investment, let's take a closer look at how stock-to-flow works and what the limitations of this model are.

What is Stock-to-Flow Ratio?



Stock-to-Flow (SF, S/F, or S2F) ratio is a tool used to measure the abundance of a resource that can be further applied to determine the scarcity of that resource. Usually it is used for natural resources such as gold, silver, and iron ore, but it functions mainly by calculating the rarity of a resource by dividing Stock by Flow, where Stock is the total amount of resources available at a given time and Flow is the volume of resources that can be produced or acquired per year. A high S2F value reflects the difficulty in accumulating the resources.



Gold is one example, the World Gold Council estimates that the total amount of gold ever mined amounts to 197,000 tons, which we'll call this as Stock, and the amount of gold that can be mined is around 2,500 - 3,000 tons/year. In this part we will call it Flow. When we divide 197,000 tons of stock by 2,500 tons of Flow, the ratio of S2F is 78.8. In other words, based on current gold mining capacity, it would take up to 78.8 years to mine gold in an equal amount to the total amount ever obtained or 197,000 tonnes.





How important is Scarcity?



Saifedean Ammous, author of Bitcoin Standard, spoke about the scarcity aspect shown in the S2F ratio that Bitcoin and gold differ from consumer goods such as zinc, copper, etc. in that they have a high S2F value, which is displayed evidently from the previous gold example. Regardless of the demand for gold in the market or how high the price increases, we can't increase the amount of gold production much more than before, so gold is not overflowing and can maintain its value from the past until the present.



As for Bitcoin, it currently has a stock of $18.8 million and a flow of approximately 300,000 U.S. dollars per year. The figure is calculated based on a new block being created every 10 minutes on average, and the creation of one block will produce 6.25 Bitcoins (As of August 2021) which brings the S2F to 62.67, which is relatively high, second only to gold.



The scarcity of Bitcoin tends to increase as its total volume is limited to 21 million coins and every 4 years the number of new coins generated per block decreases by half (Read more about Halving) Until the last halving, in the year 2140, creating a block will only reward 0.000000001 BTC, therefore Halving is another evident mechanism implemented to control inflation and allowing higher prices, which are in accordance with market demand.



Moreover, Nick Szabo, a computer scientist and cracker also talks about the scarcity in terms of unforgeable costliness. In addition to resources that are known to be rare, they have high value as they are distributed in small quantities with an incredible history. It is also difficult to recreate it due to the related high costs. Therefore, becoming another important factor that creates rarity and value.



From this point of view, Bitcoin can be considered as a rare asset, because it has a value deriving from the fact that it is difficult to recreate due to high production costs, which, in this case, is in the form of electricity bill.

In practice, does the rarity of Bitcoins make its price go up as well?





Stock-to-Flow Model and the value of Bitcoin



In order to prove that rarity is related to the coin price and to create a statistical-based price prediction model, Plan B calculates the S2F value and collects monthly bitcoin price data from December 2009 to February 2019, and after that the data were analyzed for statistics.



From the results of the distribution diagram and linear regression analysis. A significant positive correlation was found between rarity (S2F) and price or to put it simply, the rarity and the price were not coincidentally consistent. If the rarity is high the price will be high as well but if the rarity is low the price will go down accordingly, as shown in the figure, where the horizontal axis is the rarity and the vertical axis is the market price

.

Figure medium



To apply it in real predictions, the results can be seen in the figure below as a graph of the forecasted price based on the model compared to the actual price. From the first price recorded until 28 October 2021, two years after the model was created.

It can be seen that the actual price of Bitcoin is quite equal as predicted by the model from past to present. Although there are some inaccurate predictions at certain times, but overall the actual price still follows the model and this is probably why Plan B's Bitcoin's Stock-to-Flow model is so popular.



Figure S2F.hamal



Bitcoin’s Stock-to-Flow Limitation

Although taking the rarity of Bitcoin as a key predictor of the price is a strong point of this model, but having only one variable in price prediction is also a weakness. This is because other variables that affect the price are not included in the calculations such as investor sentiment, cyber attacks, replacement of other technologies, relevant law changes, and other unpredictable events. All of these variables can affect investors’ trading decisions and affect Bitcoin’s price volatility more than the model can predict.





Conclusion



Bitcoin's Stock-to-Flow Model is a Bitcoin price prediction model that uses the relationship between Bitcoin’s rarity or Stock-to-Flow ratio with its past prices to predict future prices under the assumption that the more scarce the resources are, the higher the price will be.

However, resource scarcity is not the only variable that affects an asset, like Bitcoin’s, price. There are still numerous other factors that Bitcoin's Stock-to-Flow model does not take into account for its predictions. Investors who are interested in using this model to make investment decisions should use other tools along with it to obtain the most comprehensive information, whilst also conducting a suitable risk management strategy as well.



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