A Beginner’s Guide to the Bitcoin Stock-to-Flow Model

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A Beginner’s Guide to the Bitcoin Stock-to-Flow Model

A Beginner's Guide to the Bitcoin Stock-to-Flow Model

Summary

  • The stock-to-flow model looks at a commodity’s supply from two different angles: how much is the asset’s existing supply (Stock) and how much is yet to be produced (Flow). It then assesses the asset’s scarcity.
  • Back in 2019, PlanB, an anonymous quantitative analyst and investor, introduced the Bitcoin stock-to-flow model in his “Modeling Bitcoin Value with Scarcity” article.
  • The Bitcoin stock-to-flow model assumes that scarcity drives value higher. Based on this assumption, the stock-to-flow model has found a relationship between the SF number and the market value of Bitcoin. The statistical model is created based on this relationship which estimates the Bitcoin price.
  • According to the Bitcoin stock-to-flow model, the Bitcoin price should be above $100,000 at the moment while the asset is changing hands around $27,000.

Table of Contents

What is the Stock-to-Flow Model?

The stock-to-flow model is an interesting formula that can assess how scarce a commodity is. This information then can be used to price the commodity based on its supply and demand.

The stock-to-flow model looks at a commodity’s supply from two different angles: how much is the asset’s existing supply (Stock) and how much is yet to be produced (Flow).

Stock-to-Flow Ratio = Stock Flow

To make things more clear, let’s calculate the stock-to-flow ratio for Gold, the most notable commodity to date. After that, we can better understand how this model applies to Bitcoin.

Gold is a natural resource with limited supply, meaning we will run out of new Gold to mind at some point in the future.

According to the World Gold Council, around 208,874 tonnes of gold have been mined to date, and considering that Gold cannot be destroyed, this total supply still exists in one form or another. This number is the existing supply or stock of Gold at the moment.

Now, for the flow, we need to see how much new Gold is mined each year. Looking at the data, an average of 3,482 tonnes of Gold are being mined each year. Now, we have both the stock and flow to calculate the stock-to-flow ratio of Gold:

Gold S2F Ratio = 208,874 3,482 = 59.99

A higher value of the stock-to-flow ratio indicates a higher level of scarcity for the commodity.

Now, considering that almost 52,000 tonnes of Gold is still under the ground and in reserves, it will take us almost 15 years to mine the complete reserve of Gold in the world with the current annual mining rate.

Now, let’s see how the stock-to-flow model applies to Bitcoin.

How Does the Stock-to-Flow Model Apply to Bitcoin?

Just like Gold, Bitcoin is considered a commodity with a limited supply. Bitcoin has the maximum supply of 21 million coins with 19,490,975 BTC already mined and in circulation (at the time of writing). So, we have the current stock of Bitcoin here.

The Bitcoin algorithm defines and controls the production rate of new bitcoins. In almost every 10 minutes, a Bitcoin block is created by a Bitcoin miner. In this process, new bitcoins are created to be rewarded to the miner that created the block.

Now, the interesting difference between Bitcoin and other commodities is the production rate or the flow. Bitcoin slashes its production rate every 4 years in an event known as Bitcoin halving.

At the moment, the block reward is 6.25 BTC, meaning that every 10 minutes 6.25 new coins are generated. To have the annual flow of Bitcoin:

(525,60010)6.25 = 328,500 BTC

Now that we have both the stock and flow of Bitcoin, we can calculate its stock-to-flow ratio:

Bitcoin S2F Ratio = 19,490,975 328,500 = 59.33

Interestingly, Bitcoin and Gold have the same level of scarcity at the moment. Now, how is this number used in the Bitcoin market?

What Does the Bitcoin Stock-to-Flow Model Tell Us?

The Bitcoin stock-to-flow model assumes that scarcity drives value higher. Based on this assumption, the stock-to-flow model has found a relationship between the SF number and the market value of Bitcoin. The statistical model is created based on this relationship which estimates the Bitcoin price.

glassnode-studio_bitcoin-stock-to-flow-ratio-usd

The Bitcoin Stock-to-Flow Model – Source: GlassNode

You can see the Bitcoin stock-to-flow model in the chart above. The black line shows the estimated price of Bitcoin based on the model while the colorful line shows the actual Bitcoin price.

At the bottom of the chart, you can see how many days are left till the next halving event. After each halving event, the scarcity of Bitcoin is doubled which will drive the price higher as the model is mainly based on this factor.

We can see that from 2015 to 2022, the Bitcoin price has followed the model quite closely, however, the two haven’t been correlated as before in the past couple of years.

Bitcoin is a financial asset and its price is affected by different factors that aren’t included in the stock-to-flow model. The scarcity of Bitcoin is the main component of this model and it overlooks major other factors such as the market sentiment in its price prediction.

This can be the main reason why the model sees a major divergence from the actual price when other factors are driving the markets.

Who Created the Bitcoin Stock-to-Flow Model?

Back in 2019, PlanB, an anonymous quantitative analyst and investor, introduced the Bitcoin stock-to-flow model in his “Modeling Bitcoin Value with Scarcity” article.

In 2020, despite a sharp fall in March, Bitcoin ended the year according to the estimation of the model, causing many to believe in the accuracy of the model and its price prediction.

According to the Bitcoin stock-to-flow model, the Bitcoin price should be above $100,000 at the moment while the asset is changing hands around $27,000.

Closing Remarks

The Bitcoin stock-to-flow model has been showing an acceptable performance, however, considering that it overlooks major factors such as market sentiment, it can experience large divergences from the actual Bitcoin price.

Considering this, the Bitcoin stock-to-flow model can be quite useful along with other tools you use when looking into markets and making investment decisions. You should note that the limited view of the Bitcoin stock-to-flow model makes it insufficient to be used solely in trading.

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