A Stock-to-Flow model determines an asset's scarcity by comparing its circulating supply, also known as the stock, to its annual incoming supply, known as the flow.
PlanB, a prominent cryptocurrency analyst and investor, developed Bitcoin's S2F model and contended that because the circulating supply and flow of Bitcoin are known, we could use an S2F model to forecast Bitcoin's price movements accurately.
Bitcoin has veered away from the S2F model's predictions over the last eighteen months, with the price currently around $23,000, as against about $110,000 of the S2F model's forecast.
It is critical to keep the forecasts from the model in context and keep in mind that It is just an observation and speculative projection that an observed trend may continue.
There are numerous price forecasting tools available in the cryptocurrency space. Some rely on historical price movement, while others rely on market dominance and even scarcity. Supply scarcity is a reliable long-term price forecasting method. One resource that depends on this method is the Bitcoin stock-to-flow (S2F) model.
Bitcoin attempts to establish a supply limitation narrative with stock-to-flow. And when there is a scarcity of something valuable, prices move, increasing or even flattening demand. However, stock-to-flow is more than a concept. It is a full-fledged indicator that correlates positively with BTC prices. While the stock-to-flow model has traditionally been applied to commodities such as gold and silver, Bitcoin's status as "digital gold" and fixed supply makes it a good fit for the model. The concept is straightforward: as Bitcoin's scarcity and demand grow, so will its price.
A Stock-to-Flow model determines an asset's scarcity by comparing its circulating supply, also known as the stock, to its annual incoming supply, also known as the flow. The higher the Stock-to-Flow ratio, the scarcer and more valuable the asset.
The following are the model's essential elements:
A resource's stock is the total amount of that resource that exists.
Flow = The extra amount of a resource produced each year.
The formula for calculating stock-to-flow is as follows:
As an example, consider gold's stock-to-flow ratio:197,576 tonnes in stock
Annual flow = 3,000 tonnes.
Stock-to-flow: 197,576 / 3,000 = 65.85
It means that it will take 66 years of gold mining to double the amount currently held by people worldwide. Silver, on the other hand, has a stock-to-flow ratio of 22. This ratio explains why gold costs USD 55,057.03 per kilogram while silver costs only USD 690.16 at the time of this writing.
PlanB, a prominent cryptocurrency analyst and investor, developed Bitcoin's S2F model. It contended that because Bitcoin's circulating supply and flow are known, and creating fake Bitcoin is difficult (if not impossible), we could use an S2F model to forecast Bitcoin's price movements accurately.
Essentially, the greater the existing stock of Bitcoin relative to the new flow being produced, the higher the supply to flow—and thus, the more valuable the digital asset.
Let's calculate the Stock-to-flow of Bitcoin.
The stock here refers to the current circulating supply of Bitcoin, which is around 19.19 million. The term "flow" refers to the number of Bitcoin introduced into the supply pile each year.
As a result, the ratio is as follows: Stock/Flow
Bitcoin stock is currently valued at 19.19 million.
BTC mined per year / Bitcoin flow = 356029 (Almost 975 BTC mined per day)
As a result, the SF Ratio is 53.9.
This figure indicates that the current BTC stock would take 53.9 years to produce. As you can see, Bitcoin's stock-to-flow ratio is already approaching that of gold at 63. The number of bitcoins produced by miners is reduced by half every four years. When Bitcoin first launched, the reward per block was 50 bitcoins. It was cut to 25 bitcoins in 2012. In 2016, it was cut in half again, to 12.5 bitcoins. Miners earn 6.25 bitcoins for each new block mined as of August 2021.
Bitcoin's stock-to-flow ratio will continue to rise every four years until there is virtually no new supply. This means that the price of Bitcoin will be entirely determined by demand. It naturally leads to some bullish price forecasts.
Because stock-to-flow fundamentally measures an asset's scarcity, we must ask why scarcity matters. It boils down to supply and demand, as with most economic issues.
When the price of something rises, producers usually respond by producing more of it. For example, when corn demand increases, the price rises, and farmers plant more corn. When the crop is ready, supply increases, and prices fall. Scarcity occurs when the quantity of something cannot easily be expanded. Gold is much scarcer than corn because it is more difficult to mine.
Bitcoin's pseudonymous creator, Satoshi Nakamoto, recognized the value of scarcity. He presented the thought of Bitcoin as the creation of a base metal as scarce as gold but with one unique, magical property. That is, it can be transmitted via a communications channel.
That's what he created with Bitcoin. Bitcoin serves as a digital version of gold. Instead, it is even more scarce and can be sent across the internet with the click of a button. Furthermore, Bitcoin has a fixed supply of only 21 million bitcoins to be produced. Hence, as demand grows, so must the price. This scarcity and the effect on price are what attract investors to Bitcoin.
There is another formula for calculating the fair price of BTC based on the SF model.
Model Cost = exp (-1.84). SF^3.36
Using the current SF ratio, the Model Price is approximately $104480.
The stock-to-flow line represents the model price. The indicator shows the difference between the model and actual prices by superimposing the current BTC price on top of the model price line.
Bitcoin has veered away from the S2F model's predictions over the last eighteen months, and it does not appear to be catching up soon.
Bitcoin's price is currently around $23,000, which hasn't surpassed $50,000 since December last year. According to the S2F model, Bitcoin should be worth about $110,000.
So, the answer is no; Bitcoin is not following the S2F model's predictions.
Yes, the S2F model appears to be accurate in the long run. Or, at the very least, it was up until last year. However, Bitcoin is not following the _script_ in the short term.
Yet, deviations from the model's predictions have occurred in the past, and Bitcoin's price has always returned to the model's predictions - eventually.
For example, if the S2F model had been operational between January 2013 and 2015, it would have been significantly off, as shown in the chart below.
However, following this anomaly, Bitcoin's price matched up with the S2F model until the middle of last year (2021). So the model may still be correct, but unexpected events, such as the Ukraine war or the Covid-19 pandemic, can move Bitcoin's price more than the model can forecast.
Now that we've gotten past the tricky part (mathematics), consider the following advantages of using the stock-to-flow Bitcoin price forecasting model:
It tracks price movements using fundamental drivers such as token economics.
It provides a positive outlook for long-term BTC investors.
During the halving events, prices were in line with forecasts.
It demonstrates that Bitcoin has a low-price elasticity of supply, which means that increasing the price does not increase supply. It's all thanks to the auto difficulty adjustment feature.
It is among indicators that use new supply as a parameter, which is nearly constant.
These are things to keep in mind as a trader/investor:
It fails to account for market volatility, particularly the massive fluctuations during significant events.
The model generalizes data based on some overly optimistic projects that may not hold in a bear market.
It does not take into account black swan economic events.
It assumes that BTC demand is constant and does not account for a "demand" fall.
The key takeaway from the stock-to-flow model is that it demonstrates how scarcity can affect the price. Because Bitcoin is the first digital asset in history with a fixed supply, its price will be entirely determined by demand. As a result, if Bitcoin's adoption continues to grow exponentially, so will its price. However, It is critical to keep these forecasts in context. As the CEO of Blockstream, Adam Back noted, one should think about the model like Moore's Law. It is just an observation and speculative projection that an observed trend may continue.
Given the disparity between Bitcoin's current price and the S2F model's forecast price, it's best to avoid using it in isolation. Nevertheless, it is still a valuable tool for determining how scarce Bitcoin is at any given time, but keep in mind that you must take its predictions with a grain of salt.
Author: Gate.io Observer: M. Olatunji
* This article represents only the views of the observers and does not constitute any investment suggestions.
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