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Since the introduction of Bitcoin in 2009, the digital currency has seen a tremendous increase in its unit price. Initially introduced at $6, bitcoin’s unit price at the end of June 2020 was around 9 thousand dollars.
Crypto fanatics and investors, at times, try to predict the future unit prices of bitcoin, but it has proven to be an enormous task. Investors want to understand the best time to invest in the bitcoins. So, how do you predict the price of something so volatile?
The Stock-to-Flow model is quite effective at predicting bitcoin prices. Keep reading to see how the model predicts bitcoin prices and how you can use it.
What Is the Stock-to-Flow Model?
Since its first introduction in the mid 20th century, the stock-flow model has been used to integrate stocks’ flow in economies. Stock-to-Flow ratio is the amount of an asset in reserve divided by its annual production. Stock-to-Flow measures the abundance of an asset, specifically natural assets.
The scarcity of an asset directly affects the S2F of the asset. The higher the cost of obtaining a precious metal, the higher the scarcity. The above happens to be the same for bitcoin, which takes a lot of time and electricity to be mined. The S2F ratio in bitcoin is, therefore, very high.
Fiat currency and altcoins have no proof of work needed. Therefore, even small companies can influence their supply, which makes their abundance very high and lacks value. Consumable items like copper, zinc, nickel, and brass have reasonable reserves but very high annual production that makes their S2F very low. Their ability to retain or to increase in value is therefore next to null.
How Is Stock-to-Flow Model Used In Determination of Price?
As mentioned earlier, the Stock-to-Flow ratio is between the assets stock and the annual production of the item. The S2F rate, therefore, is the stock divided by the flow of the particular item. Let’s take gold as an example.
Gold has a total current reserve of 195, thousand tonnes (stock). The estimated annual global gold production was 3 thousand tonnes (flow) in 2018. Gold’s Stock-to-Flow is, therefore, 195 thousand tonnes divided by three thousand tonnes, which gives us a flow value of between 62 and 65. It, therefore, has the highest Stock-to-Flow; thus, high value.
Bitcoin has a current stock of 18 million and an annual flow of 0.7 million. The above makes the S2F of bitcoin at 25; thus, its S2F ranks high in gold and silver leagues. But how does this affect the future prices of bitcoin?
To understand the bitcoin S2F and pricing relationship, we need to understand events related to bitcoins called halvings. Bitcoin miners get mining rewards called block rewards every time they complete a bitcoin transaction. These block rewards are new bitcoins. After every four years, which translates to around 210 thousand blocks, the block rewards for the miners are halved.
In 2009 the block reward was 50 BTC. Today around three halvings later, the block reward is 12.5 BTC. The S2F of bitcoin is around 25; thus, it should mean that it will only take another 25 years for bitcoins to be mined. However, due to halving, this process will continue until the year 2140, where the 21 million bitcoins will be mined. Now instead of the 25 years calculated in the S2F model, bitcoin has around 126 more years of mining.
In the first halving in 2012, the bitcoin price increased by 9,336%, i.e., from $12 to $1,180. In the 2nd halving, which occurred in 2016, the bitcoin price increased by nearly 288%. The unit value shot to $2800, and due to the demand surge, it shot to about $20 thousand in 2017. During the two halvings, the block rewards were halved to 25 and 12.5BTC, respectively.
The third bitcoin halving happened on 11th May 2020, and the block rewards are now 6.25 BTC. Only a few days later, the bitcoin price ranged between $8300- 8700. It’s expected that one year after the 2020 halving, bitcoin price will shoot to $100 thousand.
Limitations of The Stock Flow Model
The stock-flow method carries the assumption that the scarcity of an asset leads to a direct increase in its value. Critics argue that bitcoin does not have any possible use apart from its scarcity; thus, its demand will not increase with its scarcity.
Stock-to-Flow has not, at any point, explained the prices of other cryptos. Making a new digital asset with a higher S2F than gold and bitcoins is possible, but that would not make it more valuable. A good example comes with platinum and palladium which have an S2F ratio lower than silver but is still more expensive than gold
S2F underestimates the powers that have been there for centuries. Gold, for example, has had a high market value since millenniums ago.
S2F does not take fundamental physics into account. All the assets whose value has skyrocketed in the past got to a point where the aggressive growth stops. Although S2F projects that bitcoin values will break in the year 2140, it is doomed to break earlier due to its aggressive growth.
It has, for long, been hard to determine the future bitcoin prices. However, this hassle can be neutralized with the stock-flow model. The model relies more on the scarcity of an asset like gold, silver, and bitcoin—the scarcity is then used to determine the future value.
Assets with high S2F have stronger ability value increase or retention ability. However, S2F also hosts limitations that make it not so accurate in the determination of bitcoin prices. Whatever the case, S2F has proven to be a prediction master and can be trusted to forecast future bitcoin prices.