What is Bitcoin's stock-to-flow model?

The stock-to-flow (S2F) model is a popular method for evaluating the value of assets with a limited supply, such as Bitcoin. Originally applied to commodities like gold and silver, the model attempts to quantify the scarcity of an asset by comparing its existing supply (stock) to the rate of new production (flow). The stock-to-flow ratio is calculated by dividing the current stock by the annual production rate, providing a measure of how many years it would take to replace the current supply.

In Bitcoin’s context, the S2F model is used to predict its price by emphasizing its scarcity as a digital asset. The "stock" refers to the total number of Bitcoins in existence, while the "flow" refers to the number of newly minted Bitcoins entering circulation each year through mining rewards. Bitcoin has a fixed maximum supply of 21 million coins, and its issuance rate decreases approximately every four years in an event known as the "halving," where the mining reward is cut in half. This makes Bitcoin increasingly scarce over time, which the S2F model suggests could lead to an increase in its value.

Stock-to-Flow Ratio of Bitcoin

The formula for calculating Bitcoin's stock-to-flow ratio is:

Stock-to-Flow Ratio = Total Bitcoin in Circulation/Annual Production

Currently, there are around 19.5 million Bitcoins in circulation, and roughly 328,500 new Bitcoins are mined annually, as of the latest mining cycle. Therefore, Bitcoin's current stock-to-flow ratio is approximately:

𝑆2𝐹= 19,500,000 / 328,500 ≈ 59.4

This high S2F ratio is indicative of Bitcoin's increasing scarcity.

Halving Events and Stock-to-Flow

One of the most critical aspects of the stock-to-flow model is the role of Bitcoin halving events, which take place approximately every four years. During each halving event, the number of new Bitcoins produced every 10 minutes (reward to miners) is reduced by 50%. This makes Bitcoin's flow decrease, leading to an increase in the S2F ratio, and thus making Bitcoin scarcer.

The table below shows the historical halvings and their effects on the S2F ratio:

These halving events lead to an exponential increase in the stock-to-flow ratio, reflecting growing scarcity. Supporters of the model argue that with each halving, Bitcoin becomes increasingly rare, thereby driving the price upwards as long as demand remains constant or grows.

The Stock-to-Flow Model Formula

In the S2F model, a formula is used to predict the price of Bitcoin based on its stock-to-flow ratio:

Price= 𝑎×𝑆2𝐹𝑏

Where:
𝑎 and 𝑏 are constants derived through regression analysis.
Using historical data, the model has been used to predict Bitcoin's price with a considerable level of accuracy, although it has also faced criticism for being too simplistic.

Strengths and Criticisms

Strengths:
1. Focus on Scarcity: The S2F model is praised for effectively capturing Bitcoin's unique monetary policy and the predictable reduction in new supply through halving events.
2. Historical Accuracy: Historically, Bitcoin’s price has generally followed the S2F model, particularly around the halving cycles, which lends some credibility to its projections.
Criticisms:
1. Simplicity: Critics argue that the model is overly simplistic, as it assumes that scarcity alone determines value and does not account for other factors like demand, regulation, market sentiment, or macroeconomic conditions.
2. Lack of Demand Consideration: The model primarily considers the supply side of Bitcoin but ignores changes in demand, which can significantly influence price.
3. Empirical Limitations: Some analysts have pointed out that past performance in line with the model does not necessarily guarantee future accuracy. For instance, the model cannot foresee exogenous factors such as government regulations, market cycles, or black swan events, all of which have a substantial impact on Bitcoin’s price.

Is Stock-to-Flow Accurate?

The stock-to-flow model is not without flaws, but it is one of the more popular tools in the cryptocurrency space due to its intuitiveness and focus on the unique supply structure of Bitcoin. The model suggests that, as Bitcoin’s supply becomes more constrained, its value will rise, assuming constant or increasing demand. This perspective aligns with Bitcoin's characterization as "digital gold."

However, many argue that market dynamics are far more complex than what a single ratio can encapsulate. Economic events, changing market preferences, innovations, and regulations can easily affect the actual outcomes, making price predictions based solely on scarcity incomplete.

Conclusion

The stock-to-flow model is a compelling method for understanding Bitcoin's value from a scarcity perspective. By emphasizing Bitcoin's limited supply and halving cycles, it draws parallels with commodities like gold, which have historically been viewed as stores of value. While it has provided some predictive power over Bitcoin’s history, it is crucial to recognize the model's limitations and to consider other factors that influence Bitcoin’s price, such as demand, technological developments, and macroeconomic conditions. As such, it serves as one piece of the puzzle rather than a definitive guide to Bitcoin's valuation.