My Interpretation of Bitcoin’s Stock to Flow Model

There are many valuation models for Bitcoin. Some are based on fundamentals like much of the work done by Chris Burniske in his book, Cryptoassets. Many models are outlined in CoinMetrics work starting, here. I think relating to Bitcoin as a network and measuring the network’s usage and utility is key. However, a savvy investor cannot overlook the data from this price regression model. It’s called the Stock to Flow Model for Bitcoin.

Graph by Plan B, posted on Twitter but available for public use from his GitHub.

(My interpretation of work done by Plan B’s Stock-to-Flow Model, public use graph).

The Stock-to-Flow (S2F) Ratio is a model that models scarcity value. Now, just because something is scarce doesn’t mean it will hold value over time. Platinum is 30 times rarer than gold, but is it 30 times more expensive? No. It’s not even higher than gold right now. Why? Something called the Stock-To-Flow model explains the valuation reasoning.

Scarcity Value = Stock / Flow

The value stems from the relationship between how much of a scarce resource is mined and above ground being stored (Stock) compared to how much can be mined in 1 year (Flow). The reason platinum is not more expensive is that it is used in stuff like phones and catalytic converters. When it gets used in an industrial process, it’s removed from the stock. So, its stock-to-flow ratio goes down. Of the precious metals, gold has the best stock-to-flow ratio because there’s literally tons of it stored above ground, not being used for any industrial purposes (well rounding error compared to the amount stored), and you can only mine so much of it out of the ground each year. Over time, it’s something technology has not been able to materially improve (the relative cost per ounce to produce). With gold, it takes a certain amount of human effort, whether literally being a human mining it or stored value of human effort in the form of money that has to be expended to mine it out of the ground.

Bitcoin follows this S2F Model, too. There’s a lot of it mined, currently about 18 million, and only so much is release each year. On May 10th of 2020 the amount released to miners, through block rewards each year, is going to be cut in half which means Bitcoin’s Flow is going to be cut in half. That has a dramatic effect on price. The Bitcoin Halvening Event happens every 4 years. It’s happened twice before (see graph). Each time it’s happened, the price of Bitcoin eventually went up ~10x. The model has correctly predicted Bitcoin’s price for its entire history. It may take the price a little while to snap to the model, and it may overshoot or undershoot at times, but the price has followed the model. Based on the model, we could see a 15x change in Bitcoin’s price 12 months from now.

Only time will tell whether or not the model holds. Many detractors tout the Efficient Market Hypothesis. But, remember the Efficient Market Hypothesis treats facts and interpretations of facts as the same thing. There underlies the problem. Those “interpretations” shift all the time. Values get re-weighted all the time. My interpretation of the Stock to Flow Model is that it holds. It may not be efficient and it may take time, but ultimately there is a relationship between how much of something scarce you have and how long it takes to get more. As long as that relationship holds, staying unalterable using technology over time, then value will hold. So, as long as Bitcoin’s 21 million supply cap holds, the Stock to Flow Model will hold.

Today is April 15th.

Disclaimer: The above references an opinion and is for information purposes only. It is not intended to be investment advice. Please do your own homework.

Jake Ryan is the CIO at Tradecraft Capital, a startup advisor, an angel investor & writer on investing. If you enjoyed this article “clap” to help others find it! For more, join us on Facebook and Twitter.