What is the Stock-to-Flow model?
The Stock-to-Flow model predicts the value of bitcoin based on the stock-to-flow (SF) ratio. Is it useful? Why do so many people criticize it? Let’s find out!
The model was created by an anonymous PlanB author based on his calculations for precious metals such as silver and gold.
Stock-to-Flow is an attempt to demonstrate that the price of any product will rise due to a scarcity caused by an increase in the stock-to-production ratio.
Experts criticize the Stock-to-Flow model for incorrectly performing asset calculations, which were used to calculate the value of bitcoin as its deficit increased due to halving.
Who offered the Stock-to-flow model and when?
The Stock-to-Flow model was proposed by an anonymous PlanB analyst in the article Modeling Bitcoin Value with Scarcity, which was published in 2019.
According to the author, he was an institutional investor with 25 years of experience who had previously worked in the financial and legal fields. PlanB’s interests also include investment strategies and blockchain analysis. In another article, the trader mentions managing multibillion-dollar assets. We still don’t know who PlanB is.
How does the Stock-to-Flow model work?
The model is based on the idea of researcher Nick Szabo, who claims that precious metals and collectibles are always in short supply due to the high cost of their production. This is the approach PlanB took with Bitcoin.
For an asset, the SF parameter is quantified. It is equal to the stock-to-inflow ratio of the asset. This is the inverse of supply growth. The reserve is equal to the total volume of reserves, and the inflow is equal to the annual production or production volume.
Consumables, ferrous metals, and consumer goods all have low stock-to-inflow ratios, whereas rarer objects and precious metals have high indexes.
Low SF products and materials are not uncommon. Producers will significantly increase production and eliminate the deficit if their prices rise. It is difficult or costly to increase production of rare objects.
The author applies the concept to gold and silver, the volume of production of which was 1.6% and 4.5% of the reserve, respectively. An increase in demand for these metals will result in an increase in price because there is no way to significantly increase production while meeting demand.
For example, the Stock-to-Flow issue of bitcoin is 17.5 million, and the inflow due to mining is 0.7 million per year. The first cryptocurrency’s SF is 25. The block reward determines the inflow. It was initially worth 50 bitcoins, but payments are halved every 210,000 blocks, or roughly every four years. This is referred to as halving.
Reducing the reward for the block determines the values of SF and the inflow. PlanB calculated monthly values of SF bitcoin from December 2009 to February 2019 and received 111 points.
The graph employs a logarithmic scale to depict values ranging from $10,000 to $100 billion. A color gradient indicates the time until the next halving. Dark blue represents the month when the block reward was reduced, and red represents the month after the event.
According to the model, bitcoin’s market capitalization will be $1 trillion after the 2020 carving, and its price will exceed $55,000.
How do phase transitions complement the Stock-to-Flow model?
The author added the concept of phase transitions to Stock-to-Flow, which removes the time factor. Substances undergo transformations, which result in the acquisition of new properties. Water, for example, has four phase states: solid, liquid, gaseous, and ionized.
The US dollar was also transformed into a gold coin, a gold-backed banknote, and an unsecured banknote. Its properties varied significantly across phases.
PlanB used the concept with Bitcoin. The author compares the first cryptocurrency to water and the US dollar, both of which have different properties at different stages. Bitcoin’s perception and applications have evolved over time.
The public’s perception of the first cryptocurrency evolved smoothly, but PlanB identified four stages:
- Proof of concept
The first phase began with the publication of the whitepaper, followed by the launch of the bitcoin network. - Means of payment
The phase began with bitcoin surpassing the cost of $1, after which its gradual adoption as a means of payment on the Internet began. - Digital gold
After the first halving, the price of bitcoin approached that of an ounce of gold. These events resulted in the transition to the third phase. - A financial asset
Exceeding the volume of transactions of $1 billion per day after the second halving marked the start of the fourth phase. The latter characterizes bitcoin’s widespread adoption in the financial sector.
In one of the other works, PlanB identified four groups (groups of points). The chart depicts Stock-to-Flow models that correspond to the phases of bitcoin that he invented. The initial PlanB forecast assumed that the cryptocurrency’s value would rise to $55,000.
Bitcoin will enter the fifth phase when its SF parameter equals that of gold. As a result, the first cryptocurrency’s value will rise to $288,000, and its capitalization will reach $5.5 trillion. The forecast, according to the analyst’s assumptions, can be realized by 2024..
How does the Stock-to-Flow Deflection indicator work?
As a result, the Stock-to-Flow Deflection technical indicator was created to show the relationship between bitcoin’s price and its value as determined by the corresponding model. The parameter values are calculated over the life of the cryptocurrency.
Bitcoin is undervalued if Stock-to-Flow Deflection is less than one. If the parameter is greater than one, the cryptocurrency’s value is expected to fall.
When trading, some traders employ this indicator. They buy bitcoin when its value is less than the estimated value and sell it when the first cryptocurrency is overvalued, according to the indicator.
What is the Stock-to-Flow model criticized for?
Several years have passed since the concept was published, and it has yet to be fully realized. Strix Leviathan Investment Director, Nico Cordeiro, believes that the Stock-to-Flow model is fundamentally flawed because arbitrary data for gold and silver were used when calculating SF.
The analyst believes PlanB chose the data to best match the model. As a result, it was possible to obtain a linear dependence in logarithmic coordinates for gold, silver, and bitcoin. The critic points out that there is no relationship between the capitalization of commodities and precious metals expressed in US dollars and the increase in their production.
Cordeiro calculated the SF for gold over the last 115 years. Its findings show that there is no relationship between the capitalization of the precious metal and the calculated parameter. The total value of gold reserves ranged from $60 billion to $9 trillion, with an almost constant SF value of 60.
According to the critic’s study, the price of gold rises primarily when the purchasing power of the US dollar falls. The value of US currency has decreased by 25 times due to inflation since 1915, which explains the increase in the value of gold.
Stock-to-Flow is based solely on historical data, according to Nico Cordeiro. There are prerequisites for this, as simulation results show that the cost of one bitcoin will exceed $ 235 billion by 2045.
Huobi analysts criticized Stock-to-Flow as well. According to them, the latter fails to account for macroeconomic factors such as the Fed’s normalization of monetary policy and the increase in the discount rate.
What is the future of the Stock-to-Flow model?
Plan B correctly predicted that the first cryptocurrency’s value would rise to $55,000. It also supplemented the original model. At the same time, despite the fact that the model is intended to be applied to assets other than cryptocurrencies, the majority of them have a low SF parameter.
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