Using S2F Ratio To Explain Bitcoin Reaching New ATH
Bitcoin has finally reached a new ATH (All-Time High) above the previous December 2017 value. It happened first on November 30, 2020, when the price of the digital asset reached $19,783 at its trading peak. Then the price of BTC surged past $20K on December 16, 2020, reaching a high of $21,458.91. BTC has burst past the resistance level, and this can signal further buy opportunities. All this occurring with less concerning talk about it being in a bubble-like it was in 2017. Instead, it has been a more bullish sentiment as more backers rally the markets, while the bears take a back seat.
It is different in 2020, as the finance industry has taken a new turn on how they view the digital asset. One thing noticeable is the entry of institutional investment from the likes of Square, Paypal, Microstrategy, BlackRock, and Grayscale. MicroStrategy has raised $650M for investment in Bitcoin alone, while Grayscale is now in custody of 500,000 BTC for its investors. BlackRock’s CEO Larry Fink even mentioned that BTC could evolve as a global market asset. These endorsements bring a flow of capital that increases the valuation and propels the momentum to new all-time highs. It is turning Bitcoin into the store of value that its proponents in the crypto community have envisioned. That means it can be as valuable an asset as gold and silver.
Regulations had been the obstacle to mainstream financial adoption of cryptocurrencies like Bitcoin. This is no longer the case, as more financial institutions are meeting compliance regarding the custody and exchange of cryptocurrency. Another good news is that the US SEC did not classify Bitcoin as a security since 2018. That is another sign of relief for BTC holders and potential investors since it will not require having to register with the SEC.
Checking the charts, the massive surge in BTC can be explained using the S2F (Stock-to-Flow) ratio model. This is the ratio of the current stock of the commodity and the flow of production of new assets.
S = Current Stock
f = Flow of Production
S2F = S / f
The current stock would be the circulating supply of Bitcoin while the production of new assets are the coins created during the mining process. There have been criticisms about the S2F model when applied to Bitcoin, primarily from the mainstream finance world. However, it is hypothetical in a sense like most technical analysis.
It is making an assumption based on factors that affect the price of an asset. The idea was first introduced by an anonymous Twitter user, PlanB, who claims to have a financial trading background. Perhaps PlanB has a reputation to protect as well by not revealing a true identity since the S2F model is not a known rule that is widely accepted. You can make the argument that even if it is not accurate, at least it can provide some insights. At the moment, it seems to offer just that, though I won’t say it is the generally accepted observation by all analysts. Let us consider S2F in Bitcoin a theory for now.
To better understand S2F, let us define what it means for Bitcoin. According to the observations, the scarcity of a commodity like BTC can lead to an increase in its valuation (More about S2F explained here). After the Bitcoin halving of 2020, a reduction in block subsidy cut the supply of newly mined BTC from 12.5 to 6.25. That means that for every block produced, the miner who discovered it would receive 6.25 BTC. This is part of the Bitcoin protocol as a means to curb inflation of the digital asset and to control the creation of BTC so that not too much is circulating in the market. This leads to less BTC production, therefore, it creates a scarcity of digital assets.
The scarcity leads to higher prices because there is a demand for BTC. According to Bitcoin’s protocol, there will only be 21M BTC ever created, and this means owning at least 1 BTC would make it very valuable. The recent demand from institutions has been driving the prices higher as BTC (according to RSI) was being overbought. The market has strong buy signals being driven by the flow of capital, but the supply of BTC is lower since the halving.
When calculating the S2F for BTC, we must take into consideration that Satoshi Nakamoto (Bitcoin’s creator) mined 1M BTC that has not moved since then. It would not be considered a part of the stock for that reason, so the total circulating supply of BTC with the adjustment for S is:
Total BTC in Circulation (As of Dec. 19, 2020) = 18,574,837
S = (18,574,837–1,000,000) = 17,574,837
Now we take the production of BTC per day (based on 6.25). There are 900 BTC produced every day. Per annum that equals to 328,500.
f = 328,500
The S2F for Bitcoin would be:
S2F = 17,574,837 / 328,500 = 53.50
We can round off the value to 54, and that means at the current rate it will take 54 years to produce or mine the current stock. The S2F is a variable that will change when the circulating supply of BTC also changes. The higher the value, the more scarce the commodity and, therefore, the higher the value. Gold, in comparison, has an S2F of 62. Gold does not have a halving event though, so BTC will surpass gold in the next halving event. That would make BTC a much more scarce commodity than gold.
According to theory, S2F can also predict the price. Like predictions in technical analysis, it should be taken with a grain of salt. This doesn’t mean it will always be accurate, but if it does come close enough to the actual price, then we can say that the theory has a basis. This is much better than just speculating without some form of concept. The prediction states that the total value of BTC after this third halving in 2020 will approach $1T (Trillion). That should give BTC a valuation of $55,000 per coin.
How will $1T flow into Bitcoin is probably the next question, and with the most interesting answer. Fund manager and Real Vision CEO Raoul Pal explains how this can happen:
“I use a number of measures. I use technical analysis, logarithmic charts. I use the stock-to-flow ratio… I use a whole number of different yardsticks… They all basically come to the same thing. They basically come to: We’re going to be somewhere between $500,000 and a million dollars within five years, and we should be somewhere between $100,000 and $300,000 in the next 12 to 18 months.”
There will be a potential influx of more institutional capital in the space. This is due to a better option for financial markets to where they can earn from their investment. The fact that interest rates are either 0 or close to 0 in the traditional financial market, Bitcoin offers much higher returns in the long run. These markets include pension funds, bonds and equities. This is why PlanB even predicts that the price of BTC could skyrocket to $300,000 before the end of 2021.
There is also evidence that millennials prefer cryptocurrency to invest in the stock market. This sector will also inherit funds from their parents or guardians, and this valuation can translate to new liquidity in Bitcoin and the greater cryptocurrency market as a whole. According to a Forbes article, the millennial generation will inherit over $68T from the baby boomers by the year 2030. A significant pump into Bitcoin from this wealth transfer would continue to provide liquidity to the digital asset.
As the market-driven demand for BTC continues, we should expect to see higher ATH as well as higher lows when BTC falls against a resistance. If at present (for example) the low drops to a support of $17K, when it rebounds, the next support could be $20K, and so forth. When BTC reaches past $50K, the support levels also increase making the asset more valuable. From technical analysis, we see that at certain points, the support level also increases after each dip, and if this trend continues, then at every surge, there will be higher levels of support.
From the example graph, I plotted three support levels should the price value fall from the previous all-time high. From the data (Source: Coinmarketcap.com), the most likely support levels below the ATH is within the range of $15K — $20K. That is from a rational perspective, but the level can further drop if there were some event that causes a bearish sentiment. This is not really something we can predict, but based on the current situation, the bullish signals continue to pump the price value of BTC.
It would be nice to see the asset fall back down to a lower support level for buyers, but then it may not be as valuable if it continues to drop drastically. The more holders there are, the better BTC as a store of value. Until then, new levels of resistance will be tested, and those who believe or don’t believe the S2F model can still use that to check it against the value of BTC.
Disclaimer: This is not financial advice. The market is very unpredictable and requires due diligence before investing. Do your own research always to verify the information.
(First published in TheCapital.io 12/20/2020)