Why Bitcoin’s Value is Probably Going to Increase Very Soon
By on The Capital
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On May 12, 2020, the added supply of Bitcoin will halve. It happens once every four years. One important metric explains why the price is likely to go up in the coming months.
There’s no shortage of economic analyses to determine Bitcoin’s proper valuation.
As Bitcoin’s nascent economic implications have yet to materialize, investors must ask themselves important questions about money, value, and function. The most fundamental of these is, why do we invest in the first place? Most obviously, it’s so that the value increases over time. But for some, it might be to protect decreasing purchasing power due to inflation. Others might invest to clinch a specific utility. Asking these questions helps clarify why some might want to take money out of fiat money and put it into other assets.
What is the Stock-to-Flow Ratio?
While many champion Bitcoin’s scarcities as justification for its value, they often speak about it too broadly. The stock-to-flow ratio goes one step further. It is at once simple to understand and an extremely informative metric to justify the value of a particular good. The stock of a good is the existing supply, while the flow is the amount of the good that will be produced in the next given time period (usually one year). Dividing the stock by the flow gives you the stock-to-flow ratio.
Put simply, the stock-to-flow ratio is just the inverse rate of supply inflation each year.
The stock-to-flow ratio can provide insight into any commodity, good, or money. When looking at the value of money specifically, the ratio between stock and flow provides a trustworthy interpretation of money’s hardness — how difficult it is to meaningfully increase production of new units relative to the existing supply. Conversely, easy money is money that can have its total supply increased relatively easily. As such, a hard money would have a high stock-to-flow ratio while an easy money would have a low stock-to-flow ratio. The more annual production affects the total supply, the more flow impacts the stock, the easier the money.
Gold’s Stock-to-Flow Ratio
Gold, whose stock-to-flow ratio is quite high, is often considered the hardest form of money because the flow doesn’t impact the stock to a significant degree. By one estimate in 2017, gold’s global stock was around 190,000 tons. And because pure gold is mostly indestructible, that 190,000 tons account for almost all the gold that has ever been mined in human history. On average, global mining adds about 2500 tons to gold stocks each year. If we divide the stock of gold by its flow, we reach a figure of 76.
USD’s Stock-to-Flow Ratio
Comparatively, many consider fiat such as USD, easy money because it has a much lower stock-to-flow ratio than gold does. According to the Federal Reserve’s own figures, the United States added $600 billion to the total supply of USD in 2017. By the end of last year, the U.S. reported $13 trillion for its money supply. With these figures, we see that the stock-to-flow ratio of USD is about 21.6, indicating that USD is not nearly as hard as gold. And by taking the inverse of their stock-to-flow ratios, we see that gold’s supply inflation is 1.3 percent, while USD’s is about 4.6 percent.
From numbers alone, it’s clear that USD’s flow significantly affects its stock. But what truly shows USD’s lack of hardness is not just 2017 numbers but the nature of its supply increases. It’s not costly for the U.S. government to increase flow of USD. Theoretically, if a government wants to increase supplies of fiat money in a given year, the capital cost to do so would be trivial. With gold, however, producers would have to leverage significant amounts of capital to affect that change. Miners have to increase production by investing their own capital. Because capital is at stake, increasing the yearly supply is by nature more difficult and will always be more difficult. Some view Bitcoin’s energy expenditure and proof-of-work consensus in a similar light. With easy money like fiat currency, increasing the flow has no significant capital costs of production.
Hard Money, Easy Money, and The ‘Easy Money Trap’
Economist Saifedean Ammous has argued that if money is used as a store of value, it will have its supply increased. And if its supply is easy to increase, the value of that money as a store of value will erode. Ammous calls this the easy money trap. Even if increasing the monetary supply might have short-term benefits to an economy, the lack of capital barriers and temptation to increase the monetary supply will erode value, he argues. Conversely, if it’s difficult to increase supply of a store of value, the money’s value will be resistant to that erosion.
Global statistics corroborate Ammous’ claim. According to the World Bank, between 1960–2015, global broad money’s average annual growth rate for 167 countries grew over 30 percent per year per country. Comparatively, hard money like gold has never experienced a 30 percent increase to total supply in human history. When the only limiting factor in adding to the monetary supply is politics, governments will, in the long run, find a way to sidestep those limitations. As the monetary supply increases by such large figures year after year, the value per unit decreases accordingly — monetary devaluation.
While there are valid Keynesian supports for controlling the money supply — navigating business cycles, rebuilding after natural disasters, and war — history has proven that governments do not control government money responsibly. Applied John Hopkins economists Steve Hanke and Erik Bostrom reported in 2017 that there have been 58 instances of hyperinflation in history, 57 of them appearing after World War I, which not coincidentally is when governments decided to leave the gold standard en masse. The only other instance was France’s hyperinflation in 1790 when the French National Assembly agreed to issue paper currency called assignats. In just five years, the National Assembly printed 19.7 billion notes while the assignat lost almost 100 percent of its purchasing power. This data shows that hyperinflation is highly associated with fiat currencies.
When hyperinflation plagues a country, citizens liquidate their native currency in favor of commodities, gold, and international reserve currencies such as the dollar, euro, yen, and Swiss franc. They are fairly ubiquitous worldwide and have great stability relative to the devalued currencies.
“The reason for that becomes apparent when one examines the rates of growth of their supply, which have been relatively low overtime,” Ammous writes in his 2018 book, The Bitcoin Standard.
Hard money is sound money, while easy money is subject to debasement. Instances of hyperinflation suggest that money is rather unappealing as a store of value due to inflation of the money supply. Comparatively, history shows that gold holds value well over long time periods. Gold, however, lacks easy portability and divisibility, which some say are two major barriers to its being an efficient medium of exchange in today’s global economy.
Enter Bitcoin
Not beholden to any single entity, group of individuals, or government, Bitcoin cannot be debased. It cannot have its supply manipulated, and its code cannot be altered by any government’s action.
While most of this is not new to Bitcoin enthusiasts, looking at Bitcoin through its stock-to-flow ratio gives us enormous insight into why its value is not just justified, but also why its value will likely continue to rise significantly in the years to come.
Bitcoin’s Stock-to-Flow Ratio
As calculated earlier, the stock-to-flow ratio of gold is 76. Today in 2020, we can calculate Bitcoin’s ratio by taking the current supply (stock) and dividing it by the supply added in the past year (flow). According to figures from Blockchain.com, there were about 683,000 bitcoins added to a current circulating supply of 18,345,000 bitcoins. By calculating the stock-to-flow ratio of Bitcoin in April of 2020, we arrive at a figure of 26.8.
Even today, Bitcoin’s stock to flow ratio is a little higher than that of USD. And in its nine years of existence, Bitcoin has proven to be the better store of value, performing better every single year except 2014.
After the 2020 Halving
Through the interplay between hash power and difficulty adjustments, we can reliably extrapolate what the stock-to-flow ratio of Bitcoin will be for years to come.
After the 2020 Halving (which will happen on May 12th 2020), the yearly added supply (flow) of bitcoins will drop from 656,250 per year to 328,125 per year. Bitcoin’s controlled supply predicts there will be 18,375,000 in circulation at that time. As such, we can calculate the stock-to-flow ratio in 2020. We arrive at a stock to flow ratio of 56, higher than most commodities on the planet.
The Future
I’ll spare any additional calculations for future halvings, but in 2024, the stock-to-flow ratio will be 121, exceeding any ratio in human history.
The stock-to-flow ratio is what justifies a money as worthy of holding its value, of informing whether a money is easy money or hard money. When there exists a truly hard money, it becomes difficult to eradicate its value. Thousands of years of gold’s high stock-to-flow ratio have illustrated its hardness and ability to store value. No one knows for sure if Bitcoin will follow the same path, if the entire Bitcoin experiment will succeed. But in nine years of existence, Bitcoin has proven its resilience. It has held its value, and its stock-to-flow ratio has dramatically increased. When Bitcoin reduces its supply in May, expect a dramatic price increase in the months to come. When it surpasses gold’s stock-to-flow ratio, it will be a milestone in monetary history, and Bitcoin might be exponentially more valuable than it is today.
