Bitcoin Halving, An In-depth Analysis
With the Bitcoin halving set to happen on 12 May 2020, Tokenize Xchange is here to analyse and break down this milestone event for you to gain more knowledge and further insights so that you can make a more informed investment decision.
On the previous article — Bitcoin Halving, Explained, we briefly explained what a halving is, touched on how the halving could possibly influence Bitcoin’s price action while also discussing the future of Bitcoin when the block rewards gradually taper down. In this article, we would take a deeper dive by comparing Bitcoin with Gold and analyse the Stock to Flow (S2F) model which could possibly predict Bitcoin’s price action in this halving.
Past History and What it tells us
Before proceeding, here is a chart to show the breakdown on price action on the last two halvings. Although we only have slightly over 10 years of history with 2 halving events, both events played out similarly where a new all-time-high (ATH) would be set after each halving event and a stark correction of close to 90% would usually follow suit.
Comparing Bitcoin to Gold
Bitcoin has been dubbed by many as “Digital Gold” or “Gold 2.0” but let us take compare Bitcoin and Gold to look at the similarities and features they possess. Traditionally, gold is seen as a safe-haven which investors use to hedge against volatility in the markets.
There are several factors that make gold a strong safe-haven asset. It is valuable and scarce, while there is a strong demand and use case as consumer goods such as jewellery or electronics or just as an investment. The supply remains disproportionately low as gold cannot be manufactured like how a company issues new shares, or like how a federal bank prints money, instead it must be mined from the ground and processed.
In addition to its scarcity, gold has little to no correlation to the stock markets and most other investment vehicles which makes it an attractive hedge for investors who wishes to ride out a correction in the stock market. Gold usually performs well in times of high volatility as investors would supposedly flee risk-on assets and flock to gold which pushes up the prices accordingly.
Gold is proven safe-haven, but a newer alternative asset is challenging the old-school safe-haven. Leveraging on cutting edge blockchain technology, Bitcoin has started a digital revolution and transformed the financial landscape with a new era of digital currencies.
Let us compare Bitcoin with its gold counterpart as investment options and as a safe-haven asset.
1. Market Capitalisation
The market cap of Gold sits close to USD$9 trillion (Coindesk, 2020), while Bitcoin’s market cap is just shy of the USD$200 billion mark (CMC, 2020). To put it into better perspective, we can take a look at the market cap of Dow Jones (DJI) which has a market cap of approximately 7.5 trillion (Business Insider, 2020). We can observe that the Bitcoin market cap is a measly 2% of the entire gold’s market cap and is also far off the valuations of that in the traditional markets.
2. Scarcity
Both Gold and Bitcoin are considered to be scarce and finite resources and can only be produced through mining. The intrinsic value of Bitcoin comes from the scarcity and the required computing power for mining. Bitcoin also has another feature which makes it scarce which is its decreasing rate of supply which results in a decrease in yearly supply. Having only 21 million Bitcoins being able to be ever mined into existence couple with the block reward being halved every 4 years, the economic theory of scarcity principle (a limited supply coupled with high demand for a good would lead to higher prices) points towards Bitcoin still having plenty of room for growth.
On a side note, the intrinsic values of precious metals such as gold are sometimes measured using the Stock to Flow (S2F) model which is the ratio of total supply (stock) compared to the annual production (flow). Bitcoin can also be modelled using the S2F model which we would further discussed later on in the article.
3. Transparency, Security and Regulations
Gold being an established asset has a pristine system in place for trading, measurement, custodial services and tracking making it hard to steal or pass off as fake gold. Globally, there are numerous regulations which govern the derivatives, trading etc. of gold. As compared to Bitcoin, the blockchain technology is the security behind Bitcoin as it provides an encrypted and decentralised system. However, the infrastructure may not be mature enough as seen from several hacking of exchanges notably Mt Gox, and there are little recourse for owners of those stolen Bitcoins at that time because of the lack of regulations.
4. Volatility
Bitcoin has definitely seen a much higher volatility as compared to gold over the past decade, making gold a safer option for those who are risk adverse. However in the most recent sell-off due to the covid 19 situation, both assets were not spared in the bloodbath. Since then, the good news is that Bitcoin has recovered most of the losses from March.
Stock to Flow (S2F) Model
Stock to Flow is a model to quantify the scarcity of a certain asset. It is simply calculated by taking the Stock (Total Supply of the asset) divided by the Flow (Annual production of the asset).
SF = Stock/ Flow
Note that SF = 1/ supply growth rate
Gold currently has the highest SF at 62 and sliver at a SF of 22. In other words, it would take a total of 62 years and 22 years of production in order to get to the current supply of gold and silver respectively.
The current SF value of Bitcoin is 25 which would become 50 after the halving in May 2020. The annualised inflation rate for Bitcoin after the halving in 2020 would be lower than the global inflation rate, decreasing from ~3.7% to ~1.8. For comparison purposes, the inflation rate of gold and silver at 1.6% and 4.5% respectively.
PlanB, an analyst who first purported using the S2F model by doing linear regressions between the SF and the market value of Bitcoin and proved that there was a statically significant relationship between them with an R-Square of 95%. An interesting fact to take note was that even though gold and silver which are completely different markets are in line with the Bitcoin model values for SF which gives extra confidence to the model.
2020 Bitcoin Halving: What to expect
After much discussion and analysis on the fundamental value of Bitcoin, the million-dollar question is still “What is going to happen this time round?”. If we were to look at the history of what has happen, we can be sure that the price of Bitcoin would reach an ATH after halving but it would not come immedicably. As for the price of one Bitcoin in the next market cycle, Bitcoin has continue to and never failed to surprise the us, so here is a chart showing the S2F model of Bitcoin for you decide yourself.
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Sources:
https://markets.businessinsider.com/index/market-capitalization/dow_jones
