Bitcoin Stock to Flow Model Explained

Definition: The Stock-to-Flow (S2F) model is a valuation model used to assess the price of assets based on their scarcity. Imagine a resource like gold or, in this case, Bitcoin. The model looks at how much of that resource already exists (the 'stock') versus how much is being newly produced each year (the 'flow'). The scarcer an asset is (high stock, low flow), the more valuable it tends to be.

Key Takeaway: The Stock-to-Flow model suggests that Bitcoin's price is driven by its increasing scarcity, as its supply growth rate is programmatically reduced over time.

Mechanics: How the Stock-to-Flow Model Works

The S2F model is built upon the idea that scarcity influences an asset's value. It quantifies this scarcity using the Stock-to-Flow ratio. Let's break down the components:

Stock: This represents the total existing supply of an asset. For Bitcoin, this is the number of Bitcoin currently in circulation.

Flow: This is the rate at which new units of the asset are created. In Bitcoin's case, this is the amount of new Bitcoin mined (or 'minted') over a given period, typically one year. This is also known as Bitcoin’s inflation rate.

Stock-to-Flow Ratio: This is calculated by dividing the stock by the flow. A higher ratio indicates greater scarcity. A higher ratio typically corresponds to a higher price.

Calculating the S2F Ratio for Bitcoin:

Determine the Stock: Find the total number of Bitcoin in circulation. This number changes constantly but is easily tracked on blockchain explorers. As of late 2023, the total supply is approximately 19.5 million Bitcoin.
Determine the Flow: Calculate the annual new supply. This is determined by the block reward, which is the amount of Bitcoin awarded to miners for each new block they successfully mine. It’s also affected by the halving events, which occur approximately every four years, reducing the block reward by half. For instance, after the halving in 2024, the block reward will be 3.125 Bitcoin per block.
Calculate the Ratio: Divide the stock by the flow. For example, if the total Bitcoin is 19.5 million and the annual flow (newly mined Bitcoin) is 328,500 Bitcoin, the S2F ratio is approximately 59.36. This number changes over time due to the halving events.

The S2FX Model

The S2FX (Stock-to-Flow Cross Asset) model, developed by the pseudonymous analyst PlanB, expands on the original S2F model. S2FX incorporates additional factors, such as the market capitalization of Bitcoin, to provide a more comprehensive valuation framework. The S2FX model suggests that Bitcoin's value will increase over time as scarcity increases.

Trading Relevance: Using S2F to Inform Trading Decisions

The S2F model can be used as a tool to inform long-term investment strategies. It provides a framework for understanding Bitcoin's potential value based on its scarcity. Here's how traders might use it:

Identifying Potential Undervaluation: If Bitcoin's price is significantly below the price predicted by the S2F model, it might be seen as undervalued. This could present a buying opportunity for long-term investors.
Understanding Market Cycles: The S2F model helps to visualize the impact of Bitcoin's halving events. These events reduce the flow (new supply) and, according to the model, should lead to price increases. This understanding can help traders anticipate market cycles.
Setting Price Targets: The model provides potential price targets based on the S2F ratio. This can help traders set realistic expectations and manage their risk.

It is crucial to remember that the S2F model is just one tool and should not be used in isolation. Always combine it with other forms of technical and fundamental analysis.

Risks and Limitations

While the S2F model has gained popularity, it's essential to understand its limitations:

Correlation vs. Causation: The model shows a strong correlation between the S2F ratio and Bitcoin's price, but correlation does not equal causation. Other factors, such as market sentiment, regulatory changes, and broader economic conditions, also influence the price.
Simplification: The model simplifies a complex reality. It focuses primarily on scarcity and doesn't account for other factors that influence demand, such as adoption rate, technological developments, and competition from other cryptocurrencies.
Data Accuracy: The accuracy of the model depends on the accuracy of the data used for the stock and flow calculations. While the supply of Bitcoin is transparent, there can be some variance in data reporting.
Future Predictions: The model is based on historical data and may not accurately predict future price movements. Past performance is not indicative of future results.
Model Breakdown: In 2022, the model broke down and was not accurate. PlanB explained it was due to the unexpected macroeconomic environment. This highlights the risk of relying solely on the model.

History and Examples

The S2F model gained prominence in the cryptocurrency community, particularly after it was popularized by PlanB in 2019. PlanB applied the S2F model to Bitcoin and later developed the S2FX model. The model's predictions appeared to align with Bitcoin's price movements for a time, especially around the halving events.

Bitcoin's Halving Events: The halving events, which reduce the block reward (the flow), are central to the S2F model. Before the halving in 2012, Bitcoin's S2F ratio was lower, and the price was also lower. After the halving, the S2F ratio increased, and the price rose significantly. This pattern repeated in 2016 and 2020. The 2024 halving will be another important test of the model.
Gold as an Example: The S2F model isn't unique to Bitcoin. It's often applied to commodities like gold, which has a very high S2F ratio due to its large existing stock and relatively low annual production (flow). This high ratio is often cited as a reason for gold's long-term value.

In conclusion, the Bitcoin Stock-to-Flow model is a valuable tool for understanding Bitcoin's potential value based on its scarcity. However, it's essential to use it in conjunction with other forms of analysis and be aware of its limitations. As Bitcoin's supply continues to be reduced through the halving events, the S2F model can provide a framework for anticipating potential price movements, but it's not a guarantee.

Bitcoin Stock to Flow Model Explained