Stock-to-Flow: is Bitcoin’s price predictable?

The Bitcoin Stock-to-Flow model (S2F) is a method for calculating the scarcity of gold that can also be useful in predicting BTC price. Let’s go find out what it is and how it works, looking at the S2F’s past accuracy and its estimates for thefuture.

What is the Stock-to-Flow model and how does it work?

Financial market players have several tools at their disposal to try to anticipate price movements. In particular, there is a model that tries to predict the price of Bitcoin: the Stock-to-Flow (S2F or S/F), let’s see what it is and how it works. 

First of all, however, we must point out that, using the graphs of technical analysis and the macroeconomic factors of fundamental analysis, you can only make assumptions, never certain forecasts. Before making any transactions, you need to do your own research (DYOR) Also, do not forget to always take into account the risks involved in buying and owning cryptocurrencies.

The Stock-to-Flow model values the scarcity of goods, a quality that should influence their value, given the law of supply and demand: if demand exists and is constant, the price of an object theoretically increases the rarer it is. This relationship is evident in those goods that are difficult to produce, considering the costs as well as the time and energy involved. Think of gold and other rare metals, raw materials with a limited and almost constant supply over time, since in the short term it is not easy to increase the quantity extracted, net of technological innovation.

The Bitcoin Stock-to-Flow model, given this basis, calculates the ratio between the Stock, i.e. the total availability of an object, and the Flow, i.e. the new annual production. The number obtained corresponds to the years it would take to double the current supply, at the current rate of creation. In practice, how long it would take to reproduce the already existing quantity of a certain good.

Let’s quote some figures to better understand what the Bitcoin Stock-to-Flow model is: the World Gold Council‘s latest estimate (February 2023) suggests that a total of 208,874 tonnes of gold have been mined throughout history. Statista.com contributes by stating that 3100 tonnes were obtained in 2022, a number that usually varies between 2500 and 3300. The resulting S/F ratio, therefore, is about 67 years (208,874/3100): a measure of scarcity that, worked out in other formulae, can give an estimate of the future price.   

Can the Stock-to-Flow model predict BTC price?

Plan B, a famous Twitter user, then redefined what the Bitcoin Stock-to-Flow model is, applying his logic to Bitcoin in order to try and predict its price. In his article Modeling Bitcoin Value with Scarcity, he quotes Satoshi Nakamoto himself, who presents his cryptocurrency as the first scarce digital asset: 

“As a thought experiment, imagine there was a base metal as scarce as gold but with the following properties: boring grey in colour, not a good conductor of electricity, not particularly strong, […] not useful for any practical or ornamental purpose and one special, magical property: can be transported over a communications channel”

The scarcity of this ‘Internet metal’ is ensured by the mining mechanism, through which it is ‘mined‘ as if it were gold. In fact, Bitcoin is often called digital gold: new coins are minted as a reward for each block created by miners. Specifically, one is added to the Bitcoin blockchain every 10 minutes and this rate is maintained by an algorithm, which increases or decreases the difficulty of the calculations to be performed. This process has an ‘unforgeable costliness’: it is impossible to produce BTC without using a lot of energy or ignoring precise rules. 

First, the maximum availability of Bitcoin is set at 21 million units, distributed according to the Halving programme. In practice, every 4 years (210,000 blocks) this mechanism halves the reward for miners, so that the production of new BTC is reduced by half. Therefore, the annual Flow gradually decreases and, when compared to the existing Stock, can give us an estimate of scarcity and value. Let us therefore look more specifically at how the Stock-to-Flow model works in the case of digital gold.

Currently, 900 new Bitcoins come into circulation every day, a total of 328,500 per year; total availability, however, is around 19,400,000, so the S2F model shows a shortage of 59 points. This ratio, however, is set to double as a result of the next halving in 2024, which will raise the premium per block from 6.25 to 3.125 BTC, thus halving the annual Flow. Simply put, as more and more Bitcoins are in circulation, the annual production of new coins will be reduced to 164,250. At this ‘halving’ rate, it is estimated that the last BTC will be created in 2140, when it will reach maximum scarcity, given an almost infinite S/F ratio!

Plan B, therefore, collected data on the price of Bitcoin throughout history and noted a statistically significant correlation with the Stock-to-Flow model. Specifically, it compared the trend of BTC to its S/F ratio, raised to power and multiplied by a constant to obtain a curve. This exponential function was optimised over time, changing various coefficients, but showed some correspondence to Bitcoin’s value. 

Looking at the graph, the price increases seem to occur as a result of Halving, although it is a simple correlation and not a definite cause. In any case, these events have a direct effect on the S/F ratio and the Stock-to-Flow model, in fact, was able to follow Bitcoin’s price more or less correctly during the bull run of 2020/21, which led it to an all-time high of $69,000. However, from March 2022 onwards, the S2F model’s estimates lost consistency with Bitcoin’s actual trend, raising several doubts. 

Criticism of the Stock-to-Flow model: flaws and deviations

The price of Bitcoin observed a drastic drop in the bear market of 2022, which was not justified by the Stock-to-Flow model. In contrast, the version proposed by PlanB projected a value of $100,000 by the end of the year. Criticism was not long in coming and Vitalik Buterin even called the false sense of certainty given by the S2F ‘harmful’.

It is crucial to remember that when talking about the Bitcoin Stock-to-Flow, we have always called it a model, a hypothetical estimate, and it should be treated as such. In fact, S2F has some flaws: by nature, it only considers the weight of supply and ignores actual demand. In short, scarcity is not enough to stimulate the price, which does not increase if there is a lack of demand. Moreover, Bitcoin is an experimental technology, although it is more than 15 years old: its historicity is not comparable to that of gold, which has been established as a safe haven asset for hundreds of years. 

Finally, although Bitcoin scarcity is not regulated by price but by automated algorithms, these cannot counter unpredictable events (Black Swan) that can lead to high volatility. Examples of these are the collapse of the Terra-Luna ecosystem or the failure of the FTX exchange, cases impossible to anticipate, which had consequences for the price of Bitcoin. In short, the reality suggested by the Stock-to-Flow model is static and partial, because it is limited to ‘programmed’ factors, such as Halving and Bitcoin’s maximum availability, failing to consider macroeconomic aspects. 

The inconsistency of the model, however, did not surprise Plan B, which proposed two alternative scenarios: either BTC is extremely undervalued, or the Stock-to-Flow model, as it works, will be less useful for forecasting in the future. In any case, it does not consider its analysis to be a complete failure because, by considering two standard deviations from the S2F curve, it is possible to obtain fluctuation bands, which still seem to justify Bitcoin’s price.

To sum up, can the S2F model predict BTC price? Not with absolute certainty: all models have a margin of error, very large in the case of the Stock-to-Flow model. However, the S/F ratio gives us an opportunity to reason about Bitcoin’s fundamentals which, on a purely mathematical level, should counteract inflation, by planning for its scarcity in the long term.