Is the Bitcoin Stock-to-Flow Model Flawed?

Is the Bitcoin Stock-to-Flow Model Flawed?

Note: This blog is written by an external blogger. The views and opinions expressed within this post belong solely to the author.

Technical analysis has always been critical in determining the general sentiment of the Cryptocurrency market. This is because most traders in the cryptocurrency market rely on chart analysis to identify the next trajectory of a digital asset’s price. The stock-to-flow model is one such frequently used chart for predicting bitcoin’s movement.

Generally, the stock-to-flow model is used with natural resources such as gold or silver. Because of their scarcity and low flow, commodities are sometimes referred to as “store of value” resources, which should, in principle, preserve their worth over time. Due to the fact that bitcoin’s total supply is limited and hardcoded into its programming, it appeared to be an excellent choice for using the Stock-to-flow (SF) concept.

The SF model, promoted by a pseudonymous Dutch institutional investor going by the Twitter handle “PlanB,” has garnered widespread appreciation and has emerged as the premier valuation model for bitcoin proponents. Bitcoin had fit right into this model until now.

Why did traders use the SF model first place?

PlanB’s article “Modeling Bitcoin Value with Scarcity” describes precious metals with unchangeable costliness and limited rates of supply as maintaining monetary roles throughout history. Gold, for example, is valuable because fresh supply (mined gold) is small in comparison to the present supply, and it is impossible to replicate the huge stockpiles of gold across the world. PlanB then claims that the same reasoning applies to bitcoin, which gains value when fresh supply is decreased every four years, eventually resulting in a supply of 21 million bitcoin.

He then graphs the SF of bitcoin versus the USD market capitalization and two randomly picked SF data points for gold and silver. Following a linear regression with the natural logarithm of bitcoin’s SF metric as the independent variable and USD market capitalization as the dependent variable, the study concludes that there is a statistically significant link between USD market capitalization and SF values, as demonstrated by linear regression with an R2 (a statistical measure of how well data fits a regression line) of 0.95. The two randomly selected data points for gold and silver are consistent with bitcoin’s trajectory and are provided as additional support for the hypothesis.

Source: PlanB Original Paper

The method mentioned above, according to PlanB, may be used by investors to estimate the future USD market capitalization of bitcoin. Also, the model lends validity to the $100,000 bitcoin forecasts.

As a result, SF has gone viral and generated rags-to-riches fantasies for people betting everything on the future of bitcoin. However, I anticipate that the model’s accuracy will be roughly as good at forecasting bitcoin’s future price as other models were at predicting financial events.

Even Fidelity Digital Assets examined the S2F valuation model in August 2020, indicating that the stock-to-flow approach had some validity. 

However, no model is 100% accurate because of the various unpredictable events that could occur spontaneously. For example, the Covid 19 outbreak was a massive hit for the crypto market as prices crashed over a span of days.

What went wrong?

As Bitcoin hovers around the $30,000 mark, the price is currently the furthest away from what the chart predicts. If we consider the model, the price should be over $80,000, which is quite a lot compared to current prices. 

Early this year, PlanB predicted that Bitcoin might even surpass $450,000 by the end of this year and $135,000 in the “worst-case scenario.” Furthermore, the model forecasts that Bitcoin will reach the much-anticipated $1 million mark by July 2025.

Bitcoin SF model performance correlation chart as of press time.   

Source: buybitcoinworldwide

Several industry experts have criticized the SF approach. Johnny Lyu, CEO of KuCoin Global, recently said:

“The model creator tried to predict the continuously surging Bitcoin price based on its scarce nature similar to gold in that it also has a high stock-to-flow ratio. Therefore, the hypothesis is: As Bitcoin’s stock-to-flow rises, so will its price.”

He went on to add that models like this are often established based on historical data and that although some periodic trends may assist in determining the overall direction of the market, specific trends can sometimes be hard to track in advance.

Industry expert, Lennix Lai, elaborated on why this model is failing, stating:

“Despite its limited predictions, the S2F model only had limited power over Bitcoin price prediction because it assumes the production of Bitcoin will be limited. While its simplicity makes the concept easier to understand, PlanB debuted the Bitcoin S2F model back in 2019. Demand back in the time is a different story to now, in which demand has a direct influence on its intrinsic value.”

Over the past year, a lot has changed for the Bitcoin and Crypto markets in general. For instance, the rate of institutional adoption has gone up drastically since 2019. The other major factor being the COVID-19 pandemic that has plagued the world for more than 19 months now.  Lai elaborated further:

“The pandemic has probably also accelerated adoption, as the USD supply has inflated massively over the last year. Investors are seeking alternative assets to place their money in as a hedge against inevitable inflation. We also see daily analyses from well-respected firms and institutions predicting that Bitcoin is undervalued; the Musk effect is an ambush to the market.”

In conjunction with other reasons like the mainstream appeal of nonfungible tokens (NFTs), the Musk effect has also played a significant influence in increasing awareness of cryptocurrencies and blockchain technology in general. Since the beginning of the year, Bitcoin’s dominance as the leading cryptocurrency has declined from more than 60% to 46.3%, indicating a strengthening altcoin sector.
Ultimately, it is safe to conclude that no analytical approach can be touted as perfectly accurate. Perhaps this is the core reason behind professional traders leveraging a combination of different technical approaches. Whether or not the SF model would actually be accurate about its end of the year target is yet to be seen. Plan B has himself stated that the next few months are going to be a “make or break” situation for the stock-to-flow model.

Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.
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