Most digitally-native products and items aren’t valuable because they can be reproduced at little to no cost. In 2009, Satoshi Nakamoto solved this problem by devising the first decentralized network protocol that produced a scarce digital asset, Bitcoin.

Measuring this scarcity, as well as its potential value, has been the primary thrust behind the stock-to-flow (S2F) model. This framework, however, isn’t without its limits.

For money to be considered sound, it must be durable, portable, divisible, fungible, easily-verifiable, and widely-accepted as a medium of exchange. 

Sound money must retain its scarcity to remain valuable over long periods. In the past, sound money was born out of people’s need for protection against the princely practice of debasing money or coinage. 

To quote the famed Austrian economist Ludwig von Mises: 

“It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments.”

Since the dawn of time, humans — perhaps instinctively — have always opted for gold, silver, or other precious metals to serve them as sound money. These compounds are hard to find in nature and costly to forge and reproduce. It is for this reason that many governments adopted the gold standard.

By basing a state’s money on a scarce resource, one separated the monetary unit’s purchasing power from the policies of the world’s governments and the elite.

It meant that governments and central banks couldn’t print money out of thin air.

Bitcoins have value primarily because more people recognize Bitcoins as sound money. 

This recognition stems from Bitcoin’s inherent scarcity, and what Nick Szabo, an early proponent of digital cash and a cryptographer, calls “unforgeable costliness.”

Bitcoin, like gold, antiques, and fine alcohols, is valuable because it is very hard to create the work needed to produce it. It is costly and time-consuming to mine gold, and a finely-aged wine is far more expensive than freshly-pressed grape juice. There are other factors to consider, of course, but there is no replacing the value of time itself

Bitcoin’s market value also hinges on features of supply and demand.

Bitcoin’s total supply is capped at 21 million coins, and its real supply is much lower. Moreover, Bitcoin’s deflationary monetary policy is hardcoded into its protocol. New BTC are issued every ten minutes at a predictable, decreasing rate. 

Critically, these components cannot be changed unless users decide to fork the protocol and create a new cryptocurrency. At the time of press, the price of a Bitcoin fork has never overtaken the price of the original Bitcoin. 

From this, one can begin to see the relationship between Bitcoin’s supply-side mechanics and its market price. The independent researcher and investor PlanB took this a step further when creating the stock-to-flow model. 

They begin their thesis with a question that many have asked:

“Surely, this [Bitcoins’] digital scarcity has value. But how much?”

The stock-to-flow hypothesis states that the scarcity of Bitcoins — as measured by SF, where SF = stock/flow — directly drives the market value of Bitcoins. 

Stock is the total size of the existing stockpiles or reserves of the asset, while flow signifies the yearly production. Consider the following illustration. 

There are currently 185,000 metric tons of gold in the world. That’s the stock. 

The annual supply of gold or how much gold is mined every year in the world equals 3,000 metric tons. That’s the flow. 

In other words, the annual supply growth of gold equals 1.6%. 

To get the SF ratio of gold, one would divide the stock with the flow and arrive at an SF ratio of 62. 

An SF of 62 means that, at the current rate of production, it would take roughly 62 years (185,000 / 3,000 = 61.6) to replenish the existing stock of gold in the world.

In comparison, Bitcoin’s current stock is 16.8 million (for more on how this figure was determined, please read this article), while the supply of new Bitcoins, or the flow, is 0.7 million a year. 

This puts bitcoin’s SF ratio at 24. 

Given that the flow of Bitcoins is fixed, and it halves every 210,000 blocks or roughly every four years, with the next halving event, Bitcoin’s current SF of 24 will double to 48. This will bring Bitcoin’s value proposition closer in line with that of gold.

Bitcoin’s halving event is predicted to occur on May 12, 2020.

According to PlanB’s stock-to-flow model, there is a statistically significant relationship between Bitcoin’s SF and the market price of bitcoins.

To quote PlanB directly:

“The likelihood that the relationship between stock-to-flow and market value is caused by chance is close to zero.”

PlanB’s stock-to-flow model predicts a stunning Bitcoin market capitalization of $1 trillion in the one to two years following the next halving event in May. 

A market cap of $1 trillion would put the price of one bitcoin at $55,000. With such a generous price tag on the world’s most unpredictable digital asset, PlanB’s analysis has been criticized often. 

The latest criticism comes from Eric Wall, the CIO of Arcane Assets. 

Wall claims that the S2F model is flawed insofar as it relies too heavily on supply and demand narratives as well as ever-changing statistical models. Instead, he proposes an alternative called the Rainbow Chart.

2/15 Origin story:

The Rainbow chart was invented by the well-known Redditor /u/azop who posted these charts for years for no personal gain on /r/BitcoinMarkets.@100trillionUSD (S2F) is a pretty cool guy, but Azop is a real OG (posting these graphs since 2014). pic.twitter.com/E8RWPG3a7q

— Eric Wall 🌈 (@ercwl) April 15, 2020

The post What Is Bitcoin’s Stock-to-Flow? appeared first on Crypto Briefing.

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