Does the Stock to Flow Model Apply to Bitcoin?
The Stock to Flow (SF or S2F) model measures a resource's abundance and is applied mainly to natural resources. Bitcoin shares similar characteristics with precious metals, such as scarcity and predictable supply issuance, making the SF model applicable to it. According to the model, as Bitcoin's SF ratio decreases over time due to its limited supply, its price should see a significant increase. However, the model has limitations and may not consider all aspects of Bitcoin valuation, especially unexpected events that can undermine any pricing model.
Basics
The Stock to Flow model is a measure of a resource's abundance. This model is applied mainly to natural resources, like gold, where the Stock to Flow ratio is the amount of a resource held in reserves divided by the amount produced annually. To understand this better, let's consider the example of gold. The World Gold Council estimates that about 190,000 tons of gold have been mined, which we can refer to as the total supply or stock. At the same time, about 2,500-3,200 tons of gold are mined each year, which is the flow. By calculating the Stock to Flow ratio using these two metrics, we can determine how much supply enters the market each year relative to the total supply.
A higher Stock to Flow ratio means that less new supply enters the market relative to the total supply. This implies that an asset with a higher Stock to Flow ratio should retain its value well over the long term. Conversely, consumable goods and industrial commodities tend to have a low Stock to Flow ratio because their value comes from being destroyed or consumed, and inventories are usually only there to cover demand. Such resources do not have high value as possessions, making them unsuitable as investment assets.
Scarcity alone does not necessarily indicate that a resource is valuable. For example, gold is not all that rare, with about 190,000 tons available. However, the Stock to Flow ratio suggests that gold is valuable because annual production compared to the existing stock is relatively small and constant.
Stock to Flow Ratio of Gold
Gold has had the highest Stock to Flow ratio among precious metals throughout history. Using the previous example, we can calculate that the Stock to Flow ratio for gold is about 59 by dividing the total supply of 190,000 tons by the annual production of 3,200 tons. This means it would take roughly 59 years to mine all of the gold at the current production rate. However, it's important to note that the annual production rate is only an estimate, and if we increase it to 3,500 tons, the Stock to Flow ratio decreases to around 54.
To understand the total value of all gold that's been mined, we can use a price of about $1500 per troy ounce of gold. This calculation results in a total value of around $9 trillion, which is comparable to the market capitalization of cryptocurrencies. It's interesting to note that if we were to combine all the gold into one cube, it would fit into a single football stadium. For comparison, the highest total value of the Bitcoin network was around $1 trillion in late 2021, and at present, it's hovering around $500 billion.
Stock to Flow Ratio of Bitcoin
Similar to gold or silver, Bitcoin is considered a scarce resource, and thus, the Stock to Flow model can be applied to it. These metals are known as a store of value resources as they should retain their value over the long term due to their relative scarcity and low flow. Bitcoin shares similar characteristics as it is scarce, costly to produce, and has a maximum supply of 21 million coins. Additionally, Bitcoin's supply issuance is predictable as it is defined on the protocol level, and the amount of new supply entering the system is halved every 210,000 blocks through the Bitcoin halvings, which occur every roughly four years.
Experts like PlanB believe that it makes sense to treat Bitcoin as a scarce digital resource with compelling characteristics that make it valuable over the long term. According to the model, there is a statistically significant relationship between Stock to Flow and market value, and as Bitcoin's Stock to Flow ratio decreases over time due to its limited supply, its price should see a significant increase. PlanB is often credited with applying the Stock to Flow model to Bitcoin in his article "Modeling Bitcoin's Value with Scarcity.”
Stock to Flow Model’s Limitations
While the Stock to Flow model is a useful metric for evaluating scarcity, it does not provide a complete measure. It only works under the assumption that scarcity drives value. If Bitcoin lacks other useful qualities besides supply scarcity, the model may not be effective. Gold, for example, has global liquidity and predictable flow in addition to scarcity, making it a reliable store of value.
The model suggests that Bitcoin's volatility will decrease over time, but the cryptocurrency is still subject to significant price swings due to its self-regulating free market and low liquidity. Additionally, unexpected events like Black Swan events can undermine any pricing model. Despite these limitations, the Stock to Flow model remains a valuable tool for assessing scarcity and predicting future value.
Conclusion
The Stock to Flow model is typically used to measure the relationship between the available stock of a resource and its production rate. Although it's mainly applied to precious metals and other commodities, it may also apply to Bitcoin. This model suggests that Bitcoin is a scarce digital resource that retains its value over the long term due to its unique properties.
However, like any model, it has limitations and may not consider all aspects of Bitcoin valuation. Moreover, Bitcoin has only been around for a little over a decade, which some argue is not a sufficient timeframe for long-term valuation models like the Stock to Flow to provide reliable accuracy.