A Beginners Guide to the Bitcoin Stock-to-Flow Model
The volatility of the bitcoin makes it difficult to predict where it will be in even the coming days. Investors and people trying to start Bitcoin investments are constantly daunted by the right time to invest and if they'll get anything out of what they have invested.
The Stock-to-Flow model is one of the more reliable methods used in predicting Bitcoin trends. Of course, the model has drawbacks, and it is not accurate each time. But it helps investors make an informed decision regardless.
The Stock-to-Flow Model and the Bitcoin
Initially used to predict the value of gold and silver, the Stock-to-Flow model is generally based on predicting the asset's value depending on its scarcity.
A Stock-to-Flow Model compares an asset's stock globally to its flow. The stock of an asset is the quantity of that asset we have had over the years. The flow of an asset is how much we mine in a year. For example, in the case of gold, we have mined a total of 177,000 tons of the precious metal, ever. This is the stock of gold we have. In 2013, we mined somewhere around 3000 tons. This is the flow we had in 2013. This makes the Stock-to-Flow ratio come to 59, which means it will take us 59 years to double the gold stock we have currently at the same rate as 2013.
Bitcoin is an entirely different asset from gold; however, we still use the Stock-to-Flow Model to evaluate its trends.
Bitcoin, as we know, is a scarce asset since its total supply has been capped at 21 million coins. It also undergoes the process of halving every four years or so, which helps in keeping the scarcity intact. This is why the Stock-to-Flow model works well with Bitcoin trends too.
How Useful is it in Predicting Bitcoin Trends?
According to American cryptographer Nick Szabo, the scarcity of an asset creates costliness and gives that asset an intrinsic value.
Bitcoin has been formulated so that its flow would only decrease over the years, as in the quantity of Bitcoin would just decrease. This will be done by a process known as halving.
To ensure that the quantity of new coins decreases over time, a block reward is obtained by the miner of the coin. This reward calculates the hash that can validate a block of transactions.
After 210,000 blocks have been validated, this reward is halved. The following halving process will occur in 2024; the previous was in 2020. The halving ensures that the supply of Bitcoin remains scarce. These halving events help make the trends of Bitcoin more predictable using the Stock-to-Flow Model.
Since Bitcoin cannot be consumed, and its scarcity is an intrinsic part of the technology used to formulate the Bitcoin, the Stock-to-Flow model actually works more accurately for Bitcoin than gold and silver.
Over the past few years, the Stock-to-Flow model has helped predict Bitcoin trends without much deviation. This shows that the model does have a significant practical use for Bitcoin.
A higher Stock-to-Flow ratio shows that the asset is scarce and has a high value. A low ratio will show that the asset is being mainly produced and is lowering in value. While the product's value will be low, it will significantly contribute to inflation.
Keep in mind that there is a very minute chance for the Stock-to-Flow ratio of Bitcoin being low. This is because the stock increases every year while the flow decreases every year.
Since Bitcoin is also Open source, anyone with some understanding of coding languages can figure out how much Bitcoin is currently in circulation, its current value, and how much is being mined each year.
The Stock-to-Flow Model is more relative in predicting Bitcoin trends than gold and silver. This is because Bitcoin cannot be used as absolute currency in the real world.
The bottom line is that the intrinsic nature of Bitcoin makes the Stock-to-Flow model a helpful tool for predicting its trends each year.
What is the Stock-to-Flow Ratio of Bitcoin?
Currently, the supply of Bitcoin is somewhere around 18 million Bitcoins. The flow recently has been no more than 0.33 million coins each year. This makes Bitcoin's current Stock-to-Flow Ratio to be about 57.
The next halving event in 2024 will increase the Stock-to-Flow to approximately 120, which is significantly higher than the current ratio.
Drawbacks of the Stock-to-Flow Model:
Like most other charts and models, the Stock-to-Flow Model has a certain number of drawbacks that prevent it from being the ultimate tool for Bitcoin forecasting.
The most glaring issue with this model is that it only considers the Bitcoins supply in the market and has no mention of the demand for cryptocurrency over the years. So if cryptocurrency's demand is ever low, its price will fall, and the Stock-to-Flow Model will be unable to comprehend that trend. This is currently not an issue because the demand for cryptocurrency is only rising.
Other than that, Bitcoin is still a very volatile asset. It is less volatile now than it used to be a few years ago, but the Stock-to-Flow model fails to take this volatility into account.
Another time the Stock-to-Flow Model will not be applicable is a Black Swan Event. A Black Swan Event is any unpredictable event that can significantly impact an asset's value. So if any such event occurs and there is a dramatic change in the value of Bitcoin, the Stock-to-Flow Model will be unable to help.
The Stock-to-Flow Model is a useful tool in predicting Bitcoin trends, especially in the current cryptocurrency climate. As the currency stabilizes further, it is highly likely that this model will continue to be used by investors. The model is also beneficial for new investors and people just starting out with Bitcoin since it makes it easy to understand.
If you have been considering using this model to forecast Bitcoin, we say you go for it!