Years after the creation of the first blockchain and the first cryptocurrency, the adoption began to hit the roof, and various experts, influencers, and market investors divert their attention to the market. This move called for the replication of marketing models that exist in the previous market as much as finding the models that are peculiar to the crypto market, such that they can tread the market safely through future market movement prediction.
This Stock-to-Flow (S2F) model is one such model, and it is popular within the crypto industry. The model is used often to predict the possible price of Bitcoin in the future. The objective of this guide is to go into the details of the S2F model starting from what it is to the creator of the model, the pros and cons of the model, and how you can apply it to different assets in the crypto space.
The navigation of this guide will be as thus: The Definition of the Stock-to-Flow (S2F) Model, Understanding the BTC Stock-to-Flow (S2F) model, how the model is applied to Bitcoin, the critics of the Stock-to-Flow (S2F) model, the major Limitations and problem with the model, and the current predictions of the Stock-to-Flow (S2F) model.
The Definition of the Stock-to-Flow (S2F) Model
Basically, the Stock-to-Flow (S2F) model is a system built to predict the possible price of an asset in the future by quantifying the scarcity of the asset. Looking back in history, the model was created originally for predicting the movement of precious metals like silver and gold in the market, but in recent times, there was an attempt to apply the principles of the model to the intricacies of Bitcoin (BTC) by a popular trader who goes by PlanB on Twitter. Since PlanB first applied the Stock-to-Flow (S2F) model on BTC, he got the credit for being the originator of the BTC’s S2F model.
Based on research, PlanB is known to be a former institutional trader from the Netherlands with experience over 20 years in the finance industry. In the next section, we will dive into the basics of the BTC’s Stock-to-Flow model.
Understanding the BTC Stock-to-Flow (S2F) model
In understanding how the Stock-to-Flow (S2F) model actually works on bitcoin, there will be need to first look into the idea behind value and scarcity beginning with fiat money.
When it has to do with fiat currency, there are local central banks just like the Federal Reserve of the United States who are controlling the distribution and issuance of the fiat currency in the country. The reason for printing money is all about replacing bills that are damaged and also ensuring that there is enough money in circulation (liquidity) in the country so that businesses and merchants can execute transactions.
But then, one of the things to pay attention to is that excessive printing of money over a long period of time can cause increased and sustained inflation because the value of the money will begin to drop and will generate a massive distortion in the way goods and services are priced. Currently, there are examples of countries going through this kind of situation around the world like Zimbabwe, Venezuela, and across other countries of the world.
Compared to fiat currency, Bitcoin, Silver, gold, and other assets alike are quite difficult to produce and thus cannot be faked easily, hence their supply is fixed.
PlanB, the supposed creator of the Bitcoin Stock-to-Flow (S2F) model, relies on a concept established by Nick Szabo, a computer scientist, in The Origins of Money: “Unforgeable Costliness.” However, it is referring to the difficulty attributed to the production of certain assets such as collectibles and precious metals.
In his proposition, PlanB included that it is easier to create consumable goods like soda drinks, computer disks, cartridges, and so on, to the extent that their production rate can be doubled. However, products like gold and bitcoin, for instance, are tied to the concept of unforgeable costliness simply because production is very difficult. Take BTC for instance, mining the asset requires an enormous amount of power for the processing, and it consumes electricity a lot. In the same vein, mining gold is expensive and quite hard, and when the mine’s reserve gets so low, one is left with no choice than to be processing and scooping remnants which are often low grade.
By design, Bitcoin was not made to be an inflationary asset as there will only be 21 million BTCs. However, the value of BTC for retail traders and investors is derived from the scarcity when compared to fiat money that can always be printed at will and in excess at the central banks. Also, while the performance of BTC as a means of exchange is not really good like that of paper money, investors has turned it to a store of value, just as it is with precious metals like silver and gold. For this reason, BTC became a medium for investors to shield their net-worth and wealth from the hyperinflation created by the fiat economy.
To understand this concept of the Bitcoin Stock-to-Flow (S2F) model much better, it is expedient that we consider the application of the model to BTC and every other asset alike.
The Application of the Stock-to-Flow (S2F) model to BTC – Bitcoin
Stock is referred to as the number of stockpiles or existing reserves, and flow means the yearly production rate of the asset. However, to calculate the Stock-to-Flow (S2F) model of Bitcoin, you will need to divide the total number of Bitcoin in existence (which is referred to as Stock, per the definition) by the annual production rate (which is called Flow).
Currently, the supply of BTC is approximately 19M (that is about 90% of the Bitcoins to ever be minted,) at an annual flow [of production] sitting at 328,000 BTCs, according to the current block reward size of the asset. Applying the formula of the Stock-to-Flow (S2F) model, the S2F ratio is 57.712. By implication, it will take about 57 years for the entire BTC supply to be mined, with no regard for halvings and the possible total maximum supply in circulation.
Contrastingly, the S2F ratio of gold is 62. Over the years, factors like technological advancements in various gold mining field have caused led to the ups and downs in the rate of production of gold.
The schedule of BTC is very systematic. On average, each block of BTC is created and mined every 10 minutes, and for every block mined, the miner gets BTC as his reward. One thing to note is that the reward is a new BTC being added to the supply.
However, to keep the scarce nature of the asset class, a halving is programmed to occur when the blockchain of BTC gets to a total of 210,000 mined blocks. Halving is the act of cutting the flow rate of new BTCs into the asset circulation by half, thereby increasing scarcity. Based on the programming of the BTC blockchain, the next halving is will be taking place in 2024, and by then, the Stock-to-Flow (S2F) of BTC would have increase to 124.
Critics of the Stock-to-Flow (S2F) model
While the Stock-to-Flow (S2F) model has the massive support of different finance experts, there are some people who are against it, and in fact, there are some people that have insisted against the model. Among the many detractors of the Stock-to-Flow (S2F) model is the co-founder of Ethereum, Vitalik Buterin. However, despite his disapproval, he has this to say about the model; “it is not enough to discredit the model with the fact that there is not coherent correlation about price spikes and halvings.”
There are others that have a sharper criticism, just like the Chief Investment Officer of Strix Leviathan Crypto Quant fund, Nico Cordeiro said the Stock-to-Flow (S2F) model is a “chameleon.” This term is first used by Paul Pleifderer, a professor at Standford, to explain models developed based on “dubious assumptions.”
Cordeiro speaking about the lack of substantial evidence to support the model, said “The Stock-to-Flow (S2F) model is established on the assertion that the US Dollar market cap of a monetary good (like Gold and Silver) is gotten directly from the rate at which new assets are injected.”
The Limitations and Problems of the Stock-to-Flow (S2F) model
While the Stock-to-Flow model is adopted widely by some members of the crypto community and has been used in other financial markets, the methodology of the model is actually limited in forecasting the future price of assets. The first thing is that the S2F ratio does not put other essential factors like volatility and demand into consideration.
Another thing to put into consideration about the Stock-to-Flow (S2F) model is that the Bitcoin and other crypto market is currently susceptible to wide price swings in response to the regulatory shutdowns from the governments who are actively looking to halt the financial activities around cryptocurrencies leading to whales – wallet addresses with a huge amount of crypto assets, liquidating their open positions among many other few possibilities.
The Floor Model
There is another variant of the Stock-to-Flow (S2F) model which is named the “Floor Model,” and it is premised on different technical tools like the 200-day moving average. It was the model that PlanB used to predict the closing prices of BTC all through 2021, where he asserted the price in August as $47k and the price in September as $43K.
PlanB went ahead to predict the closing price of BTC in November to be about $100K, but it was proven incorrect as the closing price at the said month was far lower than $60K. Since the floor model has been used to predict the price of BTC, that miss in November is the first miss since using the model, and PlanB admitted, but he further shows his trust in the Stock-to-Flow (S2F) model, saying “it is still valid.”
The Current Predictions of the Stock-to-Flow (S2F) Model
PlanB, on the 14th of February, 2022, said that the Stock-to-Flow (S2F) model is currently pointing to an estimate of $100k for a Bitcoin in 2023. His prediction, however, unleased a way in the crypto community on Twitter.
Despite the recent failures of the model, investors believe that the next BTC halving which is scheduled for 2024 would increase the price of BTC theoretically due to the reduction in the entire supply of the asset. By implication, the S2F model is deemed to be current this time. However, this estimate doesn’t consider some other essential factors that could greatly influence the price of Bitcoin in the long run. An example of those factors is the demand for the asset.
PlanB reiterated his price target for BTC in 2021 to be $100k, and it is the same for the next two years. However, the price data of BTC has been under the model line on the chart since the last halving that happened in 2020. PlanB, however, said there will be a need for the model to be realigned to match the new data or that they will wait till the end of this ongoing halving cycle.
Ethereum and the Stock-to-Flow (S2F) Model: Why the Model Cannot Work with the Asset?
Since the S2F model from PlanB became famous and widely accepted in the crypto space, the next question is if the model is applied to the Ethereum (ETH). In attending to this question, one of the first things to note is that the Stock-to-Flow (S2F) model is not a predictive model but a projection based on historical data and trends.
However, the problem with the application of the Stock-to-Flow (S2F) model to Ethereum is the huge difference between Bitcoin and Ethereum, which is about the supply of the two assets. The supply of the BTC (meaning the number of Bitcoins created and injected into circulation) is almost predictable with minimal error or fallout.
On the other hand, predicting the total number of Ethereum in circulation is liable to huge errors. And this is based on two reasons. The first reason is that the monetary policy of Ethereum has been ever-changing all through history, and BTC has never been changed for any reason. As a matter of fact, the monetary policy of Bitcoin is not modifiable by anyone, at least in the next foreseeable future.
In simpler words, no one can predict the flow of production of new Ethereum in the future based on the current flow of production.
The second reason for the non-predictability of the time taken to produce new Ethereum is the London update which has made it almost impossible to predict the number of Ethereum burnt accurately. This means that you can only create a Stock-to-Flow (S2F) model for Ethereum based on the historical trends, but the data will not be scalable and projectable into the future because of the uncertainty attached to the supply of the asset in the future. However, it should be mentioned that the level of this uncertainty under discussion is very low, and it remains so.
Considering this, it is almost impossible to use the Stock-to-Flow (S2F) model to predict the future price movement of Ethereum even though the model has not worked accurately well for Bitcoin in recent months.
Back in February 2020, Vitalik Buterin, the co-founder of Ethereum, had called the Stock-to-Flow (S2F) model introduced by PlanB an un-honorable way to predict the price of BTC and just because it only works in retrospect.
In general, the model can be used to identify trends based on the past performance of Ethereum but cannot be used particularly to predict future performances.
The formula of the Stock-to-Flow (S2F) model and the Floor Model, its variant, has been under a long and serious debate since its adoption by some major members of the crypto community. Even though, some of the predictions given by PlanB using the Model have been extremely accurate all through 2021, there have been some of his predictions that have failed too.
It is evident through the guide that the crypto community has been divided on the reliability of the Stock-to-Flow (S2F) ratio as an accurate metric to predict the future price of cryptocurrencies especially when you are considering investing in the asset class. There are some that believe in the model only because it is calculated from the current flow of production of the assets and the current supply of the asset in circulation, and theoretically, the higher the S2F ratio of an asset, the higher the value of the asset.
Therefore, the usage of the Stock-to-Flow (S2F) formula on BTC just because in theory a scarcer supply would increase the value of the price is not the best thing to do as an investor. There are other considerations that should be taken into account, such as the demand of the asset, the hash rate of the asset, the response to harsh regulations, and so on.
Using the last paragraph, here is a disclaimer on this guide; the content of this guide is not financial advice but rather for educational purposes, hence, any financial action taken on account of the content of this guide is solely at the readers’ discretion.