Debunking Bitcoin’s Stock-to-Flow Model

Opening Remarks

Part of Alef Bit’s activity includes performing extensive market research to assist and support our Group’s investment activity and management of its own assets.

In this quarterly newsletter, we aim to expose our readers to some of the internal work. The goal is to provide useful and interesting information which might assist you, our readers, in your own research.

In this post, we demonstrate why we believe the stock-to-flow (S2F) model to evaluate Bitcoin’s value is false. We do this using several compelling logical arguments.
We then present our alternative for predicting Bitcoin’s future value, using the halving events and market cycles.

Stock-to-Flow

Readers of this newsletter are assumed to be familiar with Plan₿’s (@100trillionUSD) stock-to-flow model.
In case you are not, here is a link to the original medium article:
Modeling Bitcoin’s Value with Scarcity

In short, the model utilizes the S2F principle described in Dr. Saifedean Ammous’s most excellent book “The Bitcoin Standard”. The model finds a statistically significant relationship between S2F and market value for gold, silver and Bitcoin:

Why Bitcoin has Value: Scarcity

The model really took off after Plan₿ did a podcast episode with Stephan Livera (@stephanlivera).

Since then, the original article has been translated into 19 languages (and counting), receiving much praise from prominent members of the crypto community, and even appearing on CNBC.

In addition, following this success, several S2F indicators are now available, such as this one and this one.

BTC Price Prediction based on S2F

A very likely reason why S2F is so readily accepted in the crypto sphere is that it presents a very bullish case for Bitcoin.

According to the model, BTC’s price is predicted to be >$100K before Dec. 2021:

The following poll shows that the vast majority of crypto twitter believes this (we can only expect that they do so because they accept the S2F model reasoning, although there may be other reasons as well).

However, as we shall soon see, their reasoning is flawed…

Debunking S2F

While we AGREE that S2F is an applicable model to measure scarcity, we DO NOT AGREE that it is an applicable model to measure and estimate value.

In truth, there have been several articles challenging the model, such as Marcel Burger’s and Nick’s. However, these are very technical papers that go in-depth into the mathematical and statistical calculations and are subject to disputes.

In this post, we will falsify the S2F model using various logical arguments that refute the model and show that it is false.

1) Gold as a store of value

We make the following claims (without going into more details in this newsletter):

  • The world will not return to a gold standard (and even if it will, history will repeat itself and someone, sometime will remove it again)
  • The role of gold (let alone silver) as a store of value (SoV), especially with the younger generations, is fast diminishing.
  • In the upcoming years and decades, gold’s value will be derived from its industrial consumption, jewelry, and maybe as a hedge against global recessions (questionable).

Regarding jewelry, we are of the opinion that even people who purchase gold jewelry do not do so for SoV purposes, but rather for social status (except maybe still in certain parts of the world such as India for example).

Based on the constant bashing of Peter Schiff (@PeterSchiff) on crypto twitter, we believe our sentiments are widely shared.

This leads us to the conclusion that as the last vestiges of gold being used as currency (or as a reserve currency) fade, we will experience a large drop in gold’s price (as has happened with silver).

Therefore, a model that relies on the current price of gold will likely prove inaccurate in the near future.

2) What is the S2F of the S&P 500?

The S&P 500 has undoubtedly become a universal store of value.
So, what is the S2F of the S&P 500? No one knows, and probably no one really cares.
This proves that scarcity alone does not derive SoV properties, there are other factors which S2F does not take this into account.

Therefore, the model is incomplete.

3) What happens at the extremes?

This subject was previously brought up by Tuur Demeester (@TuurDemeester), in his following question:
“Bitcoin’s production is trending towards zero. Does that mean its value should trend to infinity?”

Plan₿’s answer is as follows:

This means that the model has no clearly defined boundary limits, which brings us to the next problem of initial conditions…

4) S2F of altcoins

The model does not assert that it is only applicable to one cryptocurrency: Bitcoin.

Just like gold and silver can be modeled, so does, in theory, any other asset that meets some set of initial conditions.

Plan₿ lays down a set of conditions bundled up in what he terms ‘unforgeable costliness’:

Dr. Saifedean Ammous seconds the decentralization condition (in his characteristic sharp tongue):

An asset would have to meet this set of hard-to-quantify conditions (how does one measure decentralization?) in order to be eligible for the S2F model.

Apparently Bitcoin ticks all the boxes, since even before 2011 (the first plot on the chart).

What happens if there will come a second crypto-asset which answers all of the requirements above (again – theoretically entirely possible), and has the same S2F value of Bitcoin or even higher?

What happens when there are 10? 1,000?

Will they divide the value between them based on their S2F? unlikely.

As many have claimed, currency is a winner-take-all game. The hardest money will win. Obviously, there are other no less important factors that influence the value, other than S2F (first-mover advantage, network effect, yada yada yada..).

Physical gold cannot be reproduced, not for lack of trying, through hundreds of years of alchemy. Digital gold, however, can be reproduced using “digital-alchemy” (forks or improvement of the protocol).

Therefore, a model which values physical elements by their scarcity, cannot be used to value “digital-elements” or crypto-assets.

Let’s look at Litecoin for example:

It seems as if the test is whether or not there is a good fit for S2F:

  • If the fit is good (Bitcoin), then the blurry, poorly defined initial conditions are met.
  • If not (Litecoin), then the initial conditions are not met.

Obviously this should be the other way around. The model cannot be used to determine whether an asset has the required initial conditions in order to be applicable to be used by the model.

5) Same S2F, different issuance schedule

This next and final argument is more of a thought experiment.

Imagine that in some parallel universe, Satoshi made the same Bitcoin, but with a different issuance schedule (while keeping the max cap of 21M and all coins mined after 210,000 blocks, or by ~2140), such as:

  • A fixed issuance of 10 BTC every 10 minutes per block reward.
  • Alternatively, a market flood of 90% of the Bitcoins in the first year, followed by a fixed issuance of the remaining coins up to 21M.

In both cases, at some point this parallel-universe-Bitcoin would get to the same S2F ratio as the real Bitcoin today. But, we would argue that such parallel-universe-Bitcoin would fail due to a lack of adoption.

In the first scenario, it would not create sufficient interest, since it will take it many years to reach an interesting scarcity level, and the project would probably die-out in its early years.

In the second, the issuance would concentrate almost all of the Bitcoins in mega-whales’ wallets, inhibiting the entrance of new players into the system (miners, investors, etc.)

Satoshi had what reveals as an extraordinary insight, to fix this using the halving.

The halving creates a sense of urgency, bordering on FOMO at times, to urge new players to join the game early. All this while still allowing for reasonable coins distribution as well as suitable market liquidity for price discovery.

Therefore we claim that the halving is what drives Bitcoin’s value, and we base our price analysis on this fundamental property of Bitcoin.

Alternative Price Prediction

Our price prediction is based on the halving events and market cycles, as thoroughly explained in our previous post:
Bitcoin Fundamental Analysis and Market Cycles

To summarize, we believe that a much more realistic tool to project into the future would be by measuring the progress of Bitcoin’s price using 3 checkpoints: bottom to bottom, halving to halving and high to high.

As can be seen in the excel below, it currently stands at 16X today. We can also assume with a high degree of certainty that it is going to go down over the next 2-3 decades towards its midterm place of 2X, until the last bitcoin will be mined.

progress-of-bitcoin-price

Summary

In this postwe assert why S2F, as a model to estimate Bitcoin’s value is, at best, incomplete and inaccurate. We do this using no less than 5 different arguments, each one enough to seriously doubt the model’s reliability.

As a consequence, we do not recommend relying on it for Bitcoin’s price analysis.

We then present an alternative method to predict Bitcoin’s future price using our Market Cycles Model.

On a closing note
This is not meant as a direct attack on Plan₿, or any of the other people mentioned in this post. We welcome individual, critical thinking in all things, especially Bitcoin.

If anyone can counter the arguments brought up in this article, in a constructive and logical manner, we will be more than happy to take note.


This communication is provided for informational purposes only and does not constitute, and should not be construed as, financial, legal, investment, tax or any other advice. Alef Bit Technologies Ltd. or its affiliates and/or subsidiaries (collectively, ”Alef Bit”) normally hold as principal bitcoin, Ethereum, blockchain tokens and other cryptocurrencies or asset classes that may be discussed in this communication.

This communication has been prepared based upon information, including market prices, data and other information, from sources believed to be reliable, but Alef Bit does not warrant its completeness or accuracy except with respect to any disclosures relative to Alef Bit and/or its affiliates. Any opinions and estimates constitute our opinion as of the date of this material and are subject to change without notice. Alef Bit may have relied upon certain quantitative and qualitative assumptions when preparing the analyses herein which may not be articulated as part of such analyses. The realization of the assumptions on which such analyses were based is subject to significant uncertainties, variabilities and contingencies and may change materially in response to small changes in the elements that comprise the assumptions, including the interaction of such elements. Furthermore, the assumptions on which the analyses were based may be necessarily arbitrary, may be made as of the date of the analyses, do not necessarily reflect historical experience with respect to blockchain tokens, cryptocurrencies or other asset classes similar to those that may be contained in the analyses, and do not constitute a precise prediction as to future events. Past performance is not indicative of future results.

Alef Bit does not assume responsibility for investment decisions. This communication is not intended as investment advice or an offer or solicitation for the purchase or sale of any blockchain token, cryptocurrency, security, financial instrument or other asset class. Alef Bit provides this newsletter for research and discussion purposes only and does not provide general or individually tailored investment advice of any kind. Any opinions and recommendations contained herein do not take into account individual readers’ circumstances, objectives, or needs and are not intended as recommendations of particular cryptocurrencies, other assets or strategies to particular persons. You must make your own independent decisions regarding any cryptocurrencies, blockchain tokens, asset classes, financial instruments or strategies mentioned or related to the information herein. Readers should consult with their own advisors before making any investment or other financial decision. You ultimately must rely upon your own examination and that of your professional advisors, including legal counsel, financial advisors and accountants as to the legal, economic, tax, regulatory, or accounting treatment, suitability, and other aspects of the analyses contained herein. Alef Bit shall not be liable for either (i) any errors or omissions made in the data or analyses contained herein or (ii) damages (incidental, consequential or otherwise) which may arise from your or any other party’s use of the data or analyses contained herein.

This communication may not be redistributed or retransmitted, in whole or in part, or in any form or manner, without the express written consent of Alef Bit. Any unauthorized use or disclosure is prohibited. Receipt and review of this information constitutes your agreement not to redistribute or retransmit the contents and information contained in this communication without first obtaining express permission from an authorized officer of Alef Bit..

Bitcoin Fundamental Analysis and Market Cycles

Opening Remarks

Part of Alef Bit’s activity includes performing extensive market research to assist and support our Group’s investment activity and management of its own assets.

In our quarterly newsletter, we wish to expose our readers to some of our internal work. Our aim is to hopefully provide useful and interesting information which might assist you, our readers, in your own research.

In our newsletter from Oct. 2018, we gave a brief overview of the 2018 bear market and explained why we expected further decline in prices. Our predictions were realized and Bitcoin’s price dropped from approx. $6,500, when the newsletter was released, to a yearly low of ~$3,150 at mid December 2018.

In our last newsletter from Dec. 2018, we put our reputation on the line and called the bottom in BTC price. Again, we were correct (until proven otherwise).

In both these previous newsletters, we used technical and sentiment analysis to evaluate the market.

In this issue, however, we wish to take a step back and look at some fundamental aspects of Bitcoin, in order to examine what clues these aspects can tell us regarding Bitcoin’s market cycles.

Bitcoin Fundamentals

Satoshi Nakamoto was the first to solve a long-standing computer science problem called the Byzantine Generals Problem. He did this by combining several fundamental features, thereby creating Bitcoin: a peer-to-peer electronic cash requiring no trusted third parties.

Some of these features are from the computer science field of expertise, including among others, the Blockchain and Proof of Work, while others are from the field of economic, such as max. capped amount, mining difficulty adjustment and the halving.

As it turned out, Satoshi was not only a brilliant computer scientist. He was also a shrewd economist.

Bitcoin not only solved the Byzantine Generals Problem, serving as Digital Cash, but it may also be the most “hard” or “sound” money in human history. As Dr. Saifedean Ammous put it in his most excellent book “The Bitcoin Standard” (a must read for anyone who wants to do a deep-dive into the origins of money and Bitcoin economics):

“Bitcoin is the hardest money ever invented: growth in its value cannot possibly increase its supply; it can only make the network more secure and immune to attack”

In this newsletter, we’ll attempt to show how these economic-related fundamental features, and specifically the halving, affect Bitcoin’s market cycles.

The Halving Event

So what exactly is the Bitcoin halving?

The halving is a well-known event which occurs every 210,000 blocks, or approximately every 4 years, in which the number of bitcoins generated per block is set to decrease by half.

When Bitcoin was created in 2009, the initial block reward was 50 Bitcoins. In November 2012, it dropped to 25 BTC after the first halving. The second halving took place on July 2016 and decreased the reward further to 12.5 BTC. The next halving is scheduled to occur on May 2020.

This means that by now most of the Bitcoins have already been generated: approx. 17.5M out of the total fixed supply of 21M, as can be seen in Figure 1.

You can read more on this subject here.

Figure 1: Bitcoin supply as a result of the halving

Figure 1: Bitcoin supply as a result of the halving

Of Beating Hearts and Warehouses

Here at Alef Bit Technologies, we believe that Bitcoin has an internal clock, or a beating heart, which is deeply connected to the halving.

In our research, we have found that every previous four-year period between halvings can be divided into 3 distinct phases of roughly similar durations (~16 months for each phase), as can be seen in Figures 2 – 4.

These 3 phases are:

1) Bull run: Following by the halving event and characterized by an exponential increase in Bitcoin’s price.

2) Bear market: Burst of the bubble and commencement of a bear market, with approx. 85% decrease in price from all time high (ATH).

3) Consolidation and Slow Recovery: Consolidation period with a price recovery of ~50% from previous ATH at the end of the phase.

Figure 2: First Bitcoin market cycle 15 days MA

Figure 2: First Bitcoin market cycle 15 days MA

Figure 3: Second Bitcoin market cycle 15 days MA

Figure 3: Second Bitcoin market cycle 15 days MA

Figure 4: Third Bitcoin market cycle 15 days MA

Figure 4: Third Bitcoin market cycle 15 days MA

But, how does the halving influence these market cycles?

For this theory, let us assume that due to the hash rate difficulty adjustment fundamental feature in the protocol, the cost of mining one Bitcoin (in terms of electricity costs) is approximately one Bitcoin. This means that if you manage to sell your mined Bitcoins at a higher price than the price at the time it was mined, you will increase your profit.

For example, a Bitcoin mined when the market price is $3,000 per BTC, will cost the miner approximately $3,000. If the miner manages to sell this same Bitcoin at a later date for, let’s say, $4,500, he will increase his marginal profit by $1,500.

Now, imagine that you are a bitcoin miner coming into the halving. You know that if the demand of Bitcoin remains stable, then due to the cut of new Bitcoins supply by half, the price will surely increase (in reality at the time of halving, the supply reduction will already be priced in the exchange rate, thanks to market anticipation). Therefore, you think to yourself: from now on, I will not sell all of my new Bitcoins gained from my block reward, but instead, I will hold back a small percentage (let’s say 10%) in my “warehouse”, to sell at a later date at higher profits.

This, together with the reduced supply of new Bitcoins due to the halving, will create a shortage in the market. Consequently, Bitcoin’s price will slowly start increasing as the demand exceeds the supply. As the price increases, you (the miner) will probably decide to hold back some more Bitcoins in your warehouse, another 10%. This will further drive the price up as more Bitcoins are retained by miners.

Ultimately this loop of miners holding back Bitcoins – causing price to increase – causing more Bitcoins to be stored in the miners’ warehouses, will bring about a massive bull run with price increasing exponentially, as happened in each of the previous cycles. As we can imagine, this bull run will be accompanied by mass news coverage, FOMO and the general hysteria of moons, lambos, etc.

The miners, seeing a huge wave of adoption and prices almost doubling every month, will eventually be tempted to sell. They already made huge profits and have electricity bills to pay after all. When miners cave and begin selling, long held Bitcoins in the warehouses will re-enter the market, causing prices to drop. The bubble will finally burst.

What will ensue after that is a price correction in the form of a long and painful bear market.

And thus, a new cycle will begin..

Price Analysis

Based on this model, the following conclusions can be drawn:

1) For the current cycle, we are now at the turning point between the bear market and consolidation phases, as can be seen in Figure 5 which shows cycles 2+3 on the same chart.

2) At the upcoming halving event (May 2020), we can expect the price to be at approximately $10k (50% of previous ATH).

3) Next bull run and ATH is estimated to occur ~2.5 years from now (late 2021). What will the price be? It’s anyone’s guess. Looking at previous cycles lows and highs shown in table 1, Bitcoin’s price could reach $80k.

Table 1- Bitcoin cycles highs & lows

Table 1- Bitcoin cycles highs & lows

Figure 5: Market cycles 2+3, 15 days MA

Figure 5: Market cycles 2+3, 15 days MA

Summary

As we all know, there are 3 basic types of market analysis:

  • Fundamental analysis;
  • Sentiment analysis;
  • Technical analysis

We hear all too often that Bitcoin (and crypto as a whole) has no fundamentals and traders should focus only on technical analysis. We think this is wrong.

In this newsletter, we presented what we believe is a viable theory explaining Bitcoin’s boom and bust cycles. This theory is backed by fundamentals, Bitcoin’s unique economic aspects, and historical price action. As can be seen, understanding Bitcoin’s fundamental features and economy is key to understanding Bitcoin’s long term price trends.

We invite you, our readers, to do your own fundamental research and see what theories you can come up with to improve your trading. Good luck!

This communication is provided for informational purposes only and does not constitute, and should not be construed as, financial, legal, investment, tax or any other advice. Alef Bit Technologies Ltd. or its affiliates and/or subsidiaries (collectively, ”Alef Bit”) normally hold as principal bitcoin, Ethereum, blockchain tokens and other cryptocurrencies or asset classes that may be discussed in this communication.

This communication has been prepared based upon information, including market prices, data and other information, from sources believed to be reliable, but Alef Bit does not warrant its completeness or accuracy except with respect to any disclosures relative to Alef Bit and/or its affiliates. Any opinions and estimates constitute our opinion as of the date of this material and are subject to change without notice. Alef Bit may have relied upon certain quantitative and qualitative assumptions when preparing the analyses herein which may not be articulated as part of such analyses. The realization of the assumptions on which such analyses were based is subject to significant uncertainties, variabilities and contingencies and may change materially in response to small changes in the elements that comprise the assumptions, including the interaction of such elements. Furthermore, the assumptions on which the analyses were based may be necessarily arbitrary, may be made as of the date of the analyses, do not necessarily reflect historical experience with respect to blockchain tokens, cryptocurrencies or other asset classes similar to those that may be contained in the analyses, and do not constitute a precise prediction as to future events. Past performance is not indicative of future results.

Alef Bit does not assume responsibility for investment decisions. This communication is not intended as investment advice or an offer or solicitation for the purchase or sale of any blockchain token, cryptocurrency, security, financial instrument or other asset class. Alef Bit provides this newsletter for research and discussion purposes only and does not provide general or individually tailored investment advice of any kind. Any opinions and recommendations contained herein do not take into account individual readers’ circumstances, objectives, or needs and are not intended as recommendations of particular cryptocurrencies, other assets or strategies to particular persons. You must make your own independent decisions regarding any cryptocurrencies, blockchain tokens, asset classes, financial instruments or strategies mentioned or related to the information herein. Readers should consult with their own advisors before making any investment or other financial decision. You ultimately must rely upon your own examination and that of your professional advisors, including legal counsel, financial advisors and accountants as to the legal, economic, tax, regulatory, or accounting treatment, suitability, and other aspects of the analyses contained herein. Alef Bit shall not be liable for either (i) any errors or omissions made in the data or analyses contained herein or (ii) damages (incidental, consequential or otherwise) which may arise from your or any other party’s use of the data or analyses contained herein.

This communication may not be redistributed or retransmitted, in whole or in part, or in any form or manner, without the express written consent of Alef Bit. Any unauthorized use or disclosure is prohibited. Receipt and review of this information constitutes your agreement not to redistribute or retransmit the contents and information contained in this communication without first obtaining express permission from an authorized officer of Alef Bit.

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