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.

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