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An Introduction to Bitcoin Stock-to-Flow (S2F) Model

Bitcoin stock to flow

Since virtual currencies are notoriously volatile, it can be challenging for novice investors to make wise investment choices when investing in cryptocurrencies. Considering these challenges, using the “stock-to-flow” (SF or S2F) model would be beneficial for creating a more well-structured choice.

Investments in cryptocurrency rely on predicting asset values, just like traditional investments in the stock market. In such a case, a model such as the stock-to-flow ratio may be helpful. The number indicates how long it will take for the existing stock (supply) to be reached at the current production rate. In general, the larger the number, the more expensive it is!

Since the SF ratio has historically correlated with the price of Bitcoin (BTC), it is widely used for predicting future BTC prices. Bitcoin is the oldest and most famous rare digital item in the world. There will never be more than 21 million coins like silver and gold in circulation.

As a result of its scarcity, Bitcoin’s price rises under the stock-to-flow theory. Bitcoin’s digital lack and value are determined by the stock-to-flow ratio. Does Bitcoin stock-to-flow provide reliable price forecasts? Here’s a deeper look at the stock-to-flow approach, how it operates, and how to invest in cryptocurrencies using it.

Flow-to-Scarcity Ratio and Bitcoin Scarcity

According to psychologist Nick Szabo, a scarce asset has an intrinsic value and unforgeable costliness. The underlying technology of Bitcoin makes it expected that the supply of new coins will decrease over time. The block reward is awarded to miners for determining the hash of a block and producing proof of work.

Every 210,000 blocks, the block reward is halved, as seen in the chart below. For instance, the block reward on 2009 was 50 BTC; in 2012, it was 25 BTC; in 2016, it was 12.5 BTC, and in 2020 it would be 6.25 BTC. Spring 2024 will bring another halving.

BTC’s price has skyrocketed in the past after the Bitcoin halving. However, since Bitcoin’s price increases as its supply become more constrained, investors may use scarcity metrics to determine the best time to invest in BTC.

The stock-to-flow model provides a more accurate prediction of value fluctuations. This is because the amount of assets currently in stock is compared with the rate at which they are being produced each year.

Greater scarcity is implied by a larger ratio, which typically results in a higher price. A pseudonymous Dutch former institutional investor named “PlanB” introduced the Bitcoin stock-to-flow ratio to the world.

With respect to BTC in particular, stock-to-flow was initially used in relation to gold and silver. Bitcoin’s value may be determined primarily by supply and demand because of its rarity and high production costs.

Bitcoin production is more evenly distributed due to halving occurrences, but the gold output is accelerated by technology in the precious metals mining industry.

The bitcoins cannot be converted into gold or silver, unlike gold and silver. Each cryptocurrency token represents a potential supply since investors can sell all their tokens at any time. Therefore, relative value is more critical in crypto than absolute value in the world of cryptocurrencies.

Bitcoin’s stock-to-flow ratio is far simpler to predict thanks to this relative consistent inflow, even if it isn’t always ideal. Macro variables will more influence the price of Bitcoin as it develops as a financial asset.

It compares the production flow to the total amount of available stock for a specific commodity (the amount mined in that year).

Stock-flow ratio formula

Take a closer look at Bitcoin stock-to-flow formula. Based on an annual flow of 328,500 BTC, Bitcoin’s current stock is 18,847,331, which accounts for 89.74 per cent of its total supply. However, a new block is mined every ten minutes, which causes the stock’s number to fluctuate.

In this case, the SF ratio is 57.374 (18,847,331/328,500) when these data are entered into the stock/flow calculation. It would therefore take 57 years to mine the total supply of BTC at present (without considering maximum supplies and halvings).

In addition, the price of Bitcoin rises when the supply of Bitcoin is halved, which raises the S2F ratio. The most important thing investors need to understand is why Bitcoin is treated as a currency rather than as a commodity.

What is the reliability of Bitcoin stock-to-flow price forecasts?

While Bitcoin stocks-to-flow ratios have historically correlated with BTC prices, the approach has significant limitations when it comes to predicting future value swings of digital assets.

It ignores the demand for digital currencies and only considers the supply of Bitcoin, for example. It is supply and demand that determine the price of an asset. Thus, even if Bitcoin’s SF ratio increases during halving events every four years, its price will decline sharply if demand reduces significantly.

Also, the Bitcoin stock-to-flow model does not consider the following factors that may impact the asset’s price:

It is still possible for Bitcoin to experience significant price fluctuations despite its reduced volatility. For example, the price of bitcoin may plunge sharply after a considerable value loss occurs during a period of extreme volatility, resulting in the liquidation of traders’ long positions.

Events known as black swans have significant repercussions on economics, especially when they affect asset prices. For example, there is a possibility that Bitcoin could experience a black swan scenario if the government enacts a significant crackdown on cryptocurrency trading and purchasing. The price of BTC will likely fall dramatically as a result of this fictitious scenario.

Models for predicting cryptocurrency prices

In order to assess financial market cycles, Elliott Wave Theory uses market investors’ psychology, also called “collective psychology” or “crowd psychology.” Elliott Wave Theory was developed in the 1930s by an American accountant named Ralph Nelson Elliott.

Wave patterns are thought to be developed in straight lines or ups and downs according to the Elliott Wave Theory. Every financial market, including cryptocurrency trading, oscillates between impulsive and alternative stages. These waves alternate between motive and corrective waves and are subdivided into five sets of waves. They are identical, recurring, and subdivided into five sets, each of which alternates between motive and corrective waves.

Besides the Bitcoin Rainbow Graphic, there is also the Bitcoin Logarithmic Chart which shows the price development of Bitcoin in the form of colour-banded graphs. Using a logarithmic regression provided by Bitcointalk user “Trolololo” in 2014, Holger Über Holger created the colourful bars. 

The idea does not mention any deadlines, but Holger recognises that these bands are entirely arbitrary and unscientific. The only period they are accurate for is some time in the future. By using the chart, users can keep track of BTC price changes over time and understand when it has been an excellent time to buy or sell the currency.

Because past performance does not always predict future outcomes, Holger says the Rainbow Chart cannot offer investment advice. There are, however, eight arbitrary colour bands relating to the price of Bitcoin: the definite bubble, the FOMO (fear of missing out), the sell, the bubble development, the still cheap, the HODL and the purchase, accumulation, and the deeply discounted.

Investing in cryptocurrencies using the stock-to-flow method

Despite these drawbacks, it may still be beneficial to learn how to use a stock-to-flow approach in cryptocurrency trading. As a cryptocurrency’s stock-to-flow ratio increases, its value will also increase according to the model’s historical data. By understanding this relationship, you may be able to make better investment decisions.

Stock-to-flow ratios above 50, which indicate extreme relative scarcity, suggest that values will also rise. Investors can take advantage of the high price by selling part of their cryptocurrency if they notice that ratio. Instead, they could purchase more whenever it is predicted that the ratio will increase in the future.

Even though it has its limitations, the stock-to-flow ratio can be an effective financial tactic in cryptocurrency. Therefore, if one is contemplating investing in cryptocurrency, this model should be included in their forecasting arsenal.