What is Bitcoin Stock Flow Model?

The Stock Flow (SF or S2F) model is one way of measuring the abundance of a given resource. Stock Flow rate can be found by dividing the amount of resource held in reserves by the annual production amount of this resource.

The application area of ​​the Stock Flow model is generally natural resources. As an example on the subject, gold can be examined. Although estimates vary, the World Gold Council estimates that approximately 190,000 tonnes of gold may have been mined to date. We can talk about this quantity (ie total supply) as a stock. However, about 2,500-3,000 tons more gold is mined every year. This amount we accept can be called flow.

Using just these two quantities, we can calculate the Stock Flow rate. This ratio basically shows how much supply enters the market from a given source each year compared to the total supply. The higher the Stock-to-Flow ratio, the less new supply will enter the market relative to the total supply. Therefore, an asset with a high Stock-to-Flow ratio should theoretically retain its value well over the long run.

In contrast, consumables and industrial commodities often have low Stock-to-Flow ratios. This is because their value comes from their destruction or consumption, we can say because inventory (stock) exists only to meet demand. Since these resources do not have a high value as a commodity, their performance as investment assets is generally weak. In some exceptional cases, if a shortage is expected in the future, a rapid rise in prices may be seen, but under normal conditions, production will be able to meet demand. It is important to note that the rarity of a resource does not in itself indicate that it is valuable. For example, gold is not that rare in this regard, 190,000 tons of gold have been mined so far. Inventory Flow ratio indicates that this asset is valuable because annual output is relatively low and stable compared to current inventory.

About Bitcoin and Stock Flow

At its core, the model approaches bitcoin and certain cryptocurrencies in a similar way to rare commodities such as gold or silver. Gold and silver are often described as sources or means of storing value. These assets theoretically maintain their value in the long run due to their relatively rare availability and low flow. Moreover, it is seen as very difficult to increase the supply of these assets significantly in a short time.

According to the proponents of the Stock-to-Flow model, Bitcoin qualifies as a similar resource. It is rare, expensive to manufacture, and its maximum supply is capped at 21 million coins. Also, the market version of Bitcoin's supply is determined at the protocol level, making the flow completely predictable. In addition, the amount of new supply entering the system with Bitcoin halvings is halved every 210,000 blocks (about four years). This raises the price of bitcoin.

According to proponents of this model, the combination of these features creates a rare digital resource with extremely powerful features that enables value to be preserved over the long term. Proponents of the model also assume that there is a statistically significant relationship between the Stock Flow model and market value. According to the model's predictions, the price of Bitcoin is expected to increase significantly over time due to the continuously decreasing Stock-to-Flow rate.

What Is Bitcoin's Stock-to-Flow Rate?

Currently, the circulating supply of Bitcoin is about 18 million and the annual new supply is about 0.7 million bitcoins. As of now, Bitcoin's Stock-to-Flow rate hovers around 25%. After the next halving in May 2020, the rate will increase to around 50%.

Constraints of the Stock Flow Model

While Stock Stream is an interesting model for measuring rarity, it doesn't take into account all pieces of the painting. Models are only as strong as the investments underlying them. Stock Flow, for example, is based on the assumption that rarity should create value, as measured by the model. Critics of Stock Flow think that the model will fail if Bitcoin lacks any useful feature other than scarcity. Thanks to its rarity, predictability, and global liquidity, gold has made it a highly stable store of value compared to devaluable fiat currencies.

According to this model, Bitcoin's volatility is also expected to decrease over time. The historical data of many pages confirm these predictions.

While valuing the asset, its volatility should also be taken into account. If some degree of estimation of volatility can be provided, the valuation model may become more reliable. But it is famous for the large price fluctuations that Bitcoin shows.

Although volatility is decreasing at a macro level, Bitcoin has been priced on a free market since its launch. This means that the price is largely self-regulating in an open market of users, investors and speculators. With this feature combined with low liquidity, Bitcoin becomes more vulnerable to sudden price fluctuations compared to other assets. Therefore, the model may also fail to take this into account.

Other external factors, such as Black Swan events, can also reduce the effectiveness of this model. But it's also important to note that the same will be true for any model that tries to predict the price of an asset based on historical data. The Black Swan thing, by definition, occurs suddenly. Historical data cannot account for unforeseen events.