The Frequently Discussed Stock-to-Flow Model of Bitcoin Scarcity: A Practical Guide for Investors

Bitcoin has revolutionized the digital currency world since its inception in 2009. Positioned as the first truly decentralized, transparent, and transferable currency, its price chart has experienced a journey filled with fluctuations and volatility. After reaching a record high of $69,000 in November 2021, subsequent declines have prompted many investors to ask: what is Bitcoin’s true value? This is where the Stock-to-Flow model comes into play.

In an environment where the cryptocurrency market is so volatile, there is a need for a mathematical framework to understand Bitcoin’s value. The Stock-to-Flow ( model, simply called S2F), is a tool that attempts to predict Bitcoin’s price movements based on scarcity principles and has become increasingly popular among investors over the years.

The Stock-to-Flow Model in Simple Terms: Scarcity = Value?

The value of any commodity is determined by supply and demand. However, the Stock-to-Flow model approaches from a different perspective: scarcity itself.

The model consists of two main components:

Stock: The total amount of Bitcoin currently in circulation worldwide
Flow: The amount of new Bitcoin added to the network each year

The Stock-to-Flow ratio is calculated by dividing the stock by the flow. A high ratio indicates that the asset is more scarce and potentially more valuable. Gold clearly demonstrates this: a high S2F ratio is one of the reasons gold is considered valuable.

Bitcoin’s design has a hard cap of 21 million units. This makes Bitcoin a naturally scarce asset, similar to gold. But how does this scarcity increase over time?

Halving Events: The Mechanism Increasing Bitcoin’s Scarcity

One of the most important features of the Bitcoin network is the “halving” event, which occurs approximately every four years. Mining rewards are cut in half roughly every four years. In 2012, the reward was 50 BTC; in 2016, it was 25 BTC; in 2020, 12.5 BTC; and in 2024, it will be 6.25 BTC.

The result of this mechanism is clear: the rate of new Bitcoin supply decreases, scarcity increases, and the Stock-to-Flow ratio rises. According to the theory, this should increase Bitcoin’s value.

The Historical Success of the Stock-to-Flow Model: Do the Numbers Speak?

Currently, Bitcoin’s price hovers around $87.37K, with a 24-hour decrease of 0.93%. Has the Stock-to-Flow model been able to predict this price?

Famous analyst PlanB, who has worked on the model, predicted that Bitcoin would reach $55,000 after the 2024 halving and could potentially rise to $1 million by the end of 2025. Looking at historical data, the S2F model has shown some notable correlations with Bitcoin’s price movements, especially after halving events.

Stock-to-Flow charts from LookIntoBitcoin indicate that Bitcoin’s price has followed the S2F trend relatively consistently, aside from major bull and bear runs. This consistency is promising for long-term investors.

However, a critical point remains: past success does not guarantee future accuracy.

Why Do Some Experts Criticize the Stock-to-Flow Model?

Ethereum co-founder Vitalik Buterin has described the S2F model as “not looking very good right now” and called it “harmful.” His perspective: the model oversimplifies the supply-demand dynamics.

Adam Back, CEO of Blockstream, is more moderate. He considers the S2F model to be a reasonable curve fitted to historical data but acknowledges its limitations.

Other voices include Cory Klippsten, founder of Swan Bitcoin, and renowned crypto trader Alex Krüger. Klippsten worries that followers of PlanB’s model might be misled, while Krüger considers the model entirely nonsensical.

Nico Cordeiro, Chief Investment Officer at Strix Leviathan, offers a more fundamental critique: scarcity is not the sole determinant of Bitcoin’s price. Technological developments, adoption rates, regulations, and global economic conditions are equally important.

Other Factors Influencing Stock-to-Flow

Seeing the S2F model as just a mathematical formula can be misleading. Bitcoin’s real-world value is influenced by many other factors:

1. Mining Difficulty Adjustments: The Bitcoin network recalibrates mining difficulty approximately every two weeks to maintain consistent block times. This affects the rate of new Bitcoin issuance and thus the flow.

2. Adoption Trends: The more institutional investors and individual users adopt Bitcoin, the higher the demand. With a fixed supply, increasing demand can push prices upward.

3. Regulatory Environment: Government policies can significantly impact the crypto market. Strict bans may reduce demand, while positive legal frameworks can boost it.

4. Technological Innovations: Layer 2 solutions like Lightning Network or other scalability improvements can increase Bitcoin’s usability, thereby increasing demand.

5. Macroeconomic Conditions: Inflation, currency devaluation, and financial crises can make Bitcoin more attractive as a “hedge.”

6. Market Sentiment: News, media perception, and investor psychology can cause short-term price fluctuations.

7. Competition from Alternative Cryptos: Other blockchain projects like Ethereum may threaten Bitcoin’s market dominance.

The S2F model largely ignores these factors. Therefore, many analysts believe it should be used alongside other tools such as (technical analysis, fundamental analysis, sentiment analysis).

Practical Guide for Investors: How Should You Use the Stock-to-Flow Model?

If you want to incorporate the S2F model into your Bitcoin portfolio, here are some steps to follow:

Step 1: Understand the Model
Learn the basics of the S2F model. Understand how dividing the current Bitcoin stock by the annual flow illustrates scarcity.

Step 2: Analyze Historical Data
Examine how Bitcoin’s price responded to past halving events. Remember, past performance does not guarantee future results.

Step 3: Diversify Your Portfolio
Use the S2F model as just one part of your investment strategy. Combine it with technical analysis, fundamental analysis, and market trend assessments.

Step 4: Keep Track of External Factors
Stay informed about legal changes, technological developments, and economic conditions.

Step 5: Set Risk Management Rules
Use stop-loss orders and position sizing to control your risk exposure.

Step 6: Think Long-Term
The S2F model is not reliable for short-term trading. It is more suitable for long-term investors.

Step 7: Review Regularly
The crypto market evolves rapidly. Update your strategy and approach based on new information.

Limitations of the Stock-to-Flow Model: What Warning Signs Should You Watch For?

Despite its popularity, the model has significant limitations:

1. Ignoring External Factors: It focuses solely on scarcity, while many other factors influence Bitcoin’s price.

2. Past ≠ Future: The historical correlation does not guarantee future accuracy. The crypto market is complex and often unpredictable.

3. Oversimplification: The model oversimplifies supply-demand dynamics and market complexity.

4. Risk of Misinterpretation: Novice investors might treat the S2F predictions as absolute truths, leading to faulty decisions.

5. Complexity of the Value Chain: Bitcoin’s usability, adoption, and technological progress impact its value independently of scarcity.

Final Word: Is Bitcoin’s Future Just About Scarcity?

The Stock-to-Flow model provides a useful framework for understanding Bitcoin’s value proposition. However, predicting future price movements requires considering factors beyond scarcity.

Market dynamics, technological progress, regulatory environment, and global economic conditions are equally important in shaping Bitcoin’s price trajectory. The S2F model is a valuable addition to your investment toolkit but should not be the sole basis for decisions.

For long-term Bitcoin investors, the historical consistency of the Stock-to-Flow model is encouraging, but risk management and diversification principles must always be followed. Bitcoin’s future will likely be shaped by a complex interaction of scarcity, demand, technology, and regulation.