Guellord MbusaThe Stock to flow model is a very old concept and commonly used in the world of finance and trading. It is traditionally used to predict the price course of products. The Stock to flow model, as its name suggests, in principle evaluates two values: the Stock (which designates the total existing supply of a product) and the Flow ou flux (which designates the quantity of the product that is created each year).
Simply put, The Stock to Flow model is a predictive model on the price course of a product depending on whether a quantity of the same product is added to its existing total supply.
This is found using the stock/flow ratio. Indeed, the ratio is the ratio between the stock (total existing supply) and the flow (new annual supply).
That said, what does this model represent for crypto and is it relevant to estimate bitcoin price ?
What is the Stock to Flow (S2F) ratio?
To better understand what the Stock to Flow ratio is and what it is used for, it is best to consider it in commodities. Take the example of a precious metal likeor. Certainly, estimates of the entire amount of gold already mined since the beginning of humanity are not precise. However, in 2029, the consulting company specializing in the precious metals market Thomson Reuters GFMS (Gold Fields Mineral Services) estimated that all the gold mined since the beginning of humanity represented 171 300 tons.
At the same time, the annual production of the world's gold mines is estimated at 3 tonnes. With these two values, it is easy for us to calculate the stock to flow ratio knowing that the 171 tonnes represent the total stock and the 3 tonnes represent the flow. You will understand that the less new supply there is on the market, the higher the stock/flow ratio.
So an asset with a higher stock-to-flow ratio should, in theory, retain its value over the long term.
The stock to flow of consumer materials
While the Stock-to-Flow ratio applies perfectly to raw materials, when it comes to consumer goods and industrial raw materials, it is different. These goods generally have a low stock to flow ratio since their inventories are generally consumed and are only produced to cover demand. In some exceptional cases, the price of these goods may increase rapidly if there is an anticipation of shortages in the future, but otherwise these goods inevitably follow the law of supply and demand.
—>Read the article: Understanding the law of supply and demand in crypto
Contrary to what we are often told, scarcity alone does not make a resource valuable. Gold, for example, there are 171 tonnes of it. It is therefore not that rare in absolute terms, it is in proportion to the demand there is for this metal! So, the reason the stock to flow ratio estimates it to be valuable is because the annual production relative to the existing stock is relatively low and constant.
The Stock to flow ratio applied to Bitcoin
To properly approach the subject of stock to flow applied to bitcoin, it is important to first understand how bitcoin works. After that, it will be very easy for you to understand why applying the Stock to Flow model could make sense in your fundamental analysis. Indeed, the stock to flow model deals with bitcoins in a manner comparable to commodities rare, such as gold or silver. Both of these commodities are referred to as “stores of value.” Rightly so, because in theory, these metals should retain their value over the long term due to their relative rarity and lower throughput.
For advocates of the Stock to Flow model, Bitcoin is a resource similar to gold. It is rare, relatively expensive to produce and its maximum supply is capped at 21 million pieces. Additionally, their provisioning issuance is defined at the protocol level, making the flow predictable. On the other hand, there is what is called halving. It is a process which consists of halving the supply of new bitcoins on the market every 210 blocks (or approximately four years due to one block every 000 minutes).
These combined properties create a rare digital asset with deeply compelling characteristics to retain long-term value. For proponents of stock to flow, there is a static relationship between stock and flow and market value. Thus, according to the model projections, the price of Bitcoin is expected to see a significant increase over time due to its continually reduced stock-to-flow ratio.
⛳️ This explains why some invest in Bitcoin by forecasting that the price will continue to increase, depending on the stock-to-Flow ratio applied.
What is the limit of this model on Bitcoin?
At the time of writing, the circulating supply of Bitcoin is approximately 19 BTC while the new supply is around 0,7 million per year. At this point in time, Bitcoin's Stock To Flow ratio is approximately 19,3. Bitcoin's Stock to Flow is based on the assumption that the scarcity of the crypto, as measured by the model, should generate value. Critics of Stock to Flow argue that this model fails if Bitcoin has no useful qualities other than scarcity of supply. Similarly, the Stock-to-Flow ratio therefore has very little relevance to other cryptocurrencies, including so-called " inflationary"
—>Read the article: The difference between inflationary and deflationary cryptos
Final word
Stock to Flow is a model that measures the relationship between the total stock of a product and its annual supply. Typically applied to commodities and precious metals, many analysts believe it can also apply to Bitcoin. Bitcoin being considered a rare digital resource. Following this method of analysis, the characteristics of Bitcoin make it an asset capable of retaining its value over the long term.
However, although everything seems attractive, this model does not take into account the high volatility of this digital asset which can move in one direction or another. Indeed, there are obviously other criteria which can also have an impact on the price such as the economic context, prohibitions etc.
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Note: This is not investment advice. Always do your own research.
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