Why is the Stock-to-Flow Model Criticized?

Based on the Stock-to-Production (SF) ratio, the Stock-to-Flow model makes predictions about the value of bitcoin. An unknown PlanB author developed the model based on his calculations for precious metals like silver and gold.

The theory behind stock-to-flow is an effort to demonstrate that a commodity’s price will rise due to a shortage brought on by a rise in the ratio of its stocks to production.

How does Stock-to-Flow work?

The model is based on the researcher Nick Szabo’s theory, which contends that due to the high cost of production, precious metals and collectibles are always in short supply. PlanB approached Bitcoin in this way.

The SF parameter, which measures the stock-to-inflow ratio of an asset, is determined for each asset. This is the opposite of the supply increase. The inflow is equivalent to the annual production or production volume, while the reserve is equal to the total volume of reserves.

The stock-to-flow ratio is low for commodities, ferrous metals, and consumables, but high for rare goods and precious metals. Low SF products and materials are not uncommon. Producers will dramatically expand production and end the scarcity as their prices rise. In the case of uncommon items, increasing manufacturing is either challenging or expensive.

The idea is applied to gold and silver, which were mined at rates of 1.6% and 4.5% of the resource, respectively. Since there is no way to dramatically increase output and match demand, an increase in demand for these metals will result in an increase in price.

When Stock-to-Flow was published, there were 17.5 million bitcoins in circulation and 0.7 million new bitcoins were being created annually as a result of mining. The initial cryptocurrency had an SF of 25. The block reward determines the inflow. Payments are half from their initial value of 50 bitcoins every 210,000 blocks, or roughly every four years. This occurrence is known as a halving.

The inflow and SF levels are determined by the block reward reduction. PlanB scored 111 points when it computed the monthly SF values for Bitcoin from December 2009 to February 2019.

Who came up with the Stock-to-Flow model and when?

Modeling Bitcoin Value with Scarcity, a 2019 essay by anonymous analyst PlanB, introduced the Stock-to-Flow model. The author describes himself as a 25-year veteran institutional investor who has experience in both the legal and financial sectors. PlanB is also interested in blockchain research and investing strategies. The trader mentions managing multibillion dollar assets in another article. Who PlanB is, for sure, is unknown.

How does the Stock-to-Flow Deflection Indictor work?

The Stock-to-Flow Deflection technical indicator, which depicts the link between the price of bitcoin and its value as discovered using the corresponding model, was subsequently created. The parameter values are computed over the course of the cryptocurrency’s existence.

Bitcoin is undervalued if Stock-to-Flow Deflection requires a value smaller than one. The value of the coin is expected to decline if the parameter is greater than one. This indication is used by some traders. When the first cryptocurrency, according to the indicator, is overpriced, they establish short positions and buy bitcoin if its value is lower than the projected one.

What is Wrong with the Stock-to-Flow Model?

Since the concept was first published, several years have passed during which it was not entirely realized. Nico Cordeiro, director of investments at Strix Leviathan, thinks the Stock-to-Flow approach is fundamentally flawed since arbitrary data for gold and silver were selected to calculate SF. According to the analyst, PlanB might have adjusted the data to best fit the model. As a result, it was feasible to construct a linear dependence for bitcoin, silver, and gold in logarithmic coordinates. The critic highlights the discrepancy between the increase in output and the capitalization of products and precious metals expressed in US dollars.

Over the previous 115 years, Cordeiro has computed the SF for gold. The results show that there is no correlation between the estimated parameter and the capitalization of the precious metal. All gold reserves ranged in value from $60 billion to $9 trillion, with an almost constant SF value of 60. According to the critic’s research, the price of the precious metal rises mostly when the value of the US dollar decreases. Since 1915, inflation has caused the value of American money to fall 25 times, which explains why gold’s price has increased.

Nico Cordeiro claims that Stock-to-Flow is purely based on historical data. There are prerequisites for this because, based on the results of the study, the price of one bitcoin will approach $235 billion by 2045.

What is the Stock-to-Flow model’s outlook?

PlanB correctly predicted that the first cryptocurrency will increase in value to $55,000. Additionally, it added to the initial model. Despite the fact that the model is intended to be applied to assets other than cryptocurrencies, the majority of them have a low SF parameter.

Many seasoned bitcoin analysts ceased using Stock-to-Flow around 2022. Even Vitalik Buterin, the man who founded Ethereum, joined the criticism. He stated that the model is not effective at this time. Buterin contends that any models that foresee an inescapable rise in the value of assets are detrimental.

The exponential rise in the price of bitcoin will eventually come to an end, according to the author of Stock-to-Flow and its backers. PlanB is aware that the model might lose some of its utility in the future. It still counts on the undervaluation and scarcity of bitcoin to grow its worth.