Stock-to-Flow Model for Crypto Market Analysis: Advantages and Disadvantages

Today we will look at one of the most famous theoretical models for price forecasting. BTC. Model Stock–to–flow became especially popular in the cryptosphere in 2021, when it made it possible to very accurately determine the rapid growth in the value of bitcoin during the end of the bull cycle. Nevertheless, the model has recently been subject to serious criticism, and an objective analysis is essential to understand its strengths and weaknesses.

What does the Stock-to-Flow model claim?

The Stock-to-Flow model is developed and actively promoted by an anonymous cryptanalyst and investor from the Netherlands, known under the pseudonym PlanB. He synthesized his many years of experience in the financial markets and applied this analysis to Bitcoin pricing, focusing on the change in the market supply of BTC as the main factor determining the potential for growth in the value of the asset. A model presented by PlanB in 2019 argues that comparing the flow of additional supply with total stocks to date provides a fairly accurate estimate of its market value. The model shows how many years it takes to reach the accumulated stock of an asset at current output volumes. The higher this number, the higher the cost and capitalization.

SF = stock/flow = stock/flow

This model is especially applicable to those goods that perform the functions of money. Thus, the maximum SF ratio is observed in gold, since it takes 62 years (at current production volumes) to reach the level of total world reserves: about 3,000 metric tons of gold are mined annually, with a total world reserves of this precious metal of 185 000 tons.

Applying the Stock-to-Flow model to Bitcoin pricing yields the following estimates:

SF = BTC supply / BTC flow = 19,000,000 BTC (total BTC supply as of 2022) / 657,000 BTC (annual miner production in 2022) = 29 years.

Thus, the relative scarcity of the supply of bitcoin is still much lower than that of gold, which also applies to their market capitalization ratio. However, due to the halving, which reduces the reward to miners by 2 times approximately every 4 years, the supply of BTC will increase at an increasingly slow rate, which means that the number of years required to reach the total reserves will also increase proportionally. In general, the Stock-to-Flow model confirms the potential of Bitcoin to exceed gold in terms of capitalization and become the most expensive market asset after several subsequent halvings.

What price of BTC does the model predict?

The modern version of the Stock-to-Flow model takes into account the fact that about 1 million coins were mined with the direct participation of Satoshi Nakamoto, but they did not appear in any transactions in the subsequent time. The following formula is used to estimate the price of BTC at any given time: exp(−1.84)⋅SF^3.36.

The model uses a logarithmic scale and assumes a rapid increase in the value of the main cryptocurrency immediately after the halving and comparative stabilization (slower growth) in the period from mid-halving to the next halving. Graphically, the relationship between the real market price of BTC and the model’s predictions is shown in Fig. one.

Rice. 1. Historical price dynamics BTC and the expected level calculated on the basis of Stock–to–flow.

In general, there were several cases of serious discrepancy between the actual and predicted value of the BTC price:

• June 2011: underestimation BTC market value (predicted value – $0.82; actual value – $17);
• December 2013: underestimation BTC market value (predicted value – $77.50; actual value – $1,146);
• June 2022: revaluation market value of BTC (predicted value – $110,432; actual value – $21,476).

It is also worth noting that due to the use of a logarithmic scale, despite the multiple deviation of price values ​​in all the above cases, such fluctuations look relatively insignificant on the chart.

The Rise and Fall of the Stock-to-Flow Model

The Stock-to-Flow model was introduced by a PlanB analyst in 2019 on the Medium platform, but initially it did not attract the attention of the wider crypto community. However, after successfully predicting a new cycle of rapid growth in the value of BTC in 2020-2021, many investors began to actively use this model to open long positions. The peak of popularity of Stock-to-Flow and its creator PlanB came in the second half of 2021. So, despite significant price fluctuations from August to October 2021, the deviation of the forecasted values ​​from the actual ones did not exceed 3% for these months. At this stage, many investors began to actively raise borrowed funds in order to actively buy BTC in anticipation of exceeding $100,000 per coin. Nevertheless, at the end of 2021, a correction occurred in the crypto market, which then turned into a “crypto winter”. While the market value of bitcoin continued to decline, the pattern pointed to the expected growth of the crypto market. As a result, the gap between the predicted and market values ​​continued to grow, leading to losses for traders who adhere to the recommendations from PlanB.

In June 2022, Ethereum co-founder Vitalik Buterin presented serious criticism of the Stock-to-Flow model. He cited the model as an example of harmful theoretical constructions that mislead a large number of people. Buterin noted that giving people unreasonable hope and creating the illusion of predetermined price growth in the crypto segment is extremely irresponsible, according to Bitcoin News. In response, PlanB noted that it provides all of its analytical estimates absolutely free of charge and never encourages anyone to take them as investment advice. He also highlighted the impact of the pandemic, China’s mining ban, and Russia’s invasion of Ukraine as examples of external shocks that almost no model can capture.

Using Stock-to-Flow: Pros and Cons

When evaluating a Stock-to-Flow model, one should avoid extremes and objectively understand its scope, as well as its main advantages and disadvantages. To strengths models include the following:

1. Fairly effective determination of the long-term trend of the crypto market. Stock-to-Flow clearly demonstrates how the limited supply of bitcoin leads to its fairly rapid growth in capitalization.
2. Correct explanation and application of the role of halving in pricing. In particular, the model highlights the critical importance of halving in creating a sustainable upward trend in BTC value over time.
3. Predicting different rates of BTC price change in different time periods. For example, Stock-to-Flow successfully demonstrates that the price of a cryptocurrency will be more dynamic immediately after the halving than during the mid-halving period.

At the same time to weaknesses The model should include the following aspects:

1. Failure to explain the “crypto winter” and in general any decline in the value of bitcoin. Stock-to-Flow predicts a constant rise in the price of cryptocurrency (albeit at different rates).
2. Not too accurate approximation of BTC price change by the formula exp(-1.84)⋅SF^3.36. In particular, it gives an overly optimistic forecast, and the gap between expected and actual values ​​will only increase over time. So, Stock-to-Flow expects that in 2025 the value of bitcoin will exceed $1 million (other models based on fundamental analysis show that the real values ​​will be at least 5 times lower).
3. Ignoring demand factors for cryptocurrency. Stock-to-Flow analyzes price dynamics solely in terms of changes in BTC supply, while supply and demand play an equal role in determining the equilibrium volume and price of transactions.

Conclusions and recommendations

The Stock-to-Flow model can be applied to long-term investment in cryptocurrency. It also validates the HODL strategy for Bitcoin. However, it would be extremely irrational to apply this model for short-term investment or take BTC price predictions for a specific date literally.

As famous British statistician George Box said: “All models are wrong, but some of them are useful.”

Combining Stock-to-Flow with other analysis methods can be helpful when making investment decisions in the cryptocurrency space.

Sources: BuyBitcoinWorldwide, Royal Society, Bitcoin News, Bitcoin Magazine