8 Flaws in Bitcoin’s Stock-to-Flow Model Will Doom It

Read the article or watch the video about this podcast. It's helpful to see the graphs. 

I copied the article and graphs below, but use this link if the images don't pop up in your podcast player.

https://www.youtube.com/watch?v=3k4CTL6fowA

8 Flaws in Bitcoin's Stock-to-Flow Model Will Doom It

I love Bitcoin. Nothing would make me happier than to see one of Plan B's optimistic stock-to-flow (S2F/STF) models become an accurate predictor of Bitcoin's price.

Up until now, there has been a non-spurious relationship between stock-to-flow and bitcoin's price. That's one reason it's such a compelling narrative.

I hope I'm wrong, but, inevitably, BTC's stock-to-flow models will diverge dramatically from their predicted trendline. This article doesn't distinguish between the original S2F model and the latest S2FX model since they share a similar concept.

FYI: I am writing this while the world is counting down the hours to bitcoin's third halving, which will occur on May 12, 2020. BTC costs nearly $9,000.

What is the hypothesis of bitcoin's stock-to-flow model?

Bitcoin, like gold, has a relatively large existing stock compared to the annual flow of new bitcoin mined.

Gold, unlike most metals, sees its total stock increase relatively slowly compared to its existing stockpile. There are about 200,000 tons of gold (the stock) and we mine about 3,000 tons of new gold annually. In other words, gold's flow adds about 1-2.5% to its annual stock. 

That results in a stock-to-flow ratio of roughly 65. That means that if halted gold mining today, it would take us to 65 years to consume the existing stock. I've seen lower and higher S2F estimates, so let's assume that 65 is close enough.

Gold's stock to flow is much higher than any other metal, which partly explains why it's so valuable.

Bitcoin is similar to gold in that it also has a high stock-to-flow ratio. The amount of newly mined bitcoins is tiny when compared to the existing stock of bitcoins.

Therefore, the hypothesis is: as bitcoin's stock-to-flow rises, so will its price. 

So far, that's exactly what has happened up until the 2020 Halving. Will the pattern continue?

The stock-to-flow tale is such a compelling and powerful narrative that it's become a viral hit among bitcoin fans.

I certainly bought into it enthusiastically. 

Stock-to-flow models bitcoin's price predictions

The original stock-to-flow model predicted that BTC will reach $55,000 in 2020. That means BTC needs to jump 7 times in value in the next 7 months.

On April 27, 2020, Plan B presented his BTC S2F Cross Asset (S2FX) Model. The S2FX predicts that by 2024, BTC with be worth an eye-popping $288,000.

This sounds too good to be true.

This article explains why both stock-to-flow models will soon fail. 

Since most people who are reading this don't know me, here are a few facts about me in case you're wondering, "Who the hell is this asshole?":

I'm not a newbie. I first bought BTC when it was $250. (My brother bought 10 BTC when it was $1 each - and then got hacked and lost it all).
I accurately predicted BTC's 80% price drop in 2018. 
I nailed my 2019 prediction within $33. 
I'm a Harvard MBA, so I like to analyze numbers. 

8 problems with Plan B's stock-to-flow bitcoin models

For those who don't like to read, you can watch the video:

 

The list goes from the least important problem to the most important problem. 

Problem #8: Not everyone agrees on what is gold's stock-to-flow ratio

Although most quants agree that gold's stock-to-flow ratio is in the 60s, a few believe it's much higher. For example, Philip Barton, a gold analyst, argues that gold's stock to flow is between 400 and 800!

Admittedly, Barton is an outlier. The consensus is that gold's stock-to-flow ranges between 50 and 70. Still, it's worth noting that some believe there is far more stock out there than we realize. How could gold's stock-to-flow ratio be 800?

The main reasoning is that when humans first started collecting gold, there was a lot of low-hanging fruit. Enormous gold nuggets were easy to grab in the streams and other sources. It's reasonable to assume that for billions of years, gold nuggets just sat in the streams since no animal valued them.

When humans began collecting gold, the global gold stock must have soared exponentially. Its curve must have looked like the first decade of bitcoin's supply curve.

That's why Barton and others believe that gold's stock-to-flow ratio is 10 times higher than what most people think it is.

If that's true, then bitcoin's stock-to-flow model is somewhat inaccurate since it predicts that bitcoin will exceed gold's stock-to-flow ratio by 2025.

   

This problem is the least of all the problems with bitcoin's stock-to-flow narrative. It gets worse.

Problem #7: Gold's stock-to-flow isn't fixed

Plan B presents timelines that show bitcoin's ever-rising stock-to-flow ratio. In those charts, he depicts gold (and silver) as a single data point, as if their stock-to-flow ratios are constant. 

For example, in Plan B's chart below, you'll see how bitcoin's stock-to-flow ratio has risen over 10 years. Meanwhile, on that chart, Plan B depicts gold stock-to-flow (SF) fixed at 62 and silver's SF 22. 

Bitcoin's stock-to-flow model gives you the impression that gold's stock-to-flow is nearly constant.

The reality is that gold's stock-to-flow ratio is constantly fluctuating.

Here's a chart that shows that gold's average stock-to-flow is 66, but it's had a wide range over the last 120 years.

Gold's stock-to-flow ratio has gone as low as 45 in 1940 and as high as 90 in 1920. Gold has bounced around those extremes.

Problem #6: Gold's stock-to-flow does not drive its price

Plan B observed that because bitcoin's mining flow gets cut in half every four years, bitcoin's stock-to-flow ratio leaps every 4 years. These halving events boost Bitcoin's stock-to-flow ratio dramatically. It's reasonable to assume that the contracting supply is fueling the BTC's dramatic price rise.

Intuitively, the stock-to-flow model makes sense once you conduct a simple thought experiment. Imagine if the flow of gold suddenly slowed to a trickle. Instead of 3,000 tons of gold being mined annually, we only managed to dig 3 tons of gold each year. 

What do you predict would happen to gold's price?

It would skyrocket, right?

That's because investors, national banks, jewelry makers, phone makers (0.034 grams of gold in each phone), and other industries that use gold would have to fight over a (nearly) fixed supply.   

Still, if the stock to flow ratio were such a great price predictor, then we should see gold analysts use it all the time.

But they don't. Gold bugs only cite gold's stock-to-flow to help explain why gold has monetary value. But they don't use it to predict gold's price. 

That's because, as you can see from Voima's chart below, gold's stock-to-flow ratio is sometimes uncorrelated to gold's price.

The above chart is a bit misleading because it only shows the nominal price of gold, which, prior to 1971, was fixed by the government.

Below, is the real, inflation-adjusted price of gold. When you examine the red line, overlay the cyclical stock-to-flow line over it. You'll see no correlation.  

For example, in the graph above, you can see that the STF hit a high of 95 around 1920. But below, you can see the inflation-adjusted price is rather low in the 1920s. You'll see the opposite when you compare the 1940 numbers.

In short, gold's price is uncorrelated to its stock-to-flow ratio. 

I haven't read a single gold expert argue that stock to flow drives the price of gold over the years. 

However, according to the S2F model, the alleged driver of bitcoin's price rise is its ever-increasing stock-to-flow ratio. As bitcoin's stock-to-flow ratio goes up, bitcoin's price follows. That is the thesis.

That implies that if bitcoin's stock-to-flow ever stabilizes, then its price should stabilize too.

Gold's stock-to-flow and price history tells a different story. Over the last 120 years, gold's STF ratio has gone up and down in a relatively narrow range. However, gold's inflation-adjusted price has gone all over the place. 

Problem #5: Some metals with extremely low stock-to-flow ratios are worth more than gold

In the chart below, Plan B noted the stock-to-flow of other metals besides gold and silver:

By one estimate, platinum has a measly stock-to-flow ratio of 1.1.

This surprised me because, in Dungeons & Dragons, one platinum piece is worth 10 gold pieces (back when I played, the roleplaying game used a 5:1 ratio).

In reality, it's not that big of a difference. Still, ounce-to-ounce, platinum usually costs more than gold.

It's the same story with palladium.

Palladium has a paltry stock-to-flow ratio of 0.4.

But you wouldn't guess that after looking at its price versus gold and platinum. 

Therefore, there's clearly a disconnect between stock-to-flow and price in the world of precious metals. 

That's why metal quants and forecasters hardly mention stock-to-flow when making price predictions.  

Some may say that palladium and platinum are commodities whereas gold's high stock-to-flow ratio puts it in a different category: a monetary metal.

True, but it raises some concerns about how tightly we should link stock-to-flow to the price.

Stock to flow is important, but it's not the main driver behind the price of metals.

It's just one of many important factors.

Problem #4: STF doesn't explain the prices of other cryptocurrencies

Not only does stock-to-flow explain why palladium and platinum are often worth more than gold despite having tiny stock-to-flow ratios, but it also fails to explain the value of other cryptocurrencies.

In the vast universe of shitcoins, there are some that have a stock-to-flow ratio that is much higher than bitcoin and gold. If not, we could invent one tomorrow. But that wouldn't make it valuable.

Jan Nieuwenhuijs makes exactly that point in my interview with him (see it below). He says that we could create a cryptocurrency that halves every day instead of every four years. We could engineer one that has a stock-to-flow of 50,000. However, unless there's demand, that cryptocurrency would be worthless.

Problem #3: STF assumes that bitcoin's demand continues to grow exponentially

The Achilles heel of bitcoin's stock-to-flow model is that it only looks at supply. 

Economics 101 teaches you that the price of anything is driven by supply and demand. If you only know the supply, you cannot predict the price. 

Jan Nieuwenhuijs is a gold guru who is also a Dutchman like Plan B. Jan said it succinctly, "If there is no demand for something, the value is zero."

In other words, Bitcoin's tightening supply is only half the story.

Since its genesis, bitcoin has enjoyed a robust, growing demand. Indeed, bitcoin's demand has usually outstripped the supply, which explains why bitcoin's value has been rising despite its double-digit inflation rate throughout the 2010s.  

The stock-to-flow model will be accurate provided that the demand continues to grow exponentially as it has for the last 10 years. However, as Facebook is discovering, there are fewer than 8 billion potential customers on this planet. Bitcoin will ultimately reach market saturation.

But long before that, it will run into a much more serious barrier... 

Problem #2: STF underestimates the powers that be

The stock-to-flow model underestimates the challenge of maintaining the same exponential growth as your size increases. 

When bitcoin went from a $1 million market cap to a $100 million market cap, the world hardly noticed or cared. 

Going from a $100 billion market cap to a $10 trillion market cap is also 100x growth, but it is orders of magnitude more difficult to do.

That's because if bitcoin has a $10 trillion market cap, it's no longer a fly in the room. It's an elephant in the room. That would make bitcoin's market equal to the 3,000-year-old gold market!

In the What Bitcoin Did podcast, Plan B told the host Peter McCormack that bitcoin "is not a toy anymore."

True. When it was a "toy" in the 2010s, the power players kept a wary eye on it, but they hoped it would stay small or disappear.

If bitcoin manages to grow into the next phase transition, it will step on many toes that have sharp claws. Bitcoin will disrupt industries, but not without a fight. Bitcoin will survive but will suffer blackeyes and slower growth as a result. 

In the next phase transition, bitcoin will begin to bump its elbows against many entrenched powers: regulators, governments, banks, tax authorities, Western Union, financial services, environmentalists, gold bugs, the FBI, the CIA, and grumpy old baby boomers.

If bitcoin threatens them, they will do whatever it takes to stop bitcoin and preserve the status quo. 

Bitcoin fans underestimate how powerful these entities are. Although these powerful organizations cannot destroy bitcoin, they will slow down bitcoin's adoption (i.e., the demand). They will erect troublesome roadblocks. They will impede (and perhaps stop) bitcoin's ability to continue rising to the next "phase transition."

It's naive to underestimate these future challenges, but the stock-to-flow model ignores them.

To be realistic, the stock-to-flow model ought to have some "deceleration factor" in the calculation. That's because each "phase transition" becomes progressively more difficult to achieve. 

Problem #1: S2F defies physics 

Some critics say that the stock-to-flow model will break in 2140, which is when we cannot mine new bitcoins. At that point, the S2F model predicts that the price of bitcoin will go to infinity. 

Although that is a problem, bitcoin's stock-to-flow model is doomed to break at least 100 years before that date.

Bitcoin's stock-to-flow model predicts exponential growth into the foreseeable future. Such sprightly growth is necessary for bitcoin to hit the $55,000 target in 2020 and its $288,000 target in 2024.

Bitcoin has already been the best performing investment in the 2010s.

For the stock-to-flow model to continue working, bitcoin will need to be the best performing asset in every single decade in this century.

Pick any asset that has skyrocketed exponentially. It could be the stocks from technology companies, gold in the 1970s, or tulips a long time ago. Every single time, without fail, the asset's growth slows and never consistently regains its fierce rise.

It might occasionally have other growth spurts, but a sustained, nonstop rise never happens. However, the stock-to-flow model predicts dramatic exponential growth for several decades.

According to digitalikNet's S2F projection, in 2050, one bitcoin will be worth more than $1 trillion!

Two things would have to happen for such a Panglossian scenario to occur:

Bitcoin's price would have to double every year, on average, for the next 30 years. That's 30 doublings! No asset has ever come close to such a performance. Maybe pre-IPO Microsoft or Google or Walmart had such a rise for 10 years. But doublings become extremely difficult once an asset becomes large.
We would need to invent nuclear fusion reactors and become a Type 1 Civilization. Bitcoin consumes vast amounts of energy. The higher the price goes, the more it consumes. 

Unless Bitcoin solves its energy consumption problem, its growth will suffer. It doesn't matter if that environmental critique is correct or not. If the powers that be want to destroy bitcoin, they can use bitcoin's hungry energy consumption as an excuse to ban it or tax it prohibitively.

"Stop bitcoin to stop global warming!" lobbyists will cry.

Overcoming that challenge will slow bitcoin's growth.

The current world economy is nearly $100 trillion. If one bitcoin were worth $1 trillion, then just 10 bitcoins would be equal to the 2020 global economy.

In 2050, there will be about 20 million bitcoins. Therefore, in 2050, if the stock-to-flow prediction is correct, then the bitcoin's market cap would be $1 trillion x 20 million coins = 20 x 1018

If we make the rosy assumption that the world economy grows 10-fold between 2020 and 2050, then we will have a $1,000 trillion economy or a $1015 world economy.

Therefore, the bitcoin market cap would be 1,000 times more than the total global economy - which is impossible.

In short, the stock-to-flow model is doomed.

The S2F price prediction may be right in a perfect storm

I want S2F to be right. I would be thrilled to be wrong. Let's try to imagine a scenario where it proves to be prescient. 

Bitcoin may follow the next two stock-to-flow predictions if demand stays at a feverish pitch. For that to happen, we'll need the global economy to collapse, the dollar to devalue, governments to confiscate people's wealth, and widespread pandemonium.

Less than 1% of humans own bitcoin. And most who do, don't own much relative to their wealth. 

If new buyers flood the market just as Bitcoin truly begins hardening its monetary policy, then that will create a perfect storm for bitcoin to continue its improbable rise.

Hyperinflation will increase the nominal value of the dollar and we'll get into the trillions quite quickly. 

That reminds of a few years ago when I held a fat stack of 100-billion-dollar bills.

Lessons from the Rainbow Chart 

Check out the whimsical, but surprisingly accurate, Bitcoin Rainbow Chart below. 

I love what its creator said about the Rainbow Chart:

"The color bands follow a logarithmic regression, but are otherwise completely arbitrary and without any scientific basis. In other words: It will only be correct until one day it isn’t anymore."

The same can be said with the stock-to-flow model.

Setting expectations about bitcoin's stock-to-flow model

Plan B would probably say that I'm missing the point.

In the What Bitcoin Did podcast, Plan B told the host Peter McCormack that he "accepts that models will break." Plan B also recited two proverbs:

All models are wrong, but some are useful.

I'd rather be roughly right than exactly wrong.

Well said.

Furthermore, Plan B set modest expectations. He said, "I'd be happy if it would only forecast the next halving or the next two halvings correctly. That would be very useful."

True. 

IMO #bitcoin 2020 halving will be like 2012 & 2016. As per S2F model I expect 10x price (order of magnitude, not precise) 1-2 yrs after the halving. Halving will be make-or-break for S2F model. I hope this halving will teach us more about underlying fundamentals & network effects pic.twitter.com/kiTdN0n3Lu

— PlanB (@100trillionUSD) April 16, 2020

 

Plan B predicted that the "halving will be make-or-break" his stock-to-flow model.

I hope it will make it, but unfortunately, I believe it will break it. 

I predict that there's a 70% chance that bitcoin's stock-to-flow model will break in 2020 and a 95% chance that it will break by 2024.

Each 4-year step (at the halving) gets progressively more difficult for the price to keep up. In 2025, if bitcoin isn't worth $1 million, S2F is dead. The last big jump of this decade predicts that one bitcoin will be worth $50 million by 2029. Only hyperinflation will get us there.

So where will Bitcoin's price go?

I commend Plan B for offering a model to help understand bitcoin's past and future. Whenever you criticize something, you ought to offer a solution. So I will.

My prediction is even less scientific than the Rainbow Chart. 

Beware of all price predictions, including mine although I've been accurate in my annual predictions (but I've only had two). 

I am certain that Bitcoin will continue to rise and baffle its many critics. It will march toward a $10 trillion market cap. It just won't do it as fast as the stock-to-flow model predicts.  

On December 31, 2019, I predicted that bitcoin would end above $10,000 in 2020 and that there's a 30% chance that it will close above $20,000. I also predicted that it will reach $100,000 in this decade.

Such predictions make my friends chuckle and shake their heads. They say I'm naively optimistic about this "imaginary money and Ponzi scheme." 

Meanwhile, stock-to-flow fans laugh at my predictions for being too conservative. They believe BTC will hit $100,000 by May 2021 and $50 million by 2029. 

In between those two predictions is Tim Draper, who predicted that bitcoin will hit $250,000 in 2023.

The main reason I'm more conservative than many bitcoin fans is that I expect entrenched powers to take off their gloves and pummel bitcoin. Bitcoin will survive, but its growth will take a hit. 

Besides, a 14x return in a decade would be quite spectacular. Most assets would be happy with a 2-3x return in 10 years.

Conclusion

The stock-to-flow model has been a novel way of looking at bitcoin's early, meteoric years.

However, it will soon break because it predicts nonstop doubling year after year. Our solar system prohibits nonstop doubling. 

Let's be happy with a 14x return in the 2020s. That would result in a $100,000 BTC price in 2029.

Still, I secretly hope I'm wrong and that the stock-to-flow model is right.

Additional information

Read all 3 of Plan B's articles. Become one of Plan B's 100,000+ followers on Twitter.

Jan Nieuwenhuijs, a gold researcher and early bitcoin adopter, discussed bitcoin's stock-to-flow in my interview with him:

https://www.youtube.com/watch?v=XErx5c-DxHk

Thanks to the Gold Broker for several of these graphs. Also, I copied Rob Wolfram's daily S2F graph. 

Here is a more quantitative critique of the stock-to-flow model.

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What do you think of the stock-to-flow model? Leave a comment below.