This Tried-And-Tested Model Says Bitcoin Is Worth $83,000. Is It Too Good To Be True?

This Tried-And-Tested Model Says Bitcoin Is Worth $83,000. Is It Too Good To Be True?
Stéphane Renevier, CFA

over 2 years ago5 mins

  • PlanB’s stock-to-flow ratio is currently screaming a buy opportunity for bitcoin, suggesting the cryptocurrency should be worth three times more than it is.

  • But it’s imperfect: the model doesn’t take into account demand, it doesn’t work consistently, and its longer-term prediction seems unrealistic.

  • That said, even if models are wrong, they can be useful. So use this intelligently, and it could still prove a useful signal to add to your arsenal.

PlanB’s stock-to-flow ratio is currently screaming a buy opportunity for bitcoin, suggesting the cryptocurrency should be worth three times more than it is.

But it’s imperfect: the model doesn’t take into account demand, it doesn’t work consistently, and its longer-term prediction seems unrealistic.

That said, even if models are wrong, they can be useful. So use this intelligently, and it could still prove a useful signal to add to your arsenal.

The “stock-to-flow” ratio has historically been the single-most accurate model for predicting where bitcoin’s price will head next. And right now, it says the OG crypto’s price should be at around $82,000 – almost three times more than it’s worth today. So is this the opportunity of a lifetime, or is there something else going on here?

What is the stock-to-flow ratio?

The stock-to-flow ratio (SF) is the ratio of the current supply of a commodity to the amount of the commodity produced annually.

In other words, it estimates how many years it would take to reach the current supply. The lower the ratio, the more likely new production will dwarf existing stock and send prices lower – as long as demand remains constant (more on that later).

Commodities that are used for consumption or industrial production – think corn, copper, oil – tend to have a low SF, as most of the amount produced is used to meet demand. Commodities like gold and silver, on the other hand, have a high SF: the amount of gold and silver mined every year is very low relative to their existing supply, which means prices are less at risk from the whims of producers.

That “stability” should be worth something, and that’s where the stock-to-flow model – popularized by crypto guru PlanB on Twitter – comes in.

What did PlanB figure out?

PlanB didn’t invent the SF ratio, but he did raise its profile in two main ways: he applied the same logic to bitcoin in the first place, and he built a model quantifying how much that “stability” should be worth.

For starters, PlanB noticed that it makes sense to use the SF ratio on bitcoin because – like gold – the annual flow of newly mined bitcoin is relatively small compared to its large existing stock. Even better, this scarcity is programmed into the “commodity” and therefore can’t be changed.

As for the link between the SF ratio and price, PlanB found there was a positive relationship between them, and that the price of bitcoin could historically have been predicted by the following formula: bitcoin price = exp(-1.84)*SF^3.36.

The latest reading of that formula implies the cryptocurrency should be worth around $83,000. And a lot of crypto investors have sat up and paid attention given how accurately the model’s predicted bitcoin’s price in the past…

Stock to flow model says bitcoin should be $83,000
Stock to flow model says bitcoin should be $83,000

Is it too good to be true?

Let’s give credit where it’s due: applying this ratio to bitcoin is a pretty smart idea, and the model itself has done a fantastic job of predicting bitcoin prices so far. The problem is that a good story with great results has arguably made the model a little too sacred in the bitcoin community. That’s why I think it’s worth highlighting some of its drawbacks.

First, bitcoin is valuable not just because its supply is scarce, but because demand is growing exponentially. The SF model, though, only looks at stock and flow, not demand. That’s arguably a major oversimplification of what drives bitcoin prices.

Secondly, PlanB has tried and failed to convincingly demonstrate that the model works consistently elsewhere. In fact, some analysts have already debunked its predictive power for gold, which is arguably the one most similar to bitcoin. That could be because it’s difficult to estimate an SF ratio accurately, but more likely it’s because factors beyond stock and flow are more important. Either way, the model has repeatedly failed important tests of robustness.

Thirdly, the model has to stop working eventually, but it’s not clear when. That’s because it’ll suggest an infinite price when the last of the 21 million bitcoin is mined. But what happens before then might be problematic too: the model suggests prices should reach $1 million by around 2025, meaning it’d have to more than double every year until then. And while that sort of growth was possible when bitcoin’s market cap was relatively small, it’s becoming more and more difficult as it becomes more established.

The only way it could reach those numbers is if inflation gets truly out of control and pushes bitcoin prices up and up. That’s not impossible, but since stock-to-flow doesn’t look at inflation, the model itself won’t actually have been right even if the outcome is the same.

So should you listen to the stock-to-flow model?

Here’s the thing: you certainly shouldn’t take the model’s price prediction as gospel, or buy bitcoin solely based on what it’s telling you.

Eye-catching charts are the Achilles heel of emotionally driven investors. Look no further than the rainbow chart, which was created using completely arbitrary rules and yet seems to do a great job of predicting bitcoin prices.

Te rainbow model was created using arbitrary rules
The rainbow model was created using arbitrary rules

Still, as statistician George Box famously wrote, “All models are wrong, but some are useful.” And while the SF model might very well be proven wrong in the future, it might still be useful depending on how you use it.

This is, to the best of my knowledge, the only model attempting to estimate bitcoin’s “fair value”. And the fact that the price of bitcoin followed the model’s prediction closely whenever the pace of new bitcoin creation has been cut in half shows that the author is onto something. So I’d recommend adding it to your watchlist: it could be a very timely signal to track what’s happening on the supply side.

But the truth is it's impossible to build a model that'll predict bitcoin prices perfectly: there are just too many factors at play. All you can do is look closely at all the information you have available, and try to make a smart, informed decision based on what’s in front of you.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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