In an era ruled by infinite-supply currencies, the stock-to-flow model offers a refresher on the value and meaning of scarcity. The model also offers one framework for evaluating an asset in terms of sound money. Key Takeaways

Most digitally-native products and items arent valuable because they can be reproduced at little to no cost. In 2009, Satoshi Nakamoto solved this problem by devising the first decentralized network protocol that produced a scarce digital asset, Bitcoin.

Measuring this scarcity, as well as its potential value, has been the primary thrust behind the stock-to-flow (S2F) model. This framework, however, isnt without its limits.

For money to be considered sound, it must be durable, portable, divisible, fungible, easily-verifiable, and widely-accepted as a medium of exchange.

Sound money must retain its scarcity to remain valuable over long periods. In the past, sound money was born out of peoples need for protection against the princely practice of debasing money or coinage.

Toquotethe famed Austrian economist Ludwig von Mises:

It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments.

Since the dawn of time, humans perhaps instinctively have always opted for gold, silver, or other precious metals to serve them as sound money. These compounds are hard to find in nature and costly to forge and reproduce. It is for this reason that many governments adopted the gold standard.

By basing a states money on a scarce resource, one separated the monetary units purchasing power from the policies of the worlds governments and the elite.

It meant that governments and central banks couldnt print money out of thin air.

Bitcoins have value primarily because more people recognize Bitcoins as sound money.

This recognition stems from Bitcoins inherent scarcity, and whatNick Szabo, an early proponent of digital cash and a cryptographer,callsunforgeable costliness.

Bitcoin, like gold, antiques, and fine alcohols, is valuable because it is very hard to create the work needed to produce it. It is costly and time-consuming to mine gold, and a finely-aged wine is far more expensive than freshly-pressed grape juice. There are other factors to consider, of course, but there is no replacing the value of time itself

Bitcoins market value also hinges on features of supply and demand.

Bitcoins total supply is capped at 21 million coins, and itsreal supplyis much lower. Moreover, Bitcoins deflationary monetary policy is hardcoded into its protocol. New BTC are issued every ten minutes at a predictable, decreasing rate.

Critically, these components cannot be changed unless users decideto fork the protocoland create a new cryptocurrency. At the time of press, the price of a Bitcoin fork has never overtaken the price of the original Bitcoin.

From this, one can begin to see the relationship between Bitcoins supply-side mechanics and its market price. The independent researcher and investorPlanB took this a step further when creating the stock-to-flow model.

They begin their thesis with a question that many have asked:

Surely, this [Bitcoins] digital scarcity has value. But how much?

The stock-to-flow hypothesis states that the scarcity of Bitcoins as measured by SF, where SF = stock/flow directly drives the market value of Bitcoins.

Stock is the total size of the existing stockpiles or reserves of the asset, while flow signifies the yearly production. Consider the following illustration.

There are currently 185,000 metric tons of gold in the world. Thats the stock.

The annual supply of gold or how much gold is mined every year in the world equals 3,000 metric tons. Thats the flow.

In other words, the annual supply growth of gold equals 1.6%.

To get the SF ratio of gold, one would divide the stock with the flow and arrive at an SF ratio of 62.

An SF of 62 means that, at the current rate of production, it would take roughly 62 years (185,000 / 3,000 = 61.6) to replenish the existing stock of gold in the world.

In comparison, Bitcoins current stock is 16.8 million (for more on how this figure was determined, please readthis article), while the supply of new Bitcoins, or the flow, is 0.7 million a year.

This puts bitcoins SF ratio at 24.

Given that the flow of Bitcoins is fixed, and it halves every 210,000 blocks or roughly every four years, with the nexthalvingevent, Bitcoins current SF of 24 will double to 48. This will bring Bitcoins value proposition closer in line with that of gold.

Bitcoins halving event is predicted to occur on May 12, 2020.

According to PlanBsstock-to-flowmodel, there is a statistically significant relationship between Bitcoins SF and the market price of bitcoins.

To quote PlanB directly:

The likelihood that the relationship between stock-to-flow and market value is caused by chance is close to zero.

PlanBs stock-to-flow model predicts a stunning Bitcoin market capitalization of $1 trillion in the one to two years following the next halving event in May.

A market cap of $1 trillion would put the price of one bitcoin at $55,000. With such a generous price tag on the worlds most unpredictable digital asset, PlanBs analysis has been criticized often.

Thelatest criticismcomes from Eric Wall, the CIO of Arcane Assets.

Wall claims that the S2F model is flawed insofar as it relies too heavily on supply and demand narratives as well as ever-changing statistical models. Instead, he proposes an alternative called the Rainbow Chart.

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What Is Bitcoins Stock-to-Flow? - Crypto Briefing