Limitations of the Stock to Flow model
In response to “Modeling Bitcoin’s Value with Scarcity” https://medium.com/@100trillionUSD/modeling-bitcoins-value-with-scarcity-91fa0fc03e25
The Stock to Flow model is an important factor in the price of bitcoin, but it has several flaws as a complete model.
Hindsight is 20/20
Correlation/cointegration is not causation. The price mostly following the model so far could be coincidence — other key factors not coming into play or canceling each other out.
There are many potential events that would have a major impact on BTC/USD rate that aren’t accounted for in stock to flow. Some potential events:
US dollar collapse
Bitcoin-specific critical vulnerability
ECDSA or SHA256 broken
Bitcoin outlawed by US/China/EU
Massive adoption wave (bitcoin wallet added to Facebook, Twitter, or iPhone by default)
A major country adopts bitcoin as the official currency or pegs the official currency to bitcoin
A major central bank adds significant bitcoin to its reserves
Bitcoin mining becomes more centralized or more decentralized
Massive selloff of a bitcoin whale
Hack of major bitcoin custodian (Coinbase, etc)
Reductio ad absurdum
Stock to flow predicts ludicrous values for bitcoin in the future — these values are not possible (unless the USD collapses) because they would represent more than 100% of the world’s wealth. Interpolation is safer than extrapolation (going beyond gold’s stock to flow in the model is questionable). Stock to flow implies infinite value for 2140 when block reward stops. If the block reward were to go to zero at the next halving, stock to flow predicts infinite value, but in fact a zeroing of the block reward in 2020 would be damaging to bitcoin (as the transition to fee market and layer 2 solutions is not yet complete). More likely is that the predictive value of stock to flow decreases as the flow approaches zero.
Higher supply means higher price?
The logic of the S2F model means that supply and price are positively correlated (for any given flow). Thus, if bitcoin had had a much higher issuance in 2009 but today’s daily issuance remained the same in absolute terms, the bitcoin price would be higher (and marketcap would be much higher). Consider if Satoshi had selected an inital block reward of 5000 bitcoins and an annual halving. This version of bitcoin would not be more valuable and the value would be diluted by more bitcoins in circulation (and the value would be damaged further by what would likely be a more skewed distribution towards early miners). S2F suggests the value per bitcoin in that scenario would be much higher.
Similarly, the S2F model does not account for early lost coins. If, as some people believe, up to 4 million bitcoins are permanently lost, this lowers the S2F ratio (and predicts a lower price than if the coins were not lost!)
Value of the US Dollar
The S2F model predicts prices for bitcoin in USD without considering historical, present, or future rates of inflation. The S2F model doesn’t specify if the prices are in constant dollars or not. The US dollar is affected by factors outside of bitcoin halvings, such as the Federal Reserve’s monetary policy. There is no mechanism to account for any of these factors. While the USD has been fairly stable historically, the prices predicted by S2F for later decades suggest a USD hyperinflation (unless one believes that bitcoin will become more valuable than a multiple of all assets combined, which is absurd).
Log Log chart
Everything looks correlated on a log log chart. When both axes are logarithmic, you can have fluctuations by orders of magnitude look like a minor blip.
Metal Cherry-picking
PlanB mentions gold, silver, palladium, and platinum, then says that gold and silver S2F and price support S2F. Palladium and platinum do not. Palladium is currently worth more than gold, but it has (according to PlanB’s numbers) a S2F that is about 2% that of gold! It is bizarre to count gold and silver as supporting the model while ignoring platinum, palladium and other precious metals that do not fit.
Special case
Stock to flow only works for one cryptocurrency (bitcoin). While bitcoin does have unique properties, it isn’t hard to create or point to a cryptocurrency with a higher stock to flow ratio. Thus, the other unique properties of bitcoin must be factors in a more comprehensive price model. For example, bitcoin has more resistance to 51% attacks than other cryptocurrencies. The cost and feasibility of a 51% attack on bitcoin has changed over time (and will continue to change). This cost should be a factor in the model. If the cost to attack is too low, bitcoin cannot store a large amount of value. Bitcoin security is not a binary factor that distinguishes it from everything else.
Finally, stock to flow treats bitcoin as a commodity. Bitcoin has commodity-like properties, but it is also money, a Veblen good, a special kind of database, and some other things that defy categorization. Valuing bitcoin as a commodity doesn’t capture potential value from the other aspects of bitcoin.
