Despite the apparent volatility of Bitcoin’s value, growing consumer acceptance and investor confidence in cryptocurrency are expected to eventually lead to more stability in its value.
The stock-to-flow valuation model and its application to Bitcoin is perhaps not something familiar to the average investor but could have tremendous implications on forecasting the price of the leading cryptocurrency.
The model, introduced in a 2019 paper titled “Modeling Bitcoin Value with Scarcity,” uses scarcity to quantify bitcoin’s value. Bitcoin, as an asset class, is unconventional. For more conventional asset classes, including real estate and stocks, there are tried-and-true ways of measuring their value, such as discounted cash flow analysis (DCF), Price to Earnings multiples, etc.
“Because Bitcoin is such an unknown quantity, there are no set ways of measuring its value,” said Ari Stiegler, an early investor in cryptocurrency technology and managing partner at venture capital fund Flux Capital. “Stock-to-flow provides a potential method for predicting what the value of various cryptocurrencies will be in the future.”
A former Dutch institutional investor who writes under the pseudonym PlanB coined the stock-to-flow model for cryptocurrency in a 2019 paper. He said bitcoin is the first scarce digital object the world has ever seen.
“There are good reasons for investing in bitcoin instead of equities,” Stiegler said. “The decentralized nature of bitcoin, freed from supply decision of the Federal Reserve, creates an interesting hedge against fiat currencies.”
The maximum supply of bitcoin is capped at 21 million coins, making it a scarce commodity with a fixed supply. Currently, there are more than 18 million bitcoin in circulation, meaning that over 85% of all Bitcoin to ever exist has already been created.
Using the stock-to-flow model, an investor would take the number of bitcoin currently in circulation and divide it by the number of bitcoin mined each year. He or she would then arrive at the stock-flow (SF).
Determining SF is significant because there is a statistically significant relationship between stock-to-flow and market value.
Mining for bitcoin requires significant computing power, with ~50 MWh of electricity used to mine one bitcoin, Stiegler explained. Data-mining facilities in the US and China have been built with significant computational capacities all with the goal of minting cryptocurrency.
“Miners are essentially arbitraging the cost of electricity versus the price of Bitcoin to create cashflow” Stiegler said. “They are purchasing specific use hardware, building facilities, and taking the chance that the profitability between start and when the eventual margin of mining Bitcoin is close to zero, that they will have generated a profit when accounting for both fixed and variable costs.”
The environmental impact associated with mining cryptocurrency led Tesla CEO Elon Musk to recently announced his company would not accept Bitcoin as a form of payment. A reversal of an earlier position, Musk’s announcement drove down the price of Bitcoin.
Following the decrease in the price, the stock-to-flow model for Bitcoin was still intact.
Despite the apparent volatility of Bitcoin’s value, Stiegler said growing consumer acceptance and investor confidence in cryptocurrency will eventually lead to more stability in its value.
Pantera Capital, the first US institutional asset manager focused exclusively on cryptocurrency and blockchain technology, is also an advocate of Bitcoin and an early investor. In its April Investor Letter, Pantera Capital said it expects the price of bitcoin to hit $200,000 in 2022.
When it comes to Ethereum, Pantera Capital is similarly optimistic. On May 12, Pantera Capital CEO and Co-Chief Investment Officer Dan Morehead tweeted:
“It just happened – Decentralized Finance now more valuable than any centralized finance. Bitcoin and Ethereum each worth more than any bank.”
Pantera Capital advocates going long on Bitcoin or Both bitcoin and Ethereum, calling it “a great first step” in its May investor letter. The asset manager’s positive projections on cryptocurrency stem in part from the increasing US budget deficits.
“Bitcoin is an inflation hedge,” Stiegler said. “Gold used to be a popular place to put money when people were concerned about inflation. Nowadays, bitcoin and other cryptocurrency are serving that purpose.”