cc_flow ratio

What is Stock to Flow Ratio (S2F)?

What is Stock to Flow Ratio (S2F)? One of the simplest ways of measuring the abundance of a particular resource is by using the Stock to Flow Model. The Stock to Flow ratio is the amount of a resource that holds in reserves then divides by the amount that produces annually. Generally, the Stock to Flow model is used in natural resources which is most commonly seen with gold and other natural resources. So let’s take Gold for an example. The World Gold Council estimates that a total of 190,000 tons of gold has been mined. This amount is what is referred to as a stock. Each year, there is roughly 2,500 – 3,200 tons of gold that is mined. This amount is what we will refer to as flow. 

What is the Stock to Flow (S2F) Model?

So now that we have these two metrics, we can easily calculate the Stock to Flow ratio. However, what is the underlying meaning behind this? So essentially the model helps to show how much supply enters the market each year given a resource relative to the total supply. Hence, the higher the Stock to Flow ratio is, the lesser in new supply enters the market relative to the total supply. And of course, an asset with a higher Stock to Flow ratio would, theoretically, have a stronger retaining value over the long-term. 

In comparison to consumable goods and industrial commodities. These types of products generally will have a lower Stock to Flow Ratio. The main reason for this is because the value derives from being destruction or consumption, hence there is always leftover inventory to cover the demands. So these resources don’t tend to have high value as possession and tend to work poorly as investment assets. In some cases however, the price can rise quickly if there is an anticipation of a shortage in the future, but otherwise the production should be able to keep up. A good example of this is the shortage is with toilet paper back in March of 2020 with the coronavirus. Many were predicting shortages in toilet papers and that resulted in a quick surge in prices of toilet papers as well. 

Photo taken from Forbes.

It is important to note here that a scarcity in a resource does not exactly mean that it is valuable. The Stock to Flow ratio helps to only suggest that a resource is valuable because the annual production as compared to the existing stock is relatively small and constant.

Does Bitcoin have a Stock to Flow Ratio?

Of course, if you know how Bitcoin works, you will know that Bitcoin also has a Stock to Flow (S2F) ratio. The Stock to Flow model essentially treats Bitcoin as a commodity just like gold or silver. Similar to gold and silver, Bitcoin works quite the same way given its scarcity and low flow.

Photo taken from Binance.

Now by looking at the components of this model, Bitcoin can be seen as a scarce digital resource that will be able to retain its value over the long-term. Moreover, Bitcoin’s price could see a significant increase over time since its Stock to Flow ratio continually reduces.

So what exactly is Bitcoin’s Stock to Flow ratio?

As of right now, there are roughly 18.5 million Bitcoins in circulation. The new supply is approximately 0.7 million each year. Bitcoin’s current Stock to Flow ratio is 25. Gold’s Stock to Flow ratio is about 60. So it is clear that Gold is seen as more valuable in comparison to Bitcoin. The image below shows the historical relationship of the 365-day moving average of Bitcoin’s Stock to Flow ratio with its price.

Photo taken from LookIntoBitcoin.com.

Wait so are there any limitations with the Stock to Flow ratio?

Well the Stock to Flow ratio is definitely something that is interesting for measuring scarcity. However, it does not actually account for everything. The models are just as good as assumptions. If Bitcoin does not have any other useful qualities other than supply scarcity then the model will fail. One of the biggest valuations of an asset is its volatility. Everyone knows that Bitcoin and cryptocurrencies are highly volatile. If the volatility were to be more predictable then the valuation model may be more useful.

Despite Bitcoin’s volatility being on a relative decrease on the macro level. The price of Bitcoin self-regulates on the open-market by everyone. In combination with the low liquidity, Bitcoin is more likely to have exposure to sudden spikes of volatility than other assets. It is also important to note that the model is unable to foresee economic Black Swans events. A great example of this is the coronavirus. 

Conclusion

Now just like every model, it has its flaws and downsides, not every model is perfect. Each and every model is just as good as your own assumptions. So before you decide to make any investments, be sure to always do your own research.

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