Entrance
Satoshi Nakamoto published the Bitcoin introduction report on October 31, 2008[1], created the first genesis block on January 3, 2009, and opened the Bitcoin code to the public on January 8, 2009. Thus, the journey of Bitcoin (BTC), whose market value reached 70 billion dollars, began.
Bitcoin is the first rare digital asset that humanity has ever witnessed. It is rare, just like gold or silver, and can be transferred via means such as the internet, radio and satellite.
“As a thought experiment, imagine a metal like gold that is limited in quantity, is a boring gray color, is not a good conductor material, has no specific strength, has no practical use or can be used as ornaments, but it is an incredible metal. “It can be transported through communication channels.”[2]
Of course, this digital rarity has value. But how much? In this article I measure rarity using the stock-to-flow ratio and use the stock-to-flow ratio to model the value of bitcoin.
Rarity and Stock to Flow Rate
According to dictionaries, rarity is commonly used in the sense of "the state of not being able to find or obtain something easily" and "lack of something".
Nick Szabo made a more useful definition: "Inimitable value"
“What do antiques, time and gold have in common? They are valuable. They are valuable either because of their original value or because their history is not open to probabilities, and this value is very difficult to deceive. There are some problems with adapting inimitable value to computers. If these problems can be overcome, we can achieve “bit gold”.” — Szabo [3]
“Precious metals and collectibles have a rarity that cannot be imitated due to the cost of their acquisition. This gave the money a value independent of mostly trusted third parties. But you cannot make payments online with metals. For this reason, it would be great if there were “bits” that could be generated over the internet, with an inimitable value that depended as little as possible on trusted third parties, and could then be securely stored, transferred, and analyzed with minimal trust. Bit gold.” —Szabo [4]
Bitcoin has an inimitable value because producing new bitcoins requires a lot of electricity costs. Bitcoin production is not something that can be easily imitated. Keep in mind, this inimitability is the result of fiat money currently in circulation, which has no supply limit, no proof of work, and hashrate (the number of coins made by a Bitcoin provider in a given period of time) that are low or low. It does not apply to altcoins that can be influenced by a small group of people or companies.
Saifedean Ammous talks about rarity using the term Stock-to-Flow Ratio. The fact that gold and bitcoin have a high Stock to Flow Ratio explains why gold and bitcoin are different from other consumable products such as copper, zinc, nickel and brass.
“For any consumable commodity, a doubling of production will dwarf existing stocks, driving down the price and harming owners. “The price increase for gold, which would lead to a doubling of annual production, would be negligible and would increase the stockpiling rate by 3% instead of 1.5%.”
“The main reason why gold has maintained its monetary role throughout human history is that its supply is constantly low.”
“Gold's High Stock-to-Flow Ratio makes Gold the commodity with the lowest supply-price elasticity.”
“In 2017, existing Bitcoin stocks were approximately 25 times larger than new coins produced in 2017. This ratio was still less than half that of Gold, but around 2022, Bitcoin's Stock-to-Flow Ratio will surpass gold.” —Ammous[5]
Therefore, rarity can be measured by SF.
SF = stock/flow
Inventory is the size of existing stocks or reserves. Flow is annual production. Instead of SF people also use supply growth rate (flow/stock). In this case, SF = 1 / supply growth rate.
Let's take a look at the SF numbers below:
Gold has the highest SF at 62. This means it would take 62 years of production to reach the current gold stock level. Silver is in second place with a value of 22 SF. High SF makes Gold and Silver monetary goods.
SF values of palladium, platinum and all other commodities are either slightly higher than 1 or lower than 1. Whether the current stock is equal to or less than annual production makes production a very important factor. It is almost impossible for commodities to achieve a higher SF, because as someone hoards them, the price rises, when the price rises, production increases, and when production increases, the price falls again. This is a vicious circle that is very difficult to escape from.
Bitcoin currently has a stock of 17.5 million and annual production is 0.7 million, so SF = 25. This rate puts Bitcoin in the category of monetary goods, like gold and silver. The size of the Bitcoin market is currently $70 billion.
Bitcoin supply is fixed. New bitcoins are created with each new block. A block is created every 10 minutes (on average) when a miner finds the hash value that meets the proof of work (PoW) required for a valid block. The first transaction in each block—called coinbase—contains the block reward for the miner who finds the block. The block reward consists of the fees people pay for transactions in that block and newly created coins (called subsidies). The subsidy started at 50 bitcoins and halved every 210,000 blocks (about 4 years). That's why the “halving” is so important for Bitcoin supply and SF. The halving also causes the supply growth rate (often referred to as 'monetary inflation' in the context of bitcoin) to be gradual and jagged.
source: https://plot.ly/~BashCo/5.embed
Stock to Flow Ratio and Value
The hypothesis in this study is that scarcity directly creates value, as measured by SF. Looking at the chart above confirms that market values are higher when SF is high. The next step will be to collect data and build a statistical model.
Data
I calculated Bitcoin's monthly SF value from December 2009 to February 2019 (111 total data points). The monthly block count can be queried directly on the bitcoin blockchain with Python / RPC / bitcoind. The actual number of blocks is quite different from the theoretical number because blocks are not produced exactly every 10 minutes (for example, there were far fewer blocks in the first year, 2009). You can calculate the current and stock amount with the number of monthly blocks and the known block subsidy. I fixed the missing Bitcoins by arbitrarily ignoring the first 1 million Bitcoins (7 months) in the SF calculation. A more accurate calculation of lost coins will be the subject of future research.
Bitcoin price data is available from different sources, but the first price data starts in July 2010. I added the first known Bitcoin prices (1309 BTC = $1 in October 2009; 1 BTC = $0.003 according to BitcoinMarket in March 2010, and 10,000 BTC = $41 in a payment for 2 pizzas in May 2010) and applied interpolation. Data archeology will be the subject of future research.
Since we already have data for gold (SF 62, market cap $8.5 trillion) and silver (SF 22, market cap $308 billion), I used them as a reference.
Model
SF — the first scatter plot of market cap shows that since market cap is in value magnitude 8 ($10,000–$100,000), it is better to either express market cap logarithmically or adjust the axes based on market cap. Using logarithmic values or axes for SF shows a nice linear relationship between ln (SF) and ln (market cap). Let me note that I used the natural logarithm (in base e) and not the common logarithm (in base 10), even though it would give similar results.
Charts made with gnuplot and gnumerics
Fitting a linear regression to the data confirms what can be seen with the naked eye: there is a highly statistically significant relationship between SF and market cap. (R2 95%; significance level of F 2.3E-17; p-value of the slope 2.3E-17). The probability of the relationship between SF and market value occurring by chance is close to zero. Of course, there are other factors that have an impact on the price, regulations, cyber attacks and other news… This is why R2 is not 100% (also because not all dots are on the solid black line). However, the dominant driving factor seems to be Rarity/SF.
What is quite interesting is that although they are completely different markets, gold and silver are in line with the Bitcoin model value for SF. This increases confidence in the model. I would like to remind you that at the peak of the bull market (the period when the market is in an uptrend), in December 2017, Bitcoin SF was 22 and the Bitcoin market cap was $230 billion, which is very close to silver.
Since halvings have a huge impact on SF, I showed the time until the next halving with a color change on the chart. Dark blue represents the month of the halving, and red represents the month right after the halving. The next halving will occur in May 2020. The current SF value of 25 will double to 50, which is very close to gold's SF value of 62.
The projected market value for Bitcoin after the halving in May 2020 is $1 trillion. This means 1 Bitcoin = $55,000. Exceptional value. I think 1-2 years after the halving, in 2020 or 2021, we will see whether we were right or not. This is a great event for sample testing of hypothesis and model.
People ask me where will all the money for $1 trillion Bitcoin market cap come from? My answer: Silver, gold, countries with negative interest rates (Europe, Japan, USA soon), countries with governments pursuing destructive economic policies (Venezuela, China, Iran, Turkey, etc.), billionaires and millionaires protected against quantitative easing, and institutional investors in the last 10 They discover the best performing asset of the year.
We can also model the Bitcoin price directly with SF. Of course the formula has different parameters, but the result is the same, 95% R2 and the SF of bitcoin after the May 2020 halving is 50, resulting in an estimated bitcoin price of $55,000.
I placed the price of Bitcoin based on SF (black line) and the real price on the same chart and showed the number of blocks produced each month in different colors.
Pay attention to the degree of alignment, especially the price stabilization that followed immediately after the 2012 halving. Settlement after the June 2016 halving was much slower, likely due to the Ethereum hackathon and DAO attack. Additionally, monthly block production appears to be less in 2009 (blue). Additionally, there is a decline due to difficulty adjustments at the end of 2011, mid-2015, and end of 2018. The introduction of GPU miners in 2010–2011 and ASIC miners in 2013 led to an increase in monthly block throughput (red).
Power Laws and Fractals
Another interesting issue is the existence of an indicator of the power law relationship.
Linear Regression function: Ln(Market Cap) = 3.3 * Ln(SF)+14.6
.. can be written as a Power Law function: Market value = exp(14.6) * SF ^ 3.3
Power Laws are very rare, they don't occur often. The probability of a power law with an R2 value of 95% and an order of magnitude of 8 increases the confidence that the main driver of the Bitcoin price has been correctly identified by the SF value.
A power law is a relationship in which a relative change in one quantity leads to a relative relative change in another quantity, regardless of the initial size of those quantities. [6]. With each halving, Bitcoin SF doubles and its market cap increases by 10x, this is a constant factor.
Power laws are interesting. Because they reveal an underlying regularity in seemingly random and complex systems. See the appendix for some famous power law examples. Complex systems often have entities where changes between phenomena at different scales are independent of the scales we are looking at. This self-similar entity forms the basis of power law relationships. We see this with Bitcoin as well: the 2011, 2014 and 2018 declines are very similar (all with -80% declines) but on completely different scales (like $10, $1000, $10,000). If you don't use logarithmic scales, you can't see it. Scale variability and self-similarity have a connection with fractals. In fact, parameter 3.3 in the power law function above is the 'fractal dimension'. For more information about fractals, see the famous coastline study length [7].
Closing
Bitcoin is the first rare digital object the world has ever seen, it is rare like silver and gold and is rare like the internet, radio, satellite, etc. can be sent via .
Of course, this digital scarcity has its value. But how much? In this article, I measure scarcity using the stock-to-flow ratio and use the stock-to-flow ratio to model the value of bitcoin.
There is a statistically significant relationship between stock-to-flow ratio and market value. The probability that the relationship between stock-to-flow ratio and market value will arise by chance is close to zero.
Hardening the model:
The SF value of Gold and Silver, which are completely different markets, is in line with the bitcoin model values.
There is an indication of a power law relationship.
The model predicts that bitcoin's market value will be $1 trillion after the halving in May 2020. This means that the price of one bitcoin will be $55,000.
- It is not an investment advice..
Thanks
References: Medium /huseyinoguz thank you..