BayernLB (Bavarian State Bank), a publicly regulated bank in Munich, Germany, recently published a report that analyzes the claim made by some investors that Bitcoin is outperforming gold.
The report states that the “hardness” of an asset in the traditional commodities market is determined using the stock-to-flow approach. When applied to Bitcoin, this approach shows a strong correlation between the market value of the cryptocurrency and “the ratio between existing stockpiles of Bitcoin, called stock, and new supply, called flow.”
When making forecasts using this model, even the best statistical model can fail when it comes to accurately predict future market conditions, the BayernLB report noted. The next Bitcoin halving, when the digital currency’s supply will be reduced by 50%, represents a significant challenge for the stock-to-flow model, the report stated.
However, the stock-to-flow approach is still a good heuristic for understanding the value of Bitcoin. According to the BayernLB:
“It becomes clear that Bitcoin is designed as an ultra-hard type of money. Next year, it will already exhibit a similarly high degree of hardness as gold. In 2024 (when halving is set to take place again), Bitcoin’s degree of hardness will again increase massively.”
The bank’s report adds:
“Gold has had to earn its high stock-to-flow ratio ‘the hard way’ over the course of millennia… Bitcoin’s purely digital character enables ‘supply engineering,’ which causes the stock-to-flow ratio to rise at a breakneck pace.”
Central banks throughout the world will resort to extensive loosening measures while the $15 trillion bond market has yields in negative territory, the BayernLB report noted. This may have led to the gold price temporarily breaking out above the $1,500 mark.
Gold’s attractiveness as an asset comes from the fact that the supply side cannot be increased indiscriminately, the report stated. Moreover, the limited production of gold (“flow”) only adds to a very large stockpile (“stock“), which is why the precious metal has a relatively high stock-to-flow ratio (a measure of the “hardness” of gold as an asset)
Accordingly, gold is not susceptible to the “easy money trap.” As explained in the report, this “trap” leads to a price increase and higher production, which dilutes the existing stock and causes a downward price spiral.
The report pointed out that the basic idea behind Bitcoin, which was “explicitly designed as a new monetary good and geared to precious metal forms of money,” is based on financial (store of value) concepts related to the stock-to-flow approach.
The approach provides a quantitative framework for analyzing Bitcoin’s price. It allows us to compare the censorship-resistant cryptocurrency to gold and various other commodities.
Notably, the report mentions that Bitcoin will already have “a similarly high stock-to-flow ratio as gold in the coming year.”
Bitcoin’s digital nature allowed its supply path to be fixed when the protocol was first defined, the report explained. Bitcoin creator Satoshi Nakamoto specified such “a drastic and abrupt decline in supply growth (set to halve every 4 years) that no physical element from the periodic system could possibly keep pace with it”, the report mentions.
Satoshi decoupled supply from price and from mining activity or the computing power used to mint new Bitcoins. New bitcoins are created approximately every 10 minutes (currently 12.5 BTC).
The report further explained:
“When the [Bitcoin] price rises (falls) and more (less) computing power enters the system, the difficulty of mining new bitcoins will correspondingly ratchet up (down). This safeguards the targeted bitcoin circulation irrespective of price fluctuations. A further special feature of bitcoin tokens, which is likewise due to their digital character, is that they cannot be hung around people’s necks (in contrast, for example, to a gold necklace) or used as an input in production.”
“What would appear, at first glance, to be a disadvantage is, in fact, a feature and not a bug from the point of view of the stock-to-flow approach. Given that there are no other uses at all for bitcoins, no other demand-side developments (e.g. demand for gold in connection with the spread of smartphones) can distort price formation. Due to the deterministic trend in supply, there are naturally no supply-side shocks either.”
The report closes with a significant prediction. The authors state “Bitcoin is poised to take a big leap forward in 2020” – a jump that may hit a “vertiginous” price of USD $ 90,000.