Saifedean-PlanB-Stephan-Bitcoin-S2F

Bitcoin S2FX, S2F, and Evolution from Collectible to Financial Asset |PlanB & Saifedean Ammous on the Stephan Livera Podcast

Check out The Stephan Livera Podcast Episode Page & Show Notes.

Key Takeaways

  • As Bitcoin’s stock to flow ratio changes, it becomes a different kind of asset, manifested in its evolution from a collectible to a financial asset
  • Silver is demonetizing and becoming an industrial metal, like copper or iron
  • The Stock-to-Flow Cross Asset (S2FX) model estimates the market value of the next BTC phase/cluster to be $5.5T. This translates into a bitcoin price of $288K assuming a circulation of 19 million coins
    • Making it an institutional-grade investment asset will be enough to justify the valuations
  • If bitcoin’s monetary premium keeps rising against gold, then gold is losing value in real terms
    • Gold could be hitting its limitations as money, possibly evident in its price not climbing to new all-time high despite the economic disasters worldwide
    • Bitcoin is a monetary black hole that will suck out monetary premium from everything else (e.g. real estate)
  • Because it represents less than 1% of global money supply, investing in Bitcoin is akin to investing in a fast-growing startup that aims to replace central banks and has a potential market of all the global money supply
  • A valuation of $5.5T means Bitcoin surpasses the monetary base of the US Dollar, this will have serious geopolitical consequences
    • “I know the department of defense is writing papers about Bitcoin, how to attack it, how to follow it, or whatever” – PlanB
    • “If the model is successful, it will not be a pretty picture, it will be nasty, maybe war”

Resources Mentioned

Intro

Motivation for the Stock-to-Flow Cross Asset Model SF2X

  • The original model had 2 formulae, one for the time series and another for the gold and silver, but PlanB always wanted a unifying formula
    • Raoul Pal was among the first to recognize the original model could be used to value Gold and Silver, and he encouraged PlanB to dig deeper
  • Additionally, the new model examines the same data from a new perspective
    • Whereas the first model was a strict time series analysis and co-Integration, the new model examines Bitcoin’s phases
    • PlanB hopes this will attract military and geopolitical thinkers to the space

Bitcoin is Evolving as Money

  • Bitcoin’s price has tracked stock to flow since inception, S2FX model captures an intriguing property:
    • At any given stock to flow ratio, Bitcoin becomes a different kind of asset
    • Bitcoin’s liquidity increases as it grows, making it better money, and further increasing its demand
  • That said, Saifedean doesn’t consider Bitcoin (or anything) to be a Veblen good – Here is why:
    • A Veblen good is a luxury item for which demand increases as the price increase
    • However, the demand going up with price reflects a different good purchased for a different end, not a rise in demand for the same good

Phase Transitions Applied to Bitcoins

  • Water can exist in different phases – liquid, solid, gas, ionized
    • “It’s all water but totally different things with different properties”
  • In finance, the US Dollar first was a gold coin, then it became a gold receipt. In 1971, Nixon broke the gold standard and dollar became paper money (fiat currency)
    • “We call all of them dollar, but in reality, those are different things”
  • Similarly, Bitcoin has experienced 4 phase transitions, and “While we called it Bitcoin all the time, it’s not the same”
    • Started out as a proof of concept of magical internet money
    • Payments network after achieving dollar parity – 1 bitcoin = $1 
    • E-gold: A store of value after achieving gold parity – 1 bitcoin = 1 ounce of gold
    • With futures markets opening, Bitcoin is now considered a financial asset
  • These can be considered as just narratives, but for PlanB “Quantifying it made it real”

Another Phase Transition: The Demonetization of Silver

  • Saifedean recently tweeted about how silver, like copper or iron, is becoming an ex-monetary metal and more an industrial metal – he explains why:
    • After 1871 Franco-Prussian war, most of Europe switched from a silver to a gold standard, network effects mean less reason to hold silver
    • Additionally, the need for silver for smaller transactions was replaced by modern banking instruments
    • The result: historical price between gold and silver was always 1:14, but it has been declining ever since, reaching 1:120 recently
  • The industrialization of a monetary metal comes with a serious implication – the decline of its stock to flow ratio
    • The upshot is the price is now under producers’ control, if people try to hoard silver, more production will simply crash the price (e.g. Silver Thursday in 1980)

A Walk Through the S2FX Model

  • The model plots 10 years of monthly bitcoin S2F vs market value
  • The chart shows some groups, applying a clustering algorithm reveals 4 clear clusters which map to Bitcoin phases discussed earlier
  • Interestingly, you can switch to weekly or daily data, adding more data points, but the center of clusters doesn’t move
    • This indicates the center is the real signal in the noise
  • Fitting a regression line uncovers R2 goodness of fit score of 99.7%
    • The formula also captures the value of gold and silver (Cross asset model)
    • PlanB would love to add other assets with s2f above 1 (diamonds, real estate) but valuing those is complicated
  • The model estimates the market value of the next BTC phase/cluster to be $5.5T. Assuming 19 million coins, this translates into a bitcoin price of $288K

Interpreting the S2FX Model

  • The model is about forecasting orders of magnitude changes, not predicting price targets
    • How would an asset with S2F 56 be valued?
    • S2FX enables more discussion and is less strict than time series
  •  Bitcoin’s S2F is known in advance to go up, can we relate the asset to the time epoch?
    • An interesting topic for further research: how are gold and silver moving through the S2F line?
  • “The important thing in science is not so much to obtain new facts as to discover new ways of thinking about it” – William Lawrence Bragg

Criticisms of the Model

  • A model should be used to guide your thinking. Instead, people tend to get married to models
  • Popular criticisms include S2F going to infinity in 2140 and the model breaking down, or the model only capturing supply and not taking demand into account
    • PlanB recalls the quote “All models are wrong, some are useful” – George E. P. Box
    • The model maybe broken someday, but just forecasting the next phase or two makes it useful
  • Additionally, despite all the criticisms, no other model comes close in performance
    • “The fact that you can find issues with the model, but can’t do better should make you think” – Saifedean Ammous

On Price Targets Changing

  • A common comment on valuation models is “Price targets have changed from the old model, they are just covering their basis”
  • In reality, models get tweaked and changed all the time, but this is usually done in closed debates between scientists
    • Nowadays the entire process unfolds live on twitter
    • “Somethings are better if you don’t know how they are made, it’s the same for sausages, and the law, and also with models” – PlanB
  • Additionally, the model forecasts orders of magnitude, not precise price targets
    • With that said, over the lifetime of Bitcoin, being able to forecast $3K-$13K for a certain year is astonishing

Running the Analysis Based on “Satoshi’s Schedule”

  • The problem of causation vs correlation cannot be resolved mathematically – Saifedean elaborates:
    • For example, you buy a puppy, and coincidentally, a new construction project springs up next to your house
    • Plotting the growth rate of the puppy vs the house reveals a strong correlation
      • They both “grow” for about a year or two then growth stops
    • It is hard to mathematically prove whether it was the puppy that caused the building to “grow” or the opposite
    • You just need to reason and use your brain, but “this is not a very popular thing among economists these days”
  • In an attempt to further understand the relationship between S2F and price, Saifedean and PlanB ran the S2FX analysis on “Satoshi’s schedule” – let’s expand:
    • Run the equation on the original block schedule of Bitcoin released in 2009
      • That is: assume a new block is created exactly every 10 minutes (In reality, blocks are created on average every 10 minutes)
    • The result: an even higher R2 than the actual S2F models
  • “People can get lost in mathematical details and miss the astonishing fact that an exogenous variable is predicting the human action of millions participating in a global market worth over $100B with this much precision” – Saifedean Ammous

The Model is a Challenge to Austrian Economics

  • From an Austrian perspective, one can’t rely on mathematical modelling to predict human action and behavior
    • Human action can’t be abstracted into equations and variables
  • That said, S2F is capturing the actions of billions who decide to buy/sell/ignore Bitcoin
    • “Look at regression analysis, you will never find these kind of numbers of an R2 that is this high for anything that is related to human action, for anything in which human beings are acting” – Saifedean Ammous

Is Gold the New Silver?

  • All historical attempts to replace gold were by inflationary currencies under someone’s control
    • Bitcoin attacks gold in terms of stock to flow, it’s is less inflationary than gold
    • If bitcoin’s monetary premium keeps rising against gold, then gold is losing value in real terms
  • Gold could be hitting its limitations as money – namely the difficulty of international clearance and central banks owning most of it
    • A sign of this is gold not climbing to all-time highs despite all the economic disasters worldwide

Does the Model Account for Inflation?

  • PlanB:
    • If we go back 400 years and examine gold, you have to adjust for inflation, but this is problem ridden
    • Bitcoin advancing to 6th phase means the Dollar is severely impacted or “Killed in action” – Prices in USD become irrelevant
  • Saifedean:
    • The model doesn’t have to break down, a dollar break down is equivalent to bitcoin’s market cap going to infinity in $ terms
  • Fact: Fiat currencies breakdown
    • PlanB drives it home: “All 400 of them went down, there is none that survive, especially reserve currencies, none lasted for 200 years, it will come to an end the dollar”
    • “The model will outlive the dollar” – PlanB

Bitcoin’s Threat to Central Banks

  • Because it represents less than 1% of all money supply, investing in Bitcoin is akin to investing in a fast-growing startup
    • This startup aims to replace central banks and its potential market is all of the global money supply
  • Bitcoin is addressing society’s demand for hard currency – Saifedean explains:
    • “The fact that Bitcoin beats other investments is essentially the market saying there are no better investments for the human race to be making right now than getting rid of central banks”
      • He adds: “The more people stop investing in other things and invest in this startup that replaces central banking, the faster we can be done with central banking and getting back to living like civilized human beings”
  • That said, price gains only happen in the growth phase, then Bitcoin becomes just a stable store of value

Phase 5 and Beyond

  • Making it an institutional-grade investment asset will be enough to justify the valuations
  • Beyond phase 5, Bitcoin is a monetary black hole that will suck out monetary premium from everything else
    • For instance, premium in real estate being held for its value rather than utility
    • Bitcoin has an important role to play as the hardest money without utility value
  • A valuation of $5.5T means Bitcoin surpasses the monetary base of the US Dollar, this will have serious geopolitical consequences
    • “I know the department of defense is writing papers about Bitcoin, how to attack it, how to follow it, or whatever” – PlanB
    • The Bitcoin community is currently understaffed with only developers, miners, investors, and thinkers, “We need more”
  • “Bitcoin will be bigger than just an investment or an asset, it will be money, the thing that humans choose in all their trading, as their unit of account eventually, it will be big” – PlanB

PlanB Closes With a Bomb

  • PlanB would go dark if the model succeeds, not if it breaks – here is why
    • “If the model is successful, it will not be a pretty picture, it will be nasty, maybe war”
      • Some people and countries have bitcoins; others won’t and they will fight
      • USD losing its reserve status will come with serious geopolitical and military events
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