Post
Topic
Board Bitcoin Discussion
Re: Forum moderation policy
by
torupc28
on 18/12/2020, 19:44:52 UTC
<--- I'd like to be able to see the date someone signed up, without having to visit their profile page.


Modeling Bitcoin Value with Scarcity

Satoshi Nakamoto published the bitcoin white paper 31/Oct 2008 [1], created the bitcoin genesis block 03/Jan 2009, and released the bitcoin code 08/Jan 2009. So begins a journey that leads to a $70bn bitcoin (BTC) market today.
Bitcoin is the first scarce digital object the world has ever seen. It is scarce like silver & gold, and can be sent over the internet, radio, satellite etc.
"As a thought experiment, imagine there was a base metal as scarce as gold but with the following properties: boring grey in colour, not a good conductor of electricity, not particularly strong [..], not useful for any practical or ornamental purpose .. and one special, magical property: can be transported over a communications channel" — Nakamoto [2]
Surely this digital scarcity has value. But how much? In this article I quantify scarcity using stock-to-flow, and use stock-to-flow to model bitcoin’s value.
Scarcity and Stock-to-Flow
Dictionaries usually define scarcity as 'a situation in which something is not easy to find or get', and 'a lack of something'.
Nick Szabo has a more useful definition of scarcity: 'unforgeable costliness'.
"What do antiques, time, and gold have in common? They are costly, due either to their original cost or the improbability of their history, and it is difficult to spoof this costliness. [..] There are some problems involved with implementing unforgeable costliness on a computer. If such problems can be overcome, we can achieve bit gold." — Szabo [3]
"Precious metals and collectibles have an unforgeable scarcity due to the costliness of their creation. This once provided money the value of which was largely independent of any trusted third party. [..][but] you can’t pay online with metal. Thus, it would be very nice if there were a protocol whereby unforgeably costly bits could be created online with minimal dependence on trusted third parties, and then securely stored, transferred, and assayed with similar minimal trust. Bit gold." — Szabo [4]
Bitcoin has unforgeable costliness, because it costs a lot of electricity to produce new bitcoins. Producing bitcoins cannot be easily faked. Note that this is different for fiat money and also for altcoins that have no supply cap, have no proof-of-work (PoW), have low hashrate, or have a small group of people or companies that can easily influence supply etc.
Saifedean Ammous talks about scarcity in terms of stock-to-flow (SF) ratio. He explains why gold and bitcoin are different from consumable commodities like copper, zinc, nickel, brass, because they have high SF.
"For any consumable commodity [..] doubling of output will dwarf any existing stockpiles, bringing the price crashing down and hurting the holders. For gold, a price spike that causes a doubling of annual production will be insignificant, increasing stockpiles by 3% rather than 1.5%."
"It is this consistently low rate of supply of gold that is the fundamental reason it has maintained its monetary role throughout human history."
"The high stock-to-flow ratio of gold makes it the commodity with the lowest price elasticity of supply."
"The existing stockpiles of Bitcoin in 2017 were around 25 times larger than the new coins produced in 2017. This is still less than half of the ratio for gold, but around the year 2022, Bitcoin's stock-to-flow ratio will overtake that of gold" — Ammous[5]
So, scarcity can be quantified by SF.
SF = stock / flow
Stock is the size of the existing stockpiles or reserves. Flow is the yearly production. Instead of SF, people also use supply growth rate (flow/stock). Note that SF = 1 / supply growth rate.
Let’s look at some SF numbers.
Image for post
Gold has the highest SF 62, it takes 62 years of production to get current gold stock. Silver is second with SF 22. This high SF makes them monetary goods.
Palladium, platinum and all other commodities have SF barely higher than 1. Existing stock is usually equal or lower than yearly production, making production a very important factor. It is almost impossible for commodities to get a higher SF, because as soon as somebody hoards them, price rises, production rises, and price falls again. It is very hard to escape this trap.
Bitcoin currently has a stock of 17.5m coins and supply of 0.7m/yr = SF 25. This places bitcoin in the monetary goods category like silver and gold. Bitcoin's market value at current prices is $70bn.
Supply of bitcoin is fixed. New bitcoins are created in every new block. Blocks are created every 10 minutes (on average), when a miner finds the hash that satisfies the PoW required for a valid block. The first transaction in each block, called the coinbase, contains the block reward for the miner that found the block. The block reward consists of the fees that people pay for transactions in that block and the newly created coins (called subsidy). The subsidy started at 50 bitcoins, and is halved every 210,000 blocks (about 4 years). That's why 'halvings' are very important for bitcoins money supply and SF. Halvings also cause the supply growth rate (in bitcoin context usually called 'monetary inflation') to be stepped and not smooth.


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