Investment is a factor of future contemplation of the market and the risk appetite of the investor. If you invest smartly, you are bound to reap good returns. Although to invest smartly, you must have in-depth knowledge of the assets.
To decide upon the type of investment option suitable for you, you must predict its returns. How can anyone envision the future price of an asset while making investment decisions? Investors use the Stock to Flow model for this.
What is the Stock to Flow model?
The stock to flow model is based on the hypothesis that the factor that decides the value of any asset is its scarcity. It functions around the theory of inadequacy, which can help predict the future of any commodity.
This model yields the ratio of the stock currently in reserve to its flow. In other words, it estimates the quantity of the commodity in a stockpile against its production rate. The ratio represents the per annum supply of the good in the market compared to its total supply reservoir.
A high stock-to-flow ratio indicates lesser supply into the market than the total supply. Thus, theoretically, an asset with a higher stock-to-flow proportion would maintain its value over a long period.
Where Can We Apply This Model?
The Stock to Flow model applies to a variety of assets. Based on the assumption of scarcity, it has successfully testified its applicability on precious metals. The model works best for scarce commodities and “store of value” resources.
Store of Value resources are those that can retain their value over a long period. Due to their relative scarcity and less flow, commodities with good store value maintain their worth over a long period without devaluation.
For this very reason, widely produced commodities are not considered good stores of value. Due to the readily available nature of their new supply, it is easy to destabilize their value.
One can not deny that in this digital era, technology reins every field. There is no shortage of investment options in business, and people invest as per their financial capabilities and risk appetite.
Since time immemorial, gold has been considered one of the safest assets for investment. With technological innovations, new investment options have emerged.
Cryptocurrency is one such investment option that has surpassed the yellow metal in terms of returns. Merely a decade old, it has already carved a niche for itself. It has managed to become a hot favorite amongst investors by guaranteeing better returns.
Bitcoin, a type of cryptocurrency, has already benefitted immensely from the Stock to Slow model. It has successfully utilized the stock-to-flow ratio to predict its future valuation. Since the beginning, its price has aligned with the predictions displaying minor variation.
Costly production and restrictions on their maximum supply make Bitcoins extremely scarce. Thus, investors can manage Bitcoins like other scarce commodities such as gold and silver using the Stock to Flow model.
What is the Success Rate with Other Models?
Investing in cryptocurrency may seem daunting as the crypto market is notorious for being unpredictable. Investors have tried to use traditional models like Elliot Wave Theory and Rainbow chart to predict investment factors.
While the former draws a parallel between investor behavior and psychology, the latter relies heavily on historical data to predict the future. The Elliot Wave theory failed in its predictions because it relied on unknown factors and disparate investor decisions. The rainbow chart backfired because, for long-term assets, historical data hardly aligns with future predictions.
These complex models can give any new investor cold feet. But, there is nothing to worry about when using the Stock to Flow model. The simplicity of this model reduces uncertainty in making predictions of the crypto market and helps investors make foolproof investment decisions.
Gold or Bitcoin Predictions: Which is More Accurate?
Though value prediction models initially applied to precious metals, their Bitcoin value predictions were closer to accuracy.
In recent years, the rate of production of gold has substantially increased due to technological advancement. That may drive you to think that it has better predictability due to its consistent flow.
However, when it comes to Bitcoin, its halving events are enough to outdo the predictions of gold. Halving, which occurs almost every four years, reduces the total number of Bitcoins mined, making them scarcer and thus more valuable. Due to this relatively coherent flow, the stock-to-flow model can be a good indicator.
How Reliable is the Stock to Flow Model?
Stock to Flow model may seem to show promises of accuracy, but it is far from perfection. There have been two instances where Bitcoin was misvalued using this model, causing a dent in its credibility.
As scarcity is the only assumption considered for the model, it would hold well only as long as they are accurate. The model boasts about its simplicity, but this simplicity may prove to be a double-edged sword, leading to its undoing. It does not consider all the elements that may affect predictions, thus causing variations.
For example, factors like Blockchain disruptions, cyberattacks, and investor psychology are not considered by the crypto stock to flow model for predictions. It may lead to unforeseen changes in its price in the future.
Wrapping Up
We have seen how resourceful the Stock to Flow model can be. However, everything is not always hunky-dory, as it has encountered pitfalls in the past.
But, they can be dealt with for positive outcomes. A thorough study of the model in crypto investments can better guide you in your investment decisions.
It is also clear that no model is perfect. So, if different models are combined to compensate for the shortcomings of the other, it would ascertain better predictions. If you know how to use the models precisely and appropriately, it will guarantee you good results.