A follow up on Bitcoin’s S2F model

After my recent article on why you don’t need S2F to value Bitcoin, I had an interesting conversation with PlanB, and I’ve been following a lot of conversations on Twitter since then.

As a result, I’ve edited my original article to (I hope) more fairly present what S2F actually is, and make sure none of my arguments are based on setting up a straw man.

One point I made in my original article was:

What this means is, to some level, even though demand is not an explicit variable in the S2F model, the model must implicitly assume a consistent increase in demand over future years

PlanB recently tweeted, making some really interesting points:

In a nutshell, he compares Bitcoin to a Veblen Good, and actually makes the point that S2F can be seen as a model which predicts demand.

It’s really great to hear PlanB raise this point, as in my original article one thing I really wanted to emphasize is that demand is a kind of “hidden variable” in the S2F model. In other words: S2F has this implicit assumption that demand will continue to increase over the following years.

In this framing, S2F is more saying “here’s what the price will be after each halving, given steadily increasing demand”, rather than “here’s what the price will be after halving, even if demand stays flat”.

I think this fundamental assumption that demand will steadily increase, is probably true. In case it’s not already clear, I’m a huge proponent of Bitcoin, and I think that as more people discover it, the adoption will increase, and the demand will increase.

What could be the cause of this increased adoption and demand?

• Many people do view Bitcoin as a ‘scarce’ good that they want to get their hands on while they can, in anticipation of it becoming scarcer.
• Many people want to buy Bitcoin because of the ‘intrinsic’ value of the network: the ability to prove ownership of and transfer vast sums of money, which only gets easier as more value is stored on the network.
• Many people see this as a hedge for the macro narrative; that fiat currencies will be gradually debased and devalued, and Bitcoin is a sound alternative.

These are all potentially valid lines of reasoning.

So where does S2F fit in?

Even if we treat S2F as a model for steadily increasing demand, which I think is a fair argument for why it may have the accuracy it does so far, the issues I still have are:

1. Veblen goods are valued because of their price, and because of their scarcity. S2F does not model Bitcoin’s price as a flywheel, where “as the price increases, the demand will increase and the price will increase further”. Instead it models Bitcoin’s price based on the stock to flow ratio at any given time.
2. That stock to flow ratio does not seem to truly represent the scarcity of Bitcoin. The flow of newly minted coins is a much smaller number than the daily volume of coins traded on the open market, as argued in my original article.
3. So we’re forced to conclude that if S2F is correct, it must be the perceived scarcity of Bitcoin (due to the halving cycles every four years) which has the most impact on the price trajectory.
4. I believe the perceived value of Bitcoin, is a much stronger narrative than the perceived scarcity. Especially given that the true scarcity is dictated by the market, not the miners — which any decently-sized investor or institution is certain to realize.
5. The true Bitcoin scarcity is not only programmatically defined, but a totally static number — the 21 million Bitcoin cap. It is far more common for investors to reference this 21 million cap than to reference the current block reward, when explaining their mental models on scarcity. As such the ‘real’ scarcity is much more of a factor than the ‘perceived’ scarcity.
6. I also question, even if S2F purports to model for increasing demand, how accurate that can remain in the long term. Demand is a fickle thing, which is not usually correlated years in advance with any known quantity, and is not usually just a function of time which can steadily increase forever. For one thing, there are a finite number of humans and institutions that can actually adopt Bitcoin.

Could Bitcoin be a Veblen good? Perhaps. But I’m not yet convinced that the volume of newly mined coins is the largest factor in determining that. My view is still that Bitcoin’s perceived value, actual scarcity, and massive network effects, are far stronger factors than the impact caused by perceived scarcity.