PlanB rejoins me in this anticipated follow up episode discussing his stock to flow data modelling of Bitcoin’s valuation. The first episode was hotly downloaded and discussed online, so this time we talk about whether the recent bullish price action is a reflection of speculators front running the May 2020 Bitcoin block subsidy halving. Don’t miss this episode!

Response to the first episode

Stock to flow multiple

Front running the halving

The 1% BTC, 99% Cash portfolio

Bitcoin and commodities

Future pathways for institutional investment

PlanB links:

Sponsor links:

Ministry of Nodes:

Podcast Transcript (Sponsored by GiveBitcoin.io)

Stephan Livera: Welcome to the Stephan Livera Podcast focused on Bitcoin and Austrian economics. Learn the economics and technology of Bitcoin. Today, I’ve got a really special guest. I know this has been a very highly anticipated episode with PlanB. But before that, a quick word on behalf of my sponsors. Firstly, Kraken. Kraken are the best Bitcoin exchange. Over my years in Bitcoin, I’ve been really impressed with the way they operate. They have really consistently offered a very strong focus on security. They have consistently acted ethically in the space under Jesse Powell’s leadership. They are one of the longest standing Bitcoin exchanges. They’re consistently rated the best. They’ve got a really high quality platform. They offer some of the best liquidity possible in the industry. They’ve got high trading volume and low fees.

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Stephan Livera: So with the episode today with PlanB, he first appeared on episode 67, and this episode was one of the most downloaded episodes, and I recommend you listen to that one first before listening to this one if you haven’t already. And in this episode, we essentially talked about some further discussion on his stock-to-flow modeling. We explore this question of whether people now are trying to front run the coming Bitcoin halvening. And we also discuss a few other questions around how many cycles could we anticipate this working for as well as a few other ideas that PlanB is working on. On to the interview.

Stephan Livera: PlanB welcome back to the show, mate.

PlanB: Thank you very much, Stephan. I’m glad to be here, and great to be on the show again.

Stephan Livera: PlanB, we had an incredible response to our first episode together. I mean you built your following dramatically. You had a lot of positive feedback. Let’s talk a little bit about that.

PlanB: Yeah, man. It has been crazy. Actually it still is. And I’m not very much used to it because as most of your listeners probably know, I’m an investor in traditional finance. My employer is an institutional investor with a multi-billion dollar balance sheet. And yeah, I was not so much used to Twitter, and Medium articles, but since the medium articles out and especially, Stephan since your podcast, the response has been great, and overwhelming, basically.

PlanB: It’s help from people, feedback, useful comments, but also things like job offers, business proposals, and well I guess the article was on a lot of podcasts mentioned in other articles, even on radio and TV in the Netherlands. There’s also much people working on stock-to-flow right now. For example there is a Turkish translation of the article. A German one in the making. Two websites with live stock-to-flow charts available, and even a trading view indicator out there. It has been great, and currently I’m working with two quant teams on further refining, and improving, and testing the models. So, yeah, expect at least two more articles, somewhere next month.

Stephan Livera: Fantastic. It’s just excellent to say that you’re getting a really positive response on your modeling work because it really was just something new, and I think who knows it may be the way that many people now start to look at this as a standard method of analyzing. And potentially, I mean there are many implications as well. So imagine a miner, a Bitcoin mining company has to speculate through the cycle, and they may in turn use some of this modeling to drive their own decisions.

PlanB: Exactly, yeah. It’s the price and especially the expectation of price. It’s of course very difficult. But for miners it’s very important to do that and to make as an entrepreneur their investment decisions on that. So, yeah, I got a lot of response from miners as well. Actually I talked to a lot of them. What’s also very funny is that coming from a traditional finance backgrounds, I noticed that maybe a lot of traditional finance might not be in or even interested in Bitcoin, but that quant teams certainly are. Oh, man. I talked to so many quants. I guess about 10% of my followers at the moment is a quant somewhere, at a bank or even a central bank, or a hedge fund, and boy, do they understand Bitcoin, and many have skin in the game too. So that makes me very, very optimistic.

Stephan Livera: Look, let’s dive into some of their feedback a little bit. Now, one point that came up was around, “Oh, can you apply the stock-to-flow analysis or modeling to Altcoins?” But I suppose the question would be are Altcoins unforgeably costly?

PlanB: Right, yeah. That’s the most frequently asked question that I got, can you make a stock-to-flow model for Litecoin or B Cash or Ethereum. So let’s dive a little a little bit deeper there. The thing with a stock-to-flow analysis indeed is it’s based on unforgeable costliness. So maybe go one step back for our first-time listeners. Stock-to-flow is stock or the reserves or something like Bitcoin 17 million, almost 18 million in stock, and that’s divided by flow, so stock-to-flow, and flow is the protection. And that’s about 0.7 million bitcoins per year at the moment. And if you divide those two, you get the number 25, and 25 is the stock-to-flow number for Bitcoin.

PlanB: And it’s not just a number, I mean I called it scarcity, a quantitative measure of scarcity in the article, but really the key of stock-to-flow is the inability of production to inflate the stock. If the stock is large enough and the production is kept or restricted somehow then the production and the producers are enabled to inflate the stock. And we know what kind of problems you get when certain individuals or companies, or governments can inflate stock. Look at Zimbabwe for example where Mugabe can print, and did print as many Zimbabwe dollars as he wanted, and with disastrous effects for the economy. And the same with Maduro in Venezuela. And you could say the same from the dollar, and the Euro at the moment as well with quantitative easing. They’re printing… I’m not allowed to say printing, but creating electronic dollars, and Euros, and Yens to bail out banks, and whole economies.

PlanB: So the inability of production to inflate the stock that’s what stock-to-flow really is about to prevent things that we see in fiat currencies in Zimbabwe and Venezuela, and currently in quantitative easing. So if we apply that to crypto, if you like, then the thing like decentralization becomes very important. If one person, one company or a country can decide to change the monetary policy, it’s not decentralized. The producer, this person or government, or company can, it will be able to make more coins and inflate the stock.

PlanB: For example, take Ripple. The CEO of ipple can premine another hundred billion ripples if he wanted that. And if you look at Ethereum as well, there was no cap on the supply of Ethereum, and now they changed that. So they’re changing the money supply. It’s not what it was or what it will be, the money supply, but the fact that they can change it is… Well, that’s the thing I would be worried about as an investor. And that’s totally different in Bitcoin. Bitcoin, you have this truly peer-to-peer network with many nodes, and you can verify the money supply yourself. You’re not dependent on a third-party like a bank or company, or a data center to tell you how much the money supply is.

PlanB: You cannot change the money supply or change that magic 21 million coins number, and if you do you’re basically hard-forking away from Bitcoin. And, yeah, I guess nobody will follow you. A bit like Bitcoin Cash with the big blocks. Yeah, but you can do it, but don’t expect people to follow you. Maybe a last thing to mention is that that on the theoretical side of stock-to-flow on Altcoins, money has to be hard to produce, expensive like gold. So there’s lots of gold in the oceans, and I even read this article about the asteroid, the golden asteroid recently.

PlanB: It would be very expensive to mine that gold in the ocean or asteroids, and that prevents it from happening, I guess. And the same for Bitcoin. It has a hash-based proof-of-work with a very high hash rate. So it costs a lot of electricity to mine bitcoins, and that’s totally different for a lot of Altcoins of course. So for example, Ripple again has no proof-of-work or Bitcoin Cash has almost no hash rate, so no security. Again, that would make me a little bit nervous as an investor, and people who’d like to know more about this, it was Nick Szabo who invented the term, and described the unforgeable costliness in great lengths. So make sure you read that all.

PlanB: On top of this theoretical argument of unforgeable costliness, I decided a bit against my will, but because there was so much demand to model Altcoin’s with stock-to-flow. Just to see if practically it would be possible to do it. And that’s in fact one of the strains of research I’m working on right now with a team of quants. And I can tell you a little bit already what the result is, and I tweeted a little bit about that as well. They all have very low R-squares, so the models don’t really fit very well. For example, Litecoin which is very interesting because the halving is very soon. Litecoin has an R-squared of 32%. That’s versus Bitcoin 95%. 32 is really low. It basically says there is no relationship there. The same with Ethereum around 50% R-squared. Coins like DCR, Decred. I don’t know how you pronounce it properly, but 0% R-squared.

PlanB: So the theoretical argument of unforgeable costliness already makes you expect that it is not possible, but if you actually do the work and make the stock-to-flow models the outcomes are not very good. So we’ll publish an article about this in a couple of weeks, and yeah, I’m very interested in what the response will be.

Stephan Livera: Excellent. I think it’s really as many of us would have anticipated that basically the shitcoins are not unforgeable costly as Nick Szabo would say, and it brings to mind this idea, and I think Saifedean has touched on this as well, but if any of the listeners have read Julian Simon, The Ultimate Resource, and in that book Julian talks about how really any resource that we’ve wanted in the world. If people dedicated enough human ingenuity they could go and make more of it. But as Saifedean points out, and other bitcoiners point out that that’s exactly why Bitcoin is so interesting and so exceptional precisely because of the difficulty adjustment making it more, basically making it so that you can’t just go and make more.

Stephan Livera: So, yeah, it’s a very interesting point there. So, I think the other thing that everyone is trying to now understand is can the stock-to-flow multiple be used as some sort of Bitcoin peak and Bitcoin bottom price indicator. And the other interesting consideration is how it might change the game because if some traders, and speculators are anticipating that other speculators are trading based on stock-to-flow modeling. You might have well changed the game here.

PlanB: Yeah. I don’t know of course, but it’s an interesting point that the stock-to-flow multiple before we dive into that, let me say that the R-squared that I mentioned in the article, and that I mentioned just in the podcast, it’s not understood by everybody. So maybe I should talk a little bit about that. The R-squared is a goodness-of-fit measure. So it tells you how good the model fits the data, and an R-squared of, say, below 50 or 60% is not very good. It’s bad. It basically says there’s no fit. And a 100% R-squared means that you have a perfect fit, a perfect model, and you almost never see that because it’s a model. It’s not the reality. There is always some noise that disturbs it.

PlanB: So the 95% of the stock-to-flow model is really, really good. It shows that the relationship between stock-to-flow and value, and well the chance that it is caused by anything at all than stock-to-flow is close to zero. And a lot of people reject the stock-to-flow model because it doesn’t take into account things like demand or Forex and hacks, and economic news, and all that, but what would it add? It would only add like 5%, the missing 5%.

PlanB: We already have 95% good model. So in my opinion all those other factors even demand as important as it is, all those other factors are noise and stock-to-flow is the real signal that we have to keep focused on. But still, and then we go to the stock-to-flow multiple. Still it is interesting to see where the model is wrong. So basically the model error, and stock-to-flow that is the real Bitcoin price divided by the model price. And sometimes the real price is higher than the model price, sometimes it’s lower.

PlanB: Now, ideally in statistics the error should be white noise like a random no pattern thing, but if we look at the stock-to-flow multiple the error basically of the stock-to-flow model then you see clear patterns, and we can see what causes the lag or the error, and one thing is the lagged reaction to the halving. So when the halving was there, after the halving, the price shoots up so that the model price goes up a factor of 10, but the price of course does not. So it lags behind, can be a couple of months, can be can be a year, but that’s what we saw the last two times.

PlanB: And the other thing where the error is on the other side, on the upside. If markets are in a bull market, and the all-time highs when people get really greedy, fear of missing out, the total madness is there. Then you see the market overshoot the stock-to-flow model. In 2011 it was 13X. In 2013 it was 10X. And recently in 2017, the real price overshot 3X. Yeah, it’s really interesting to see that pattern because if you know that those two things lagging the halving, and all-time highs are what causes the error, it gives you even more confidence in the model.

PlanB: And indeed you could try to use it as a top and bottom indicator like the Mayer Multiple where Trace Mayer, he looks at the difference between the 200-day moving average, and the real price, and then you see those spikes when the price is really high above the 200-day moving average. And you see the dips when it’s a good buy moment so to speak. But, yeah, if you do that with a stock-to-flow multiply that put the charts out there. It turns out to be a very good stock top and bottom indicator. Maybe even better than the Mayer Multiple because the thing I don’t like about the Mayer Multiple as useful as it is, but it’s the effect that for example in 2013, there were two peaks in the Mayer Multiple.

PlanB: So you would have sold too early probably at the first peak when Bitcoin was a hundred dollars, and if you look at the stock-to-flow multiple it only shows one peak in 2013. So there’s… Yeah, I think it’s a little bit more accurate. Well, I think the most important thing for myself of the stock-to-flow multiple is that every single year since 2010 or ‘09 actually every single year, Bitcoin was below and above the stock-to-flow model. So a multiple of above one and below one in every single year. That shows sort of a reversal to the model, and yeah, I think it means that you can use the model as a sort of compass that it always returns to.

Stephan Livera: Are you referring there that that’s a reversion to the mean?

PlanB: Yeah, where a mean then is the stock-to-flow model in this case. I also think that’s when… It’s a model and I wrote it in the article. I think it’s a hypothesis. It can be wrong, and I really should say that. It’s based on historic data. It’s very well back tested of course, but still the big test is in the future, the next halving. I think I can say that if we don’t go above the 50K, the $50,000 that the model predicts after the halving then the model will break down. I don’t expect it. I expect it to go there because it did so every single year, but that’s the big test.

Stephan Livera: Interesting. And the other point there is that as the years have gone on, the number at the top right, the multiple has come down a little bit, correct? So as you were saying in 2011 it was something like 13, and then in 2017 it sort of went maybe three and a bit times. So who’s to say whether the next time if we do have another big, big bull run whether the next one will be at like say 3X or even 2X, just a bit less. Because I could sort of see an argument both ways there, right? Because some people might say well, more of the world are waking up to Bitcoin. People might actually start putting serious sums of money into it.

PlanB: Yeah. I’ve been wrapping my head around this one. A lot of questions about it as well. I don’t know frankly. Yeah, there is a pattern. It goes down 13X, 10X, 3X. Maybe it’s 2X next time, but then again it’s a power-law distribution, so it’s a very nonlinear market. You get big moves that are not outliers, they’re really structural in this kind of distribution. So I would also not be surprised if we see another 10X move again. So that should be a warning as well because you can use the multiple as a timer of bottoms and tops, but you can be very wrong with it as well. So be very careful to use it with actual money.

Stephan Livera: I think that’s a good piece of advice for the listeners. Next point, and I think this is really just the… This is the question as we record this now in early July, 1st of July and the price now as we record this is a little bit below 11,000 USD. The question then is are we front-running the halvening model?

PlanB: Yeah. I started using that term front-running, and it certainly looks like it. But, again, if we look at the theoretical argument in this case efficient market hypothesis, it should be priced in of course. So everybody knows the halving is there. It’s public information. And, yeah. If it has an effect, the best way of reasoning would be its priced in right now. On the other hand, if we look at the stock-to-flow model we know that now that the price after the halving should be around $50,000. So the current price… And especially the price at the time of the article that was a little under $4,000 is way below that number.

PlanB: So if people believe in the model like I do, but I know there’s more. But if people believe in it, it doesn’t have to be everybody. But if a handful or couple handful of big investors believe in the money, in the model, and put money on it, and start buying, then of course it could be that the halvening is front run this time. And I should add that that wasn’t the case last two times, right? In 2012, we saw, I think it was 100X directly after the November 2012 halving. It was certainly not priced in. And I can imagine because it was the first one, and there was a lot of talk about the death spiral, and how miners, that their reward is half as well. How they would stop mining and that would lead to a death spiral.

PlanB: So there was a lot of fear. It was a bad thing, the halving. And then if we look at 2016, we had one halving before. People had learned but on the other hand the price lagged the June of 2016 halving enormously like a year or something it took the price to catch up with the theoretical stock-to-flow value. And, yeah, maybe that was because it was also the time that the Altcoins became popular, Ethereum of course, and that might have taken some of the money away. So, yeah, what happens in 2020, if you look historically, the big bull run will be after the halving. So somewhere in 2021, you could say.

PlanB: But now you have this stock-to-flow model, and if you believe in it, if you believe Bitcoin will be above $50,000, why should you wait? Why should you wait until that happens until it’s 20,000 and 30. It’s a psychological thing. So, yeah, I don’t know. I think it’s very remarkable that we have seen this almost 3X since the publication and the podcast we did. I certainly don’t want to attribute that to the stock-to-flow model 100%. I mean, there is all sorts of other things like the eternal quantitative easing that was started, and the trade war there with China and the coming recession with the inverted yield curves. All good things for Bitcoin. So it could be that as well. But it certainly is interesting to see this big rise, this 3X rise already since the bottom towards the $50,000 model price.

Stephan Livera: So we’re not saying it was that your work that did it, PlanB, but we are 3X higher. So who knows, right?

PlanB: Yeah. If you think about the next halving, how far… If there’s front-running, how far could it go? Say you believe really strongly in the model, I put this table out somewhere indeed in the tweet. So it’s very rough numbers of course. I’d like to argue orders of magnitudes, and not very precise numbers. So the model predicts 50,000 after 2020 halving, but 400,000 after 2024 halving, and even three million after the 2028 halving. If that becomes sort of truth, it needs people to believe in it and it needs to be fundamentally true. We don’t know that. Again, it’s an hypothesis and proof is in the pudding. But if that were true, and you would front-run it, then you wouldn’t only front-run the 2020 halving.

PlanB: I have a lot of discussions about this with the people that are even more bullish than I am, that I am underestimating the… bit surprised. So that’s very funny because usually I’m overestimating if you compare it to the logarithmic regressions out there. My model price are a lot higher. But there are people who are even more bullish. They say, “Okay, it’s going to front-run every halving. And in a way that’s true. If there is only 10% of the people that believe the 3 million number in 2028, then the theoretical price would be 10% of 3 million is 300K right now which of course it isn’t. But it’s a mind-boggling thing, this front-running.

PlanB: It’s just also a bit of a warning that look, the market was lagging the halvings last two times, but it’s not necessarily the same this time. It could be front-running it because a lot of people learn about the halving. We have the stock-to-flow model. Well, very interesting. We shall see.

Stephan Livera: Yeah, it’s fascinating stuff. And this table that you’ve got, so you think, so just for the listeners, it’s showing the year, the halving, and the model predicted price. So as you said 50,000, 400,000, and then 3.2 million for the 2028 halving. Now, to the extent that stock-to-flow modeling works, so again caveat, this is not economic law, it’s some sort of modeling, but to the extent that the modeling works. Do you have any reflections on how many cycles we could anticipate this working for?

PlanB: Yeah, that’s also a discussion on Twitter, lots of questions about exactly this infinite value if you wish. If you follow the table, we could go all the way to 2140 when the flow is zero, when there’s no more new bitcoins, only fees. And the theoretical value how to stock to flow model would be infinite. So how can that be? And basically I think this is a very theoretical argument. And I’m a very practical guy. So if I look at the next three halvings alone. So we’re now at, say, 100, $200 billion market. Every halving this market goes 10X. So after 2020, we go to one trillion, after ‘24 we go to 10 trillion. And after ’28, so the third halving we go to a 100 trillion US dollars, hence my name, my Twitter handle.

PlanB: I think that we don’t have to wait until 2140 before the model breaks or before something breaks. I think we’ll be there sooner than we think. I think we’ll be there well, maybe 24. Somewhere between 24 and 2028 because 10 to $100 trillion Bitcoin market that’s enormous if you compare it to the US dollar for example. It has a monetary base of three trillion, and I think an M2 of about 12 or 14 trillion. So then that means that somewhere between 2024 and 2028, bitcoin is bigger than the US dollar. It basically means the US dollar will die, and we’ll be measuring things in Bitcoin.

Stephan Livera: Very bullish.

PlanB: Well, yeah. And the model, it measures Bitcoin in dollars, and it measures gold and silver, et cetera in dollars. But if Bitcoin is bigger than the dollar then we measure things in Bitcoin. It will be the unit of account. And, yeah maybe we measured the dollar in Bitcoins then instead of Bitcoin in dollars. It really is exactly that. I have this other chart that I get a lot of discussion about that one. It was one of my first chart that I ever put out there. It compares to the price of Bitcoin of the last 10 years with Weimar, Germany, the hyperinflation where the German mark, the paper mark grows like a trillion times the original value. They keep adding zeros, and it’s like Zimbabwe and Venezuela.

PlanB: But if you look at how closely the Bitcoin price tracks the dollar price, the dollar Bitcoin price, tracks this German mark price, it’s amazing. And it gives you an historical example of what might happen. Again, it’s what might happen. It’s not an expectation but it’s a possible scenario maybe with not too much probability, but it certainly looks like… It gives you a view about how hyperbitcoinization, that’s how we call this moment in time on Bitcoin starts to overtake the dollar, and everything is priced in Bitcoin. That’s how it could look like. And, yeah, maybe… Think about how beautiful that might be. Today, we build our economies on the dollar, and euro, and the yen, and central banks are producing those coins like crazy especially right now with quantitative easing.

PlanB: So it’s a bit like we’re building an economy like an architect building a house with a meter that is changing or an inch that is changing every day. Imagine how that house would look like, and that’s our economy at the moment. If we have Bitcoin and nobody can touch the supply. It will be a metric as stable as a meter or an inch, or a temperature measure like the Fahrenheit. And imagine what kind of economy and society we can build on that. It will bring us the next renaissance. I really believe that, and that’s basically why I’m in the space working on Bitcoin.

Stephan Livera: Fantastic. Yeah, look, I think I’m very much agreed about the renaissance idea. I think many Bitcoin bulls are aligned with you on that point. Although, I would say we have to be careful about considering it as a set meter because, yes, the amount of bitcoins is only 21 million and so on. I think from the Austrian school they would think of this like there can be no such thing as neutral money. So they would think of it like well, your desire to even hold a cash balance can vary, and that in turn can also vary the value of the purchasing power, the real purchasing power of the bitcoins or in sats as we probably will be denominating.

Stephan Livera: But I think on the whole, it will be a much more better society, a much more a free-market world that we would be living in. And I think I really like the point you’re making around how the US dollar is changing too because it’s difficult then to model because over time the US dollar is coming down in value as well. So how much of that is kind of… Maybe it’s a bit silly to think of it this way, but it’s like how much of that is Bitcoin going up versus how much of that is just the US dollar going down.

PlanB: Yeah, absolutely. That’s a very good point because if you look at the Weimar period, hyperinflation in Germany around 1923, I read a lot about this period. Living in Holland next to Germany it may be something that is very alive and actual. So I read a lot. There’s one book, it’s called When Money Dies. It’s written by Fergusson. If people like to read, it’s a really good read. And it talks about this period from a diary perspective of people actually living in this period. And it’s exactly this point that you make, Stephan that those people in Germany thought that, not that their own coin was going down that the German mark was going down, they thought that the pound, and the French franc at that time, they all went up.

PlanB: And because they were after the first world war repaying all their debts, and they thought the whole world was advancing and going up, and they were well, stable. But it was the other way around of course. They were printing money. Their currency was going to zero. But it didn’t feel like that, and it could be the same now that that we think the stock market is going up and all the housing prices are going up. Well, inflation is not there yet, but you certainly see it in all the assets. We can call it asset inflation maybe this time around. But we are thinking all those things go up where in fact it could be that our currency is going to zero.

Stephan Livera: Very interesting. And PlanB, I’m very interested as well to discuss. So you were posting some charts showing this idea of bitcoins path plus commodities on a pathway to 30 trillion. So can you outline what’s going on there?

PlanB: Yes, actually. That’s one of the most interesting questions and critiques I got on the model, on the stock-to-flow model. Overall, I got really less critique and comments than I expected, and maybe hoped for. So maybe that means the model is good or maybe if people don’t mention it or don’t want to mention it, but there was one critique that is very, very important. And I urge everyone using this model to really take this serious as well, especially if you invest on the model. And this critique is okay, you have a correlation of 95% R-squared, but correlation is not causation. How do you know it’s not a spurious regression?

PlanB: And in econometric terms, you could say the variables stock-to-flow and market value are non-stationary. They both go up. So stock-to-flow of course only goes up, and value at least last 10 years. It only goes up. And if you regress those, if you model the one with the other then yeah, of course you get a very nice correlation, and a very high 95% R-squared. But you could also do that with the global beer consumption. It goes up as well. So I bet you, there will be a very nice correlation between the rising global beer consumption, and the rising Bitcoin price. But that correlation will be totally spurious, and not hold for the future per se.

PlanB: So how can you tell, it’s not a spurious regression. Now, I have a lot of quants commenting on this, modeling on this. I put all the data and the models out in GitHub. So they’re using those. And we’re with an international quant team at the moment making this robust, and looking if it’s spurious regressions, and doing all the formal tests to see if it’s if it’s okay or not, but even then it’s always a thing to. You don’t know 100 percent sure. So that was the reason I decided to look at totally unrelated commodity markets. They have nothing to do with Bitcoin. Especially the gold market, they use stock-to-flow measure. It’s actually I learned the stock-to-flow measure from the commodity markets, and from Saifedean Ammous’ book, The Bitcoin Standard, must read.

PlanB: So I thought that would be a very nice market to look at. So I looked at gold, I looked at silver, diamonds, platinum, and palladium. Totally different markets. All different stock-to-flows, and all different values. And when I made a stock-to-flow model on all those different markets, I was shocked really to find an R-squared of 99.5%. So basically 100%. It blew my mind. Of course, it’s only five data points, right? It’s not much, but that’s the same with Kepler and his third law with the planets orbiting the Earth, and distance to the Earth. They have a power law. He had only like five planets, and a 99.5% correlation.

PlanB: So I really take this serious that the stock-to-flow measure is also working on a totally unrelated market from Bitcoin, gold, silver or palladium, platinum, and diamonds, and gives this high R-squared. Those markets are not serially correlated. It’s stationary. So there’s no problems that we have with looking at Bitcoin. And it gives me extra confidence in the model. And what’s even more interesting is that both models, and that’s also what the chart is showing, both models point towards one point where it stopped an asset with a stock-to-flow of a hundred and a market value of 30 trillion US dollars will be.

PlanB: So Bitcoin is growing towards that point when it reaches a stock-to-flow of 100. And the market, the total commodities market points to an asset like that as well. So I find that really remarkable. Well, we have to see if it really happens because we have never seen an asset with the stock-to-flow of a hundred before. So we also don’t know how it should be valued. And it’s also interesting to see that that we don’t have a model for Bitcoin valuation. Well, stock-to-flow model is an approach, but we also don’t have a formal model for gold valuation. It’s really interesting.

PlanB: There is no cash flow. There is nothing to model. So how is gold valued? It really is without a fundamental model. And there was one other thing I discovered during this exercise into the commodity markets, and that was that silver stock was disappearing fast. And in fact that I had the wrong silver data in my first article. One of my followers mentioned it. He said, “Okay. The silver stock is way less than you report.” So I researched it, and the data I had in the article before was from Wikipedia, and it turned out to be including below-ground silver. So it was way too high. So in the end I now have a better silver source, data source. It’s the Silver Institute with way lower stock, and way lower stock-to-flow as well.

PlanB: So stock-to-flow of silver is not 22 that you see reported at several locations, by the way but it’s three, only three. That’s a shocker. That basically means that the monetary value of silver has disappeared the last hundred years. That’s one of the things that silver finding, but also the stock-to-flow model for all the other commodities. That’s one of the things that got great interest from the gold community, and the commodity community. It’s really a different community than the Bitcoin community.

PlanB: By the way, I talk a lot with Willem Middelkoop. I guess you would you say Middelkoop in English. He is a well-known Dutch commodities expert, and an investor. And he teaches me a lot about gold and silver, and the community there because I’m not in the commodities community. So he has a fund, and written a lot of books, and I learn really a lot about it. One of the very hopeful things I see is that the gold and the Bitcoin community are growing towards each other a little bit. So there is a part of the gold community. I think Peter Schiff is in there that is really against Bitcoin. But there’s also a part in the in the gold and silver community that really sees gold and e-gold Bitcoin as a hot combi for the future. So also companies like. I like the In Gold We Trust report from Incrementum.

Stephan Livera: Incrementum?

PlanB: Yeah, it’s Incrementum. It’s a team from Liechtenstein in Europe. I read it for years but they’re now for the first time having a paragraph in there with Bitcoin and gold as a very nice combination for having in a fund. So that’s really something to watch. I think we’ll see more of that. It’s a logical thing especially with the stock-to-flow model showing. Gold as a physical asset and Bitcoin as a digital asset both high stock-to-flow, high value. It’s very interesting.

PlanB: So, yeah, again, maybe to wrap this one up, the stock-to-flow model on commodities gives me extra confidence in stock-to-flow model on Bitcoin because it doesn’t have this spurious regression problems, and both point towards $30 trillion market which is it’s almost unbelievable at this price point.

Stephan Livera: Very interesting, and I guess just to summarize for the listeners as well. So looking at your table, PlanB, the stock-to-flow ratio predicted for Bitcoin is at the 2020 halving, it’ll be a ratio of 50, and at 2024 it’ll be a hundred, and then at 2028 it’ll be incredibly 200. So really once we get beyond gold, it’s just uncharted waters, correct? We’ve never seen anything that scarce.

PlanB: Absolutely. Uncharted waters, for sure, and very interesting to live in these times.

Stephan Livera: Excellent. All right. So I also wanted to touch on some of Tuur Demeester’s comments. Now, I actually had the chance to meet Tuur Demeester at Bitcoin in San Francisco 2019. And now he had some comments around the halvening and how potentially it might not be as convincing from his point of view. So maybe I’ll just quickly summarize some of his points. I think some of them you’ve already touched on, but you can just sort of go through your discussion on that as well. So firstly, he was talking about well, how do we define the stock in Bitcoin? How do we know how many coins have been lost? Because the estimates vary between one to four million.

Stephan Livera: Point two was Bitcoin’s production is trending towards zero. Does that mean it’s value should trend to infinity? And PlanB, I think you’ve already touched on that. Number three, the stock-to-flow estimates for gold and silver are a little bit debatable. I think you might have touched on that as well. And then fourth was just around the theory behind the date, and how does the predefined low production rate somehow create value? And the question he asks is if he created a new coin with an even lower emission rate than Bitcoin, could it theoretically have an even higher value? So, PlanB, do you have any thoughts on some of Tuur’s comments there?

PlanB: Yeah. First of all, it’s great to get feedback, and especially from guys like Tuur who are in space almost from the beginning. And that’s also why I put everything on Twitter and GitHub to get the feedback to learn. So, yeah, I appreciate his four concerns very much, and let’s go through them. Yeah, the lost coins, that is a question that’s asked more, how does that impact the stock? It does of course. And how does that impact the stock-to-flow model, and maybe your prediction? So I did the analysis, I implemented four different ways of adjusting for lost coins.

PlanB: The original way was to just ignore the first million coins, the so called Satoshi coins. We don’t know of course if those were Satoshi coins, but that’s the narrative, and well those coins haven’t moved. So let’s do as if they are lost. So that’s one approach. Then I did the no adjustment approach so leave those one million in there. I did a gradual loss scenario. So there’s about four million lost coins around now, 2019. So that’s about, what is it, 30 something percent. What if every year there is 30% of coins lost, and make that gradually overtime. And I combined the two in a fourth scenario.

PlanB: So first one million loss, and then a lower percentage loss every year. And then look what that did with the stock-to-flow analysis. Basically, there was no impact. So it changed the parameters of course a little bit, but the outcome was the same, and the R-squared was basically the same all above 90 to 90-95 in that area. So I think lost coins is not so much a problem, but I do understand the question very much. I think we can safely sleep on that concern.

Stephan Livera: Sure. Let’s go on to the second one.

PlanB: The second one was okay gold and silver numbers are debatable. Well, that’s true. I mean, my silver numbers were wrong. So I adjusted those. But let’s debate it. So he didn’t really mention why they were debatable or Tuur didn’t show me his numbers. But I’d like to learn. So if there’s somebody out there that has better numbers, better sources. I also asked that in the tweets. Please share them with us and make this more robust. But on the other hand gold and silver sources that I have at the moment, so the Incrementum report and the Silver Institute data, and same with palladium and platinum.

PlanB: Those numbers are not very much debated in commodity circles. So we could double-check it, but, yeah, I don’t know. I think those are pretty okay, but I’d like to hear more about why Tuur thinks they could be wrong or if he has different numbers. Let’s indeed debate this. One thing to add is the gold and silver numbers are not the model itself. So they’re basically apart from the Bitcoin stock-to-flow model. They’re just an extra check on whether it’s a spurious regression or not. Even if those numbers were totally wrong and the whole stock-to-flow model on gold and silver is not there, and et cetera, that says nothing about the Bitcoin stock-to-flow model. It just stands there as it is. It’s made from data. So, yeah, I think we could put that to sleep as well.

Stephan Livera: Sure. All right. I think there’s nothing I can think of on that. So you’ve already touched on the second one which is about Bitcoin, does the value trend to infinity? And I think basically it’s similar to the hyperinflation point we’re talking about. So let’s go on to the fourth one which is around if someone were to hypothetically create a new coin with a lower emission rate than BTC then why wouldn’t that coin also have really high value?

PlanB: Yeah. I like that question most, and that concern. I actually have thought of this as well, what if we create a better Bitcoin or next Bitcoin with even scarcer or stricter money supply or no money supply at all, how would that go? But then of course you run into a lot of other problems because this new coin should at least be as expensive to mine, and as decentralized as Bitcoin at the moment is. So a coin without a proof-of-work wouldn’t work. A premine coin like Ripple is a no-go because who gets the coins? How is it distributed? A coin without the peer-to-peer network that Bitcoin has at the moment would not be decentralized, and would have a central party, me or Tuur or whoever makes this coin deciding over the supply.

PlanB: And then hash rate. So you need the security, and you need to attract miners to make ASICs hardware, and spend all the electricity costs to make this high hash rate. So basically you need to do everything right in a new coin like Bitcoin did. All the network effects the Trace Mayer talks about, all the Seven Network Effects need to be there. You need to have miners, speculators, investors, and developers, and even if you could pull all that off with a lower supply then a slow introduction of coins, so not a premine because that’s a no-go. But a slow creation takes time, and Bitcoin has already 10 years head start. So maybe theoretically it could be done, but in practice I think there will never be a next, and better Bitcoin in my opinion.

Stephan Livera: Yeah, I don’t think I could have said it better. Essentially I’m with you there. I think it’s an interesting thought experiment, but I think in practice it just would not be achievable for those reasons. You would not have the so-called next Bitcoin having the same level of decentralization, the same level of spreading out of the supply as well as enough people now sort of hold Bitcoin that they wouldn’t necessarily all just jump over to the, quote-unquote, “next Bitcoin”. Correct me if I’m wrong but I think there may have been one or two of the four coins or Altcoins who tried to do something like this, and then they failed probably for these reasons that we are discussing.

Stephan Livera: But it’s an interesting question even if I think the answer in the end is still no, it can’t be done. PlanB, I’m also interested to talk about another graph which you showed, and it’s talking about this idea of well, you’re talking a little bit about Random Walk Down Wall Street, and in this graph you show a very interesting allocation because in this chart you show 1% Bitcoin, and 99% cash versus actually just holding other things like UST bonds, 10-year, or gold, or the S&P 500. Can you just outline for the listeners what’s going on there?

PlanB: Yes. The Random Walk Down Wall Street title is of course from the famous book Random Walk Down Wall Street from Malkiel. It talks about volatility, risk return, efficient market. It’s really a must read. I highly recommend it. And I use this chart to show that Bitcoin is a really strange thing if you look at it from a financial point of view, and especially the high volatility thing, because if you read about Bitcoin in the mainstream media mainly, but also in Bitcoin cycles, there’s a lot of talk about the high volatility, high risk that, “Oh, yeah. Bitcoin goes minus 80%, and basically it does that every couple of years. It has done it three times before minus 80%.

PlanB: So that’s a lot of risk for most of us too much risk, in fact for most investors, and the reason they’re not looking any further. However, risk is not necessarily a bad thing. It is the source of income as well. If you don’t have risk, so no risk, no return is what we say as investors, and also the other way around. If you see something with high return there should be high risk, a high loss percentage. So in the end it’s all about not only volatility at risk, but also return. You have to look at risk return, and that’s what this chart is showing. It shows risk on the X-axis, return on the Y-axis. It’s a classic thing. And it shows the typical investments like stocks. Indeed stocks have a… If you look at the last 50 years on average without dividends have an average return, it’s a geometric return by the way, of 8%, and some very bad years like 2008 or 2001 where stocks have a drawdown of a really bad loss of 40%.

PlanB: So stocks drop 40% once in a while, but you get 8% return. Gold is a little less risky. It can go down 30% in a year. So that’s less than stocks. But it will earn you less return as well. It has a seven and half percent return. And even less risk and return is treasury bonds, because treasury bonds right now the interest is really low, but on average last 50 years. It will give you 6% return, and only 8% max annual loss. So the nice thing is all those classic investments they’re on a line, a straight line. I put this in this chart and the numbers can be a little bit different, but this is the general idea. They’re on a straight line.

PlanB: So you can earn more return, but you need to take more risk. That’s what this is basically saying. You can’t go to stocks, but then you need to be willing to accept a 40% loss because that can happen. Now, if you put Bitcoin in there, it’s really crazy. First, of all, it’s not on the line. So it’s above the line from stocks, and gold, and US Treasury bonds. It shows a very… I’m sorry. I take one step back. If we put Bitcoin on this chart, it would be off the charts. It would be very high volatility, twice the volatility of stocks, 80% maximum loss in a year. And return would also be off the charts because it would not be 6, 7, 8%, it would be on average last 10 years. It would be 200%.

PlanB: So what I did in this chart was okay, you can reduce, if something is very volatile has a lot of risk, you can reduce the exposure to that investment. You can downsize your investment, and I downsized it all the way to 1%. So 1% Bitcoin and 99% cash basically doing nothing earning zero return, zero risk. So it’s 99% doing nothing. Only 1% of your investment in Bitcoin, and if you put that in the chart it still is off the chart. It’s above the line. So the maximum loss if you only put 1% of your money in is of course 1%, that’s the risk, but the return is still 8.3% over last 10 years.

PlanB: So it’s no guarantee it will be the same the next 10 years, but last 10 years, it was 8.3%. So you get more return and less risk than stocks. And that’s the whole thing I wanted to show in this chart. Basically, two things. One, high volatility is not a problem. You can size your investment. Just reduce your investment, and you have lower risk, and you’ll see with Bitcoin that it still has a very high return. There’s a technical term for this, it’s called the Sharpe ratio where they divide return by the risk, and basically or officially the risk is measured as a standard deviation. But I like to use the drawdown, so that’s even bigger risk. It’s the maximum risk in a year. Not the standard deviation.

PlanB: But what you see with all the traditional investments like stocks is that the risk, so the maximum loss is higher than the return. So for stocks to return was 8% risk, 40% if you divide 8 by 40, you get the Sharpe ratio. And it’s lower than one. With Bitcoin, it’s the other way around the return is 200%, the risk is 80%. So the Sharpe ratio of this asset seems to be larger than one and that is-

Stephan Livera: Phenomenal, right?

PlanB: That’s phenomenal, right. Exactly. And there’s all sorts of technical things, mathematical things you can do with distributions like Bitcoin’s distribution. And maybe it’s too technical for now, but I’ll just like to mention the Barbell Strategy of Nicholas Taleb especially in environments where there are fat tails in extremistan in his words like Bitcoin, right? Fat tails maybe there is a power law distribution here. That’s what that’s what I think especially in those environments it makes sense to have a Barbell Strategy, and that means to have a not like an average spread at portfolio, but to have some very volatile risky investments, and some very low-risk investments.

PlanB: So basically my 1% Bitcoin and 99% cash portfolio would be an extreme Barbell investment. And those work very good in fat tail environments. And that’s what this chart shows. I think it’s very, very encouraging. It needs a lot more work, but yeah. I know there’s a lot of traction in the financial community. If I show this chart, the jaws drop and discussion is guaranteed.

Stephan Livera: Fantastic. And it’s really a reflection that maybe we really do live in extremistan. Just to clarify as well with that 1% is that annual rebalancing? So let’s say your Bitcoin went up, would you now sell and rebalance into cash?

PlanB: Yes. I forgot to say that. Yeah, it’s a yearly rebalancing, and it’s a very crude model. A yearly rebalance at the end of year December close price.

Stephan Livera: Excellent. So then really the big question is what happens when the rest of the world wake up to that strategy?

PlanB: Yeah, in fact I think it can be the basis for a very nice arbitrage strategy between the fiat and the Bitcoin world. I’m working day and night on that. I think I’m very close especially in this negative interest environment. It’s crazy, but yeah, you can do very nice mathematical things with this. In the end, I think this will lead to do something that will be amazing or hard to ignore. Maybe one thing I can point out already, and that’s the futures market. If you look at the futures market right now, and there’s of course the CME, it’s a big futures market in Chicago, but soon there will be Bakkt, physically settled to the futures in New York which is great.

PlanB: But if we look at the futures market right now, it’s in contango. And that means that the future price of Bitcoin is higher than the spot price, the current price of Bitcoin. And it’s about the last couple of months, it was about… It varies of course but it was about 1% on average higher the next month. So we’re in July now. The August Bitcoin price would be… Future price would be 1% higher than the spot price. That makes possible a cash-and-carry strategy where you buy a Bitcoin, and sell it the same time you buy it and you future sell it for 1% more. And that means that you have a guaranteed 1% return on your investment in a month.

PlanB: So you could do that 12 months in a row, and make a little a over 12% per year which is really, really good especially if it’s because it’s risk-free basically. You cannot earn more but you also cannot earn less because you have the asset, you future sell it. So there’s no risk involved. 12% at the current future market conditions which is amazing from a institutional investor point of view.

Stephan Livera: Excellent. So really it’s just they would be taking only the, I guess, the custodial risk or kind of delivery risk from the CME, and that’s not very high risk is it?

PlanB: Right. With Bakkt it will be it physically settled. So it will be great to see when they launch… Its 22nd of July I think, when they launch what those prices will look like, and what CME prices will do because the good thing about a physically settled futures market next to a cash-settled futures market like the CME is that you can’t have shenanigans anymore. They can’t play tricks if one market is… For example, the cash market is manipulated, you can easily arbitrage that away with the physical settled market. So they, the price on those markets should not vary very much, and it will be very, very interesting to see what those are.

PlanB: And if the market, the natural Bitcoin future market would be a contango market then all this would open a door to very nice risk returns for the ones that are forward-thinking, and unable to implement those strategies.

Stephan Livera: So actually, I’m curious then. Do you have any views on which specific investors could actually undertake such a strategy or whether maybe their policies or their governance might restrain them from undertaking such a strategy. I mean, a quick example maybe a pension or endowment funds or family office, would these sort of institutional kind of investment vehicles might they have certain restraints placed upon what they can invest in and how they can undertake that strategy?

PlanB: Yeah. That’s a very good question, also one that I struggle with every day as an institutional investor. So I talked about Bitcoin in our company of course but I guess it will be very difficult for a big insurance company or a big bank to put Bitcoin on their balance sheet because of regulation, and central bank regulation. I think the discussion has to be started, and especially in Holland, the central bank is very liberal as in they are open to discussions about blockchain and Bitcoin, and there. I think but in the end those companies are investing the money of pensioners, of savers so they should have really good risk management, and capital management, and low-risk investment strategy.

PlanB: So Bitcoin is not the first thing that comes in mind, and that would be very difficult to put capital charges in the sense of Basel or solvency. So those are not in my mind the logical first adapters, first big institutional investors in Bitcoin. On the other hand funds that are investing for the risk of the fund holder, the participation holders, especially hedge funds above a certain investment that they are not regulated. Those are in a much better position to add Bitcoin to their balance sheet. And I’m especially looking at for example commodity funds.

PlanB: So that’s why I’m so happy to be learning about the commodities market right now, and making some contacts there because those funds could easily rotate a little bit out of gold or silver or whatever, and a little bit into Bitcoin. And, yeah still be within our mandates, and it would be a logical fit. Also, I talk to a lot of people get a lot of response and I see a lot of family offices. So either billionaires, rich families high-net-worth individuals, they can do of course… It’s their money. They can do with it what they want. And they see Bitcoin as an interesting new investment but also as a hedge vehicle.

PlanB: So what if this whole negative interest rate printing of money, quantitative easing thing is not going according to plan, and we have some hyperinflation or even Bitcoinization kind of scenario. What if I just bought like 0.1 or 2% of my portfolio into Bitcoin and even more. And I see that as a very possible scenario for the future.

Stephan Livera: Excellent. It reminds me… I mean, we’ve been talking about front-running the Bitcoin halvening, but maybe certain institutions will be better able to maneuver themselves and position themselves to actually use this information and buy some Bitcoin.

PlanB: Yeah, absolutely. And of course I’m working… It would be my dream to be a bridge between the Bitcoin and the institutional investor world. As a matter of fact I think I’m perfectly situated for that with my background and the position I have at the moment. But again I think it’s a long way, but if I learned one thing is that from the last month, and all the comments and talks I had is that the institutional investors, the pensions and the banks might not be in Bitcoin or invested in Bitcoin, but their quant teams certainly are.

PlanB: They are not all, but let’s say 25, 50%, they heard of Bitcoin, they have Bitcoin or they work on Bitcoin but they are very, very interested. And those are institutional investors as well. So they will influence. Maybe it’s a generational thing as well but it’s very encouraging to see quants from all over the world, all sorts of banks even central banks personally taking an interest in this and making investments with this.

Stephan Livera: Well, it’s truly a very bullish set up. Actually at Bitcoin 2019, Brendan Bernstein made a comment saying something I can’t remember the exact words, but I think he was saying if you put me in a room and asked me to design the perfect bullish setup for Bitcoin, I could not imagine or design a better one than what we have right now.

PlanB: He’s right. He’s, well, we’re at something of a perfect storm right now with recession around the corner, yield curves are inverting everywhere, are going negative. The recession might have already have started. So that’s a very nice test case for a Bitcoin if it will be… a negatively and uncorrelated asset because we have not have the opportunity to test it until now. Bitcoin was made in the last big recession, 2008. It was the reason it was made, but we haven’t had a real big recession until well maybe now or next year, so that’s one. And the quantitative easing of course is a big unknown. And then, yeah, Bitcoin is growing like crazy and adapted by more and more investors. So, yeah, I totally agree with Brandon.

Stephan Livera: Excellent. Well, look. I think that’s pretty much all we had to cover for today. So, PlanB, before we let you go, just make sure you tell the listeners where can they find you, and what are you looking for in terms of feedback?

PlanB: Okay. So I’m at Twitter. My Twitter account is @100trillionUSD. If you don’t have read the article on Medium please, please do so because it has a lot of the backgrounds of the model, and it might answer a lot of your questions. Also, if you haven’t heard the first podcast where we discussed the model into detail, please listen to that one, and make sure you look out for the next Medium articles. So we’re writing two. One about the Altcoins and the stock-to-flow, and one about the spurious regressions stationary or non-stationary variables, more econometric paper. And I’m always open to suggestions. My DM is open. Comments are welcome. And if you are a quant working at a big firm have some ideas please reach out that would be great.

Stephan Livera: All right. Well, look. That’s been a fantastic episode. I really enjoyed that discussion, PlanB. So once again, thank you for joining me today.

PlanB: Thank you very much, Stephan.

Stephan Livera: I hope you guys enjoyed that chat with PlanB. And just a quick reminder to check out my sponsors, they are who make this possible. So go and check out Kraken and Unchained Capital. Lastly, just an announcement about a new Australian Bitcoin Education venture. I’m launching with my co-founder, Ketan. It’s Ministry of Nodes. We believe there’s a need for more guidance and hand-holding for Australian Bitcoiners who want to learn how to run a Bitcoin full node, and also just basic digital security hygiene, and privacy practices. So we’re setting up a website, and a web store, and we will be also looking to run workshops starting in Sydney, but also around Australia.

Stephan Livera: So make sure you check out the web store and the Twitter account. We will be posting up material there with some guides, and articles, but also targeted to an Australian audience. So make sure you check that out. That’s it from me. Thanks guys, and I’ll speak to you soon.