Bitcoin vs USD vs Gold: Analysing the Stock-to-Flow Ratio and Inflation Resistance

I am a Bitcoin ‘believer’. It simply is a compelling inflation-proof store-of-value - and in some ways, a better alternative to gold.

Understanding the Stock-to-Flow Ratio

The Stock-to-Flow ratio is a measure used to evaluate an asset's scarcity and implied proneness to inflation. It's calculated by dividing the current stock (total available amount) by the flow (annual production rate). A higher ratio suggests a lower inflation rate and potentially greater value retention over time.

USD: The Global Reserve Currency

The departure from the gold standard in 1973 marked a significant turning point for the USD, fundamentally altering its inflation trajectory. Since then, the real inflation rate of the USD has been a subject of concern. To put this into perspective, it's instructive to look at the value of the USD in terms of gold. In 1973, an ounce of gold was priced at approximately $65. By April 2023, the price of an ounce of gold had soared to over $1,900. This dramatic rise reflects not just the increased demand for gold but also the decreased purchasing power of the USD.

Inflation, measured by the Consumer Price Index (CPI), has varied over the years, with periods of higher rates (like the late 1970s and early 1980s) and relatively lower rates (such as the late 1990s and early 2000s). However, the overall trend since 1973 shows a consistent decrease in the USD's purchasing power. This decrease became particularly noticeable following significant monetary expansions, like those in response to the 2008 financial crisis and the 2020 pandemic.

As a fiat currency, the USD doesn't have a fixed stock. Its supply is controlled by monetary policy decisions made by the Federal Reserve. Recent years have seen significant increases in the money supply, especially due to stimulus measures in response to economic crises. The Federal Reserve reported an approximately 25% increase in M1 Money Supply in 2020 alone. This expansion dramatically lowers the USD's S2F ratio, indicating a higher susceptibility to inflation.

The stark contrast in the value of the USD against gold over these five decades highlights the impact of inflation and the risk associated with fiat currencies not backed by physical assets. It underscores the appeal of assets like Bitcoin, which are designed to be insulated from such inflationary pressures.

Gold: The Traditional Safe Haven

Gold has historically been a go-to asset for storing value.

Gold's stock-to-flow ratio has exhibited remarkable stability over the last 50 years, a testament to its enduring status as a store of value. This stability results from the unique characteristics of gold's supply dynamics. The total stock of gold has steadily increased due to consistent, albeit limited, mining outputs each year. Over the past five decades, the annual increase in gold supply has generally hovered around 1% to 1.5% of the existing stock, a relatively small figure compared to other commodities or financial assets.

In 1973, the total estimated stock of gold was around 90,000 tonnes, with an annual production of approximately 1,500 tonnes, giving a stock-to-flow ratio of about 60. Fast forward to 2023, and while the annual production has increased to around 3,000 tonnes, the total stock has also grown substantially to over 200,000 tonnes. This growth maintains the stock-to-flow ratio in a similar range, around 65-70, indicating that gold's scarcity and its appeal as a hedge against inflation have remained relatively consistent over time.

Bitcoin: The Digital Gold

Bitcoin's S2F ratio is significantly high. This is due to its halving events, occurring every four years, which reduce the flow (rate of new Bitcoin creation) by half. For instance, after the 2020 halving, Bitcoin's annual production dropped to around 328,500 BTC, with an existing stock of approximately 18.5 million BTC. This puts its S2F ratio at around 56.3, indicating a high level of scarcity and potential resistance to inflation.

A crucial aspect of Bitcoin's appeal as a store of value is the finality and immutability of its total supply. Unlike fiat currencies, which can be influenced by government and central bank policies, Bitcoin operates on a decentralized protocol that strictly caps the total number of coins at 21 million. This hard cap is programmed into the Bitcoin network and cannot be altered without a consensus among most its users, which is highly unlikely. This feature starkly contrasts with fiat currencies, where governments can, and often do, print additional money, leading to potential inflation. Bitcoin's immunity to such external influences enhances its reputation as a digital store of value, impervious to the whims of government monetary policies.

Looking ahead, Bitcoin's stock-to-flow (S2F) ratio is set to undergo a significant transformation over the next 20 years. This change is inherently tied to Bitcoin's halving events, which occur approximately every four years and halve the rate at which new bitcoins are created. We have witnessed several halving events, with the most recent one in 2020 reducing the block reward to 6.25 bitcoins. The next halving, expected in 2024, will further reduce this to 3.125 bitcoins per block.

By 2043, Bitcoin will have undergone multiple additional halvings. These events will progressively reduce the flow (annual production of new bitcoins), while the stock (total number of bitcoins in existence) will asymptotically approach the maximum cap of 21 million. This will lead to a substantial increase in the S2F ratio, making Bitcoin increasingly scarce.

If we assume a continuation of this trend, the S2F ratio of Bitcoin could surpass 100 in the next two decades, a figure significantly higher than both current gold and historical norms for any commodity. This dramatic increase in the S2F ratio implies that Bitcoin could potentially become the world's most scarce asset, surpassing traditional stores of value like gold in terms of scarcity. This projected scarcity underpins many of the bullish forecasts for Bitcoin's future value and its role as a potential hedge against inflation and currency devaluation.

Comparing the Inflation Resistance

To compare these assets in terms of inflation resistance, we must look beyond just the S2F ratios:

1. Bitcoin's Digital Scarcity: Bitcoin’s S2F ratio is expected to increase with each halving, enhancing its scarcity. Unlike gold or USD, this programmed scarcity is predictable and unalterable, making it potentially more resistant to long-term inflation.
2. USD's Policy-Driven Supply: The USD is subject to monetary policy changes. Recent expansive policies have increased the money supply, reducing its purchasing power and making it less inflation-resistant.
3. Gold's Consistent Value: Gold maintains a steady S2F ratio and has a long history as an inflation hedge. However, its physical nature and its associated costs (storage, insurance) can affect its practicality as a store of value.

A New Era of Value Preservation

In conclusion, when assessing these assets through the lens of the Stock-to-Flow ratio and inflation resistance, Bitcoin emerges as a strong contender for the most inflation-proof store of value. Its digital scarcity, driven by a predictable and unalterable issuance schedule, sets it apart from the USD and even gold. While gold remains a steadfast option, its physical limitations and Bitcoin's unique properties signal a shift towards digital assets in the realm of value preservation.