Why Bitcoin could hit $90K... At least on paper

1 November, 2019

Common sense and history dictate that attempting to predict Bitcoin's long-term price is a fool's errand. That goes for any other investment opportunity as well. Too much can happen between now and whatever future point in time you choose. Yet that has not stopped a well-known German bank from predicting a post-halving price of $90,000 per Bitcoin.

Bayern LB released a report in late September 2019 discussing the possibility of Bitcoin eventually overtaking gold as the top 'hard money' choice in the world. The report also touches more broadly on the concept of digitalization in the financial sector. Key to their predictions of BTC's $90,000 price is something known as the stock-to-flow (SF) ratio.

When you look into this ratio and how it applies to gold, you can make a very compelling case for Bitcoin as hard money. Yet there is something inherently different when you are talking digital assets: they are not tangible. You can hold a chunk of gold in your hand. You can melt it into a bar or form it into a coin. You can even make jewelry out of it. You cannot do any of that with Bitcoin because, as a physical asset, it does not exist.

This is not to say that Bitcoin is worthless. If you follow Bitcoin pricing, you know that it absolutely has value. But linking its value to gold via a mathematical ratio that may or may not apply is questionable. For purposes of our own education, let us look at that ratio and why the German bankers think Bitcoin pricing could explode in 2020.

The Stock-to-Flow ratio

Bankers and economists use a number of different tools in their attempts to figure out economic direction. One of those tools is the SF ratio. The ratio is based on two quantifiable factors: stock and flow. Stock is the circulating supply of a given asset while flow is a measurement of its annual production.

SF ratio is easy to observe in gold. There is only a limited amount of gold in circulation at any given time. Likewise, it is easy to measure gold production just by looking at mining company reports. With a little bit of legwork you can come up with some fairly accurate numbers. Then you can do something with those numbers.

As a general rule, there is a correlation between SF ratio and an asset's market price. A higher SF value means a higher market price, and vice versa. Bayern LB analysts look at Bitcoin's SF ratio and see very positive things. They believe Bitcoin will only get better once the mining reward is halved next year. But will halving be enough to send BTC to the $90,000 mark?

Comparing gold to Bitcoin

Gold has been valuable throughout the history of humankind due to its limited availability. It is called a 'precious metal' for a reason. Finding gold is not easy, nor is mining it. And of course, everybody wants it. This creates an immediate demand that is not likely to fade any time soon.

Gold's SF ratio has likewise been extraordinarily strong ever since analysts began measuring it. Gold stock is already substantial the world over while flow is limited. Indeed, annual production has long been kept in check by mining difficulty. As a result, gold is not just a hard asset in the sense of being tangible, it is considered hard money that will always have intrinsic value.

We can look at Bitcoin using the same principles. As it stands now, Bitcoin's supply in the marketplace is substantial. Its production is also limited. That is by design. Written into Bitcoin's code are two fundamental principles that prevent the market from being saturated with new coins. These are:

1. Mining procedures

An initial supply of BTC was released to the market a decade ago in order to get the project off the ground and get some money behind it. Once that initial offer was complete however, Bitcoin's code called for further circulation through mining. What is mining? It is the process of using sophisticated computer equipment to build blocks in the chain by processing and validating transactions.

Mining ensures that new coins are gradually released into circulation while simultaneously protecting the integrity of the blockchain and keeping the network in operation. But there is a caveat to all of this: Mining gets more difficult with every new coin released. The more difficult mining becomes, the less quickly new coins are put into circulation.

2. Reward halving

The second principle built-in to the Bitcoin code is that of halving the reward for mining. Every time 210,000 blocks are mined, the reward for mining is cut in half. This occurs every four years or so. Halving the reward further limits production. It also increases prices, at least in theory.

Bitcoin's SF ratio

The next halving is expected to occur in the spring of 2020. When it happens, the mining reward will drop to 6.25 BTC per block. Here's why that's important: halving the reward will push Bitcoin's SF ratio much higher. According to Bayern LB, it should jump from 25.8 (where it now stands) to somewhere in the neighborhood of 53. Guess what gold's current SF ratio is? It currently stands at 58.

Remember the general rule that states a stronger SF ratio commands higher market prices. The analysts at Bayern LB are convinced that Bitcoin's SF ratio is going to be in line with gold in the post-halving era. That would dictate a much higher price than the market will bear right now. As to how they reached the $90,000 mark, that is not clear.

What we do know is that Bitcoin's current SF ratio commands a price of about $7,500 based on the math of the SF model. BTC was trading at just over a $8,200 when this post was written. That's not far off. If the SF model is an accurate predictor of price, you can plot a chart that clearly demonstrates a $90,000 price point for Bitcoin.

Prices will go up

SF ratio is just one tool economists use to predict future economic events. It is also a tool that not all the experts agree on. However, there is a general consensus that Bitcoin prices will go up post-halving. Even without the SF ratio in play, halving the reward while not reducing the amount of work necessary to earn that reward naturally increases prices. The simple laws of supply and demand dictates as much.

When the supply of a given asset is low while demand remains high, prices go up. It is pretty simple. If you have one banana and 10 hungry people who want it, you can charge maximum price. If you have 10 bananas and 10 hungry customers, your pricing ability goes down.

Halving the reward for mining reduces the number of coins put into circulation. Reduced circulation without reduced demand creates higher prices. And because the same amount of work will be necessary to earn the money reward, demand for the coins will increase. All of this points to a higher price beginning spring 2020.

How high will the price go? That's anyone's guess. Bayern LB is comfortable with $90,000. Others have gone so far as to suggest a price as high as $1 million. The big unknown here is investor comfort. That is always the question when you are dealing with assets that represent a store of value.

What it means to you

So, what does all this mean to the day-to-day Bitcoin user? Not much, at least for the next 8 to 10 months. While scores of competing analysts predict lower and higher BTC prices, the most likely scenario sees Bitcoin continuing to move up and down between $7,500 and $10,000 through the end of the year and into 2020.

Late winter is when we are likely to see what direction BTC will take post-halving. If strong consensus suggests anything close to Bayern LB's $90,000, there should be a commensurate up-tick in trading by the time spring 2020 arrives. Smart investors with money to spend will want to stock up on their coins prior to halving.

Meanwhile, you are still free to use your BTC the same way you use it now. If you are an online gambler who loves to play Bitcoin casinos, have at it. If you spend BTC to make online purchases, there's no need to stop. Bitcoin will still be usable as an alternative monetary system irrespective of what happens to prices in the spring of 2020.

If you are willing to take a little bit of risk, you might want to set aside a small amount of your BTC and just let it be until then. Whatever amount you can afford to not touch is fine. Then just wait for halving to occur. Jumping from $7,500 to $90,000 represents a 12-fold increase. Every dollar of BTC you set aside now could be worth $12 if Bayern LB's analysis is correct.

It is possible, at least on paper, that Bitcoin will reach $90,000 at some point in 2020. Thanks to an economic measurement known as the SF ratio, Bitcoin's stock and flow could make it an asset that is as strong as gold. It might even surpass gold as a store of value and a hard money asset.