Three ratios crucial for understanding Bitcoin Price

According to crypto analyst PlanB, who popularized the Bitcoin stock-to-flow model, understanding the world’s largest cryptocurrency comes down to just three things—its Sharpe ratio, its correlation with other assets, and cointegration with the stock-to-flow model.

Boiling down Bitcoin to three crucial ratios

While Bitcoin’s unique proposition attracted hundreds of millions of people in the ten years since it was created, it might take another ten before it attracts the same amount of institutional interest.

That isn’t to say that traditional financial companies have turned a blind eye to the world’s largest cryptocurrency—they just need a gentle push to realize the potential the industry has. With institutional investors being a notoriously difficult crowd, breaking through requires a careful and diligent approach.

According to crypto analyst PlanB, the simplest and easiest way to understand Bitcoin is to represent it through three ratios, all used in traditional finance—its Sharpe ratio, its correlation to other assets, and its correlation and cointegration with stock-to-flow.

The analyst, known for popularizing Bitcoin’s stock-to-flow model, said that using these three ratios in a pitch to institutional investors garnered an “amazing response,” as it shows its immense underlying value.

Apart from that, the analyst said that it was important to highlight that Bitcoin isn’t a fad, but a product of more than 50 years of scientific research and development.

Chart showing the research and development process that preceded Bitcoin (Source: PlanB)
Chart showing the research and development process that preceded Bitcoin (Source: PlanB)

Bitcoin through the charts

The Sharpe Ratio

Used to determine the performance of an investment in comparison to the rate of the return on a risk-free investment, the Sharpe ratio has been a favorite among portfolio and mutual fund managers since the late 1960s. It’s calculated by subtracting the risk-free rate of return from the expected return on the asset and then divided by the standard deviation of returns of the asset.

When using a 4-year holding period to run the Sharpe Ratio calculation, analyst Willy Woo found that Bitcoin had an average ratio of 3.0. With a ratio higher than 1.0 considered acceptable, and ratios of 3.0 or higher considered excellent, Bitcoin outperformed every other asset, including U.S. stocks, bonds, gold, and oil.

Chart showing risk-adjusted returns (the Sharpe Ratio) for Bitcoin and other assets
Chart showing risk-adjusted returns (the Sharpe Ratio) for Bitcoin and other assets. Source: Woobull

Correlation with other assets

Apart from its high Sharpe ratio, one of Bitcoin’s unique propositions is its independence from other markets. According to Messari Crypto, Bitcoin has by and large been uncorrelated with other macro classes such as equities, fixed income, gold, and oil.

While it sports slightly higher correlations with European stocks, its average correlation of 0.08 is as close to zero as it could be.

Chart showing Bitcoin's correlation to assets such as gold, bonds, stocks, and oil
Chart showing Bitcoin’s correlation to assets such as gold, bonds, stocks, and oil. Source: PlanB

Stock-to-flow

Popularized by crypto analyst PlanB, applying the stock-to-flow model to Bitcoin highlights its scarcity and shows that it does, in fact, move in predictable ways. Put simply, the stock-to-flow ratio is the amount of a commodity held in inventories divided by the amount produced annually.

Bitcoin’s stock-to-flow ratio of around 25 puts it in the monetary goods category, alongside silver and gold. Gold currently has the highest SF at 62, while silver is second with an SF of 22.

According to the latest data from PlanB, Bitcoin currently has a 95 percent correlation and integration with stock-to-flow, meaning it almost perfectly follows its scarcity model.

Chart showing Bitcoin's correlation and cointegration with the stock-to-flow model
Chart showing Bitcoin’s correlation and cointegration with the stock-to-flow model. Source: PlanB

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