The following is a guest post by Rajagopal Menon, Vice President of WazirX.
Come the bull market, come the models to predict the price of Bitcoin. During the last bull market of 2021, the Stock-to-Flow (S2F) model was popular. This model, created by Plan B, assessed asset scarcity by comparing inventory to annual production. Applied to Bitcoin, the S2F model highlighted its “digital gold” potential and provided long-term price predictions based on scarcity. However, the S2F model faded in the crypto winter of 2022.
But fear not, in the current bullish trend there is a new model in town: the power law model, claiming to predict the price of Bitcoin with remarkable accuracy.
Understanding Power Laws
In a world seemingly filled with chaos and randomness, scientists have discovered hidden patterns and relationships known as the laws of power. These laws provide a framework for understanding how different phenomena interact, revealing consistent mathematical patterns that govern various aspects of our universe.
The laws of power in everyday life
Power laws are fascinating mathematical relationships that appear in many phenomena, offering insight into the underlying simplicity of complex systems. They describe how two quantities relate to each other, with a change in one quantity resulting in a proportional change in the other. This relationship extends across different scales, from microcosmic to cosmic, influencing biology, society, technology and natural phenomena.
Animal size limits
Galileo's square cube law is a classic example of a power law in nature, explaining how an animal's size affects its strength. As animals grow, their volume and weight increase much faster than their strength. This law sets natural limits, explaining why larger animals have thicker bones and why larger animals are found in aquatic environments where buoyancy compensates for weight.
Metabolic rates
Max Kleber's research on metabolic rates further demonstrates the applicability of power laws. It reveals that an organism's metabolic rate scales to the power of ¾ of its mass, indicating that larger animals are more energy efficient. This principle has a significant impact on understanding the life cycle, growth rates and sustainability of species.
Natural phenomena and human activities
Power laws govern various phenomena, from the distribution of earthquake magnitudes to the frequency of words in a language. They explain why we observe a small number of significant events alongside many smaller cases. For example, Zipf's law describes the frequency of words in languages, highlighting the disproportionate occurrence of common words compared to less frequent words.
Beyond natural phenomena
The laws of power extend to human activities such as economics, finance and technology. They explain the distribution of wealth, where a few individuals own a significant share of the wealth. In technology, power laws describe how content interacts on the Internet, with a few very popular nodes and many less popular nodes forming a long-tail distribution.
The Law of Bitcoin Power
Astrophysicist Giovanni Santasi discovered this connection. He says 15 years of data shows that Bitcoin also follows a power law principle. Santostasi first shared the power law model in the r/Bitcoin subreddit in 2018. However, it saw a resurgence in January after financial YouTuber Andrei Jeikh mentioned it to his 2.3 million followers. subscribers in a video.
Giovanni's theory says that the price of Bitcoin is not as random as it seems. There is some randomness, but over the long term, the price of Bitcoin follows a specific mathematical model. This isn't just a mathematical formula that some guy drew a line through; instead, it follows a power law like those observed throughout the universe.
The yellow line represents the current price and the red line represents the support line, the Bitcoin level usually never goes below. The green line is the linear regression line, which is like the fair value price, to which Bitcoin will eventually return, and the purple line is the resistance line at which Bitcoin typically peaks.
Predicting the Future of Bitcoin
Santostasi's Power Law model plots the price trajectory of Bitcoin with remarkable precision. It features a chart showing the current price of Bitcoin, a support line indicating the level Bitcoin generally does not go below, a linear regression line representing a price at its fair value, and a resistance line marking the level Bitcoin reaches usually before a slowdown.
This model highlights Bitcoin's remarkably linear growth, particularly evident when outliers are removed. Despite occasional fluctuations, Bitcoin's overall trajectory follows a discernible pattern reminiscent of other phenomena governed by power laws.
Implications for investors
The Power Law model offers fascinating insights into Bitcoin's potential future peaks. Santostasi's analysis suggests that Bitcoin could peak at $210,000 in January 2026, followed by a subsequent decline to around $60,000. It then predicts that Bitcoin will be worth $1 million in July 2033. Although mathematical models provide valuable information, they are not immune to error and may not account for unforeseen events that could have a significant impact on prices.
“All models are flawed, but some are useful” means that even if models are not perfect, they can still provide valuable information. Models, like the power law model or the stock-flow model for predicting the price of Bitcoin, have their flaws and limitations. For example, Julio Marino of Crypto Quant pointed out problems with the power law model, such as underestimating errors and creating a misleading impression of correctness.
Interestingly, power law and stock-flow models have been subject to similar criticism. Despite their flaws, they have historically made almost the same predictions regarding the price of Bitcoin. However, over time, their predictions may diverge.
The question arises: if these models are correct, why bother with traditional investment strategies like the 60/40 portfolio? Some argue that new models explaining Bitcoin's behavior could provide better returns.
While some may think these models are worthless, others, like the speaker, think they still have value. Scarcity, driven by Bitcoin's fixed supply, plays a role in its price appreciation. Additionally, factors such as M2 growth also influence the price of Bitcoin.
Although models can provide useful information, they cannot predict the future. Even though the models have flaws, Bitcoin's trajectory appears upward. So, while it is essential to consider these models, it is also essential to recognize their limitations.