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Use power laws to predict when the price of Bitcoin will reach $1 million
The following is a guest post by Rajagopal Menon, the Vice President of WazirX.
The bull market arrives, the models to predict the price of Bitcoin arrive. In the last bull market of 2021, the Stock-to-Flow (S2F) pattern was the flavor of the season. This model, created by Plan B, assessed resource scarcity by comparing inventories to annual production. Applied to Bitcoin, the S2F model emphasized its potential as “digital gold” and provided long-term price predictions based on scarcity. However, the S2F model fizzled out during the cryptocurrency winter of 2022.
But fear not, in the current bull run, there is a new model in town: the Power Law Model, which claims to predict the price of Bitcoin with remarkable accuracy.
Understanding power laws
In a world seemingly full of chaos and randomness, scientists have discovered hidden patterns and relationships known as power laws. These laws provide a framework for understanding how different phenomena interact, revealing coherent mathematical patterns that govern various aspects of our universe.
Laws of power in everyday life
Power laws are fascinating mathematical relationships that appear in numerous phenomena, offering insights into the underlying simplicity of complex systems. They describe how two quantities relate to each other, with a change in one quantity leading to a proportional change in the other. This relationship extends across different scales, from the microcosmic to the 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 get larger, their volume and weight increase much faster than their strength. This law establishes 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. He reveals that an organism’s metabolic rate scales up to ¾ of its mass, indicating that larger animals are more energy efficient. This principle has a significant impact on understanding the life cycles, growth rates and sustainability of species.
Natural phenomena and human activities
Power laws govern several 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 numerous smaller cases. For example, Zipf’s law describes the frequency of words in languages, highlighting the disproportionate presence of common words compared to less frequent ones.
Beyond natural phenomena
Power laws extend to human activities such as economics, finance, and technology. They clarify the distribution of wealth, where a few individuals own a significant portion of wealth. In technology, power laws describe how content interacts on the Internet, with some very popular and many less popular nodes forming a long-tail distribution.
The power law of Bitcoin
Astrophysicist Giovanni Santasi discovered this connection. He says that 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 told his 2.3 million subscribers about it in a video.
Giovanni’s theory says that the price of Bitcoin is not as random as it seems. There is randomness, but over the long term the price of Bitcoin follows a specific mathematical pattern. It’s not just a mathematical formula that someone drew a line on; 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 level below which Bitcoin usually never falls. The green line is the linear regression line, which is like the price to fair value, 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 tracks Bitcoin’s price trajectory with remarkable accuracy. It features a chart showing the current price of Bitcoin, a support line indicating the level below which Bitcoin typically does not fall, a linear regression line representing a fair value price, and a resistance line marking the level which Bitcoin typically reaches before a recession.
This pattern highlights Bitcoin’s remarkably linear growth, especially evident when outliers are removed. Despite occasional fluctuations, Bitcoin’s overall trajectory follows a recognizable pattern reminiscent of other phenomena governed by the laws of power.
Implications for investors
The power law model offers interesting 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. He goes on to predict that Bitcoin will be worth $1 million in July 2033. While mathematical models provide valuable information, they are not immune to errors and may fail to account for unexpected events that can have a significant impact on prices.
“All models don’t work, but some are useful” means that even though models may not be perfect, they can still provide valuable information. Models, such as the power law model or the stock-to-flow model for predicting the price of Bitcoin, have their flaws and limitations. Crypto Quant’s Julio Marino, for example, pointed out problems with the power-law model, such as underestimation of errors and the misleading impression of precision.
Interestingly, both power law and stock-to-flow models have faced similar criticisms. Despite their flaws, they have historically made almost the same predictions for 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 such as the 60/40 portfolio? Some argue that new models that explain Bitcoin’s behavior could offer better returns.
While some may think these models are useless, others, like the person speaking, believe they still have value. Scarcity, driven by Bitcoin’s fixed supply, plays a role in its price appreciation. Furthermore, factors such as M2 growth also influence the price of Bitcoin.
While 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 equally essential to recognize their limitations.