Is Bitcoin A Substitute For Gold?

April 4, 2018

John Maynard Keynes once famously called gold the “barbarous relic”. The emergence of the cryptocurrencies seems to validate that thesis. Will gold survive in the digital era?

Bitcoin as Digital Gold

Let’s face it. Bitcoin and gold are similar. Both assets are rare and their supply is limited (it cannot be increase at will by politicians or central bankers). Actually, Bitcoin was conceived as the digital gold from the very beginning – the process of generating bitcoins is called “mining”. And both Bitcoin (and cryptocurrencies in general) and gold are not government issued media of exchange – instead, both are alternatives to fiat currencies.

According to Aswath Damodaran, a valuation guru, one scenario for Bitcoin is that it will become “gold for Millenials”, i.e. it will take the role that gold has fulfilled for hundreds of years – a safe-haven asset for people who don’t trust governments & central banks and their currencies.

But There Are Important Differences

Bitcoin’s parabolic rise at the end of 2017 prompted some analysts to claim that cryptocurrencies may replace gold. They forgot that Damodaran’s vision was only a one of possible scenarios for Bitcoin’s future. And they neglected several distinctions between gold and Bitcoin. The World Gold Council has recently published an investment update, arguing that cryptocurrencies are no substitute for gold. Their reasons are that gold:

  • is less volatile;

  • has a more liquid market;

  • trades in an established regulatory framework;

  • has a well understood role in an investment portfolio;

  • has little overlap with cryptocurrencies on many sources of demand and supply

Bitcoin vs. Gold – Volatility

The Bitcoin’s enormous volatility is perhaps the biggest obstacle to replace gold. One function of money is to be a store of value such as the yellow metal – as Bitcoin moves, on average, 5 percent each day, it hardly serves as a viable medium of exchange. Actually, cryptocurrencies are much more held and used as a speculative investment rather than medium of exchange used for transactions. Gold is not money anymore, but it is definitely used as an inflation hedge and a store of value.

Bitcoin vs. Gold – Liquidity

Another important issue is market liquidity. Bitcoin trades, on average, $2 billon a day, which is is less than 1 percent of the total gold market that trades approximately $250 billion a day. The modest Bitcoin’s liquidity is partially responsible for its huge volatility. We know that Bitcoin is still young, but the gold’s established role as a monetary asset will be very difficult to dethrone. People have a status quo bias – and there are network effects in operation. Actually, as there are currently over 1,400 cryptocurrencies available, the future of Bitcoin is under question – it has “first-mover advantage”, but we cannot exclude that it would be replaced itself by better cryptocurrency.

Conclusions

We often disagree with the World Gold Council, as it has a clear bullish bias toward gold. The shiny metal and Bitcoin have some similarities, but there are not substitutes, at least not perfect. It’s not that we don’t like cryptocurrencies – we keep our fingers crossed for all alternatives to the government-sponsored fiat money (especially that blockchain technology looks very promising).

But we are not blind to obvious differences. Gold has a long history of being monetary asset behind it and the gold market is well established, very liquid and relatively stable. Meanwhile, the cryptocurrency market is young, with small liquidity and high volatility. Investors buy Bitcoin and other alt-coins not as safe-havens, but rather as speculative vehicles. Hence, contrary to some commentators, the gold prices shouldn’t be affected by rallies and downturns in cryptocurrencies. Stay tuned!

Arkadiusz Sieron

Sunshine Profits - Free Gold Analysis

Arkadiusz Sieroń is the author of Sunshine Profits’ monthly gold Market Overview report, in which he keeps subscribers up-to-date regarding key fundamental developments affecting the gold market and helps them prepare for the major changes. Arkadiusz is a certified Investment Adviser, a long-time precious metals market enthusiast and a Ph.D. candidate. He is also a Laureate of the 6th International Vernon Smith Prize.  You can reach Arkadiusz at Sunshine Profits’ contact page.

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