Financial commentators regularly compare Bitcoin to gold. Generally, it is argued that Bitcoin is gold for the digital age and should act as a long term store of value. As Bitcoin was taking off it was often referred to as digital gold. The original vision for Bitcoin was that it should be a currency for the internet. However, much of the current focus has been on it’s skyrocketing price leading many to consider it as digital gold.
Historically, gold was used as a form of currency but has since transitioned into a globally recognised store of wealth. This international tacit agreement facilitates investors to store wealth in the form of gold with some assurances over its long term value.
Despite the similarities in terms of currency and store of value it is interesting to test whether the comparison is reasonable.
How liquid is your gold versus digital gold?
Critics of digital gold often herald gold as something pure when compared to Bitcoin. At the same time they criticise Bitcoin’s inability to spend easily. Often times transactions made using Bitcoin can take hours to complete. This makes it a non-ideal means of making purchases.
Despite this, when compared to gold the liquidity of Bitcoin is more impressive. There are many online vendors that will accept Bitcoin. Even in the non-digital world, there are sellers who will willingly accept Bitcoin in payment. In contrast, gold cannot be easily used as a medium of exchange.
Where Bitcoin can be broken down into 100 million Satoshis, gold isn’t easily divisible. Were you to transact with gold you would need the exact right ounce of gold at the current market value.
Furthermore, an ounce of gold cannot be easily transferred into fiat currency. You would need to find either, a pawn broker, gold shop, specialist metal trader, or a perhaps a jeweller willing to buy your gold. Even after finding a buyer, you’re unlikely to achieve the market price.
In the case of Bitcoin, there are several well known exchanges. These exchanges would be willing to exchange your digital gold for fiat currency after charging a percentage fee which can range between 1.5% to 5%.
Store of value during a recession
An interesting sub-question for this debate is to consider which you would rather own during a global recession. During the latest recession that commenced during 2008-09 gold prices shot up to $2,000 per troy ounce. Will gold continue to be the safe haven during the next recession?
Gold doesn’t produce any income like fixed income from bonds, property rental income or stock dividends. However, gold often features as a 5-10% holding within a portfolio. The idea is that gold is inflation proof as it isn’t pegged to any particular currency. Furthermore, it is assumed to hold it’s value over time as it has limited supply.
Given that Bitcoin is entirely decentralised, it represents the antithesis of a government led capitalist system. As such, it seems likely that during economic collapse within a country Bitcoin offers a means of storing your wealth in a way that isn’t connected to the economy.
There have been recent examples in 2017 in both Zimbabwe and Venezuela. Both countries were in economic difficulties and members of those economies turned to Bitcoin rather than to gold as a way of transacting and sustaining wealth. Zimbabwe in particular was an interesting case as Zimbabwean Bitcoin exchanges were selling Bitcoin at a rate that was significantly above that of the rest of the world and Zimbabweans were still buying. This demonstrates the trust that the Zimbabwean population placed in Bitcoin over the fiat system.
Whilst Zimbabwe and Venezuela offer extreme examples, it suggests that during the next recession gold may not be the automatic safe haven.
Risk of fraud
Ever heard of fools’ gold? Nowadays it’s extremely unusual to hear of anyone being defrauded out of their gold. In contrast, stories of fraud surrounding Bitcoin are pervasive.
Whilst the Bitcoin code has never been hacked, Bitcoin wallets and exchanges have been. Furthermore, there have been multiple instances of Bitcoin being used by money launderers and criminal gangs.
Security and storage
The risk of theft from an online wallet or exchange makes security a key aspect of Bitcoin. Since the currency is decentralised there is no bank to take responsibility for security. Instead each holder of digital gold is responsible for their own security. Fortunately, the one off purchase of a hardware wallet enables a user to take their cryptocurrency offline and inaccessible to hackers.
Additionally, the Bitcoin holder needs a private key (a long code of digits and numbers) to access their coin. These private keys can be printed onto paper and stored in somewhere offsite in a safe. Clearly, this level of security is reasonably cheap.
In contrast, to store gold, even a relatively small amount, you will likely need to pay for a safe. Storing large amounts of gold will require regular payment for a professional safe for maximum security. The more gold you have, the increase in the cost of storage. Whereas, the same level of security costs can be used for any amount of Bitcoin.
Gold trades on global regulated markets and exchanges. This means that evidence of price fixing and manipulation are investigated, with appropriate prosecutions to follow.
In the case of Bitcoin there have multiple accusations of price fixing. However, as the system is decentralised there is no authority ensuring integrity. Furthermore, there is no regulator monitoring any price fixing. As such, a Bitcoin investor has fewer assurances over price fixing compared to a gold investor.
Traditionally governments, central, federal and national banks have held gold. These institutions stand behind the currency of the economy as a lender of last reserve should something catastrophic occur. The gold was the traditional backing for the status as last lender.
There is no institution supporting digital gold. If there was then it would defeat the point of a decentralised currency. Bitcoin currently represents one of the top 20 world currencies in terms of market capitalisation. Despite that, there are no underlying assets for Bitcoin other than the innovation and security provided by the code itself.
Where does the value come from?
It seems reasonable to challenge this notion of underlying assets in the case of gold. The only reason we believe gold is a valuable asset is because we believe it has value. This is a fairly tautological argument. Some may argue that gold has actual industrial use thus providing its value. However, the industrial and jewellery uses of gold are minor when compared to its main use as a store of value.
Gold’s value is based on an agreement that it can be accepted as a transfer of value in a transaction or a store of value. Similarly, Bitcoin’s value is based on the general acceptance of that it has value. There is little difference except the gold is a physical commodity, whereas Bitcoin is an intangible commodity. Gold takes up physical space, whereas digital gold takes up data memory.
In both cases, value is based on the market equilibrium of supply and demand.
Fixed or variable supply
The supply of gold depends on how much is taken out of the ground. The supply of gold increases slowly over time. It is this relatively limited supply that makes it an attractive safe haven during times of inflation and economic troubles. A limited supply gives gold scarcity value. Additionally, the supply of gold is largely independent of central bank actions. Therefore, investors can protect their money from the deflationary impact of banks increasing the money supply.
The supply of Bitcoin is even more limited. Whilst Bitcoin mining does increase the supply of Bitcoin over time, this is ultimately capped at 21 million Bitcoins. The supply of Bitcoin is even more independent from the actions of central banks than the gold supply. As such, the price of Bitcoin is entirely isolated from the impact of printing fiat currency.
The main downside to the fixed and limited supply of Bitcoin is that price is generally determined by demand. As such, there are times when liquidity could be extremely low. In which case, the price of Bitcoin can be extremely volatile.
In contrast, gold is generally seen as a fairly stable asset that rarely sees volatile price movements. The volatility in the price of digital gold might be a result of the immaturity of the market. After all, gold has been traded for millennia. In contrast, trading of Bitcoin began in 2011.
Anonymity of transactions
The main benefit of Bitcoin is the anonymity gained when sending money. This attribute has come under a lot of scrutiny over the past few years. Bitcoin has gained a reputation for being favoured by the undesirables in dodgy dealings. This is because the protocols of Bitcoin allow the user identity to remain private.
In the case of gold it is much harder to gain anonymity during a transaction. Given the high value per unit of gold, virtually all transactions of any material size are noted by a regulator, a government, or an exchange in an open and transparent way.
Whilst Bitcoin lacks transparency it appears unfair to define this as a criticism. Just because 1920s American gangsters money laundered their dollar bills does not make dollar bills a bad thing. Similarly, the Bitcoin by gangs and drug dealers should not discredit the entire system. In fact, you may start to ask yourself why it is that your transactions should not be private?