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Blockchain and finance in 2019
Gold, Bitcoin or Gold/Bitcoin? Part 2
Gold vs. Bitcoin
Although gold has seen brighter days, it is still a major player in the global markets. In fact, in recent years, gold seems to be making a comeback, with a gradually rising price, more attention from governments and central banks, and the expectation that it will function as a hedge against the bumping markets. Bitcoin is a ten year old asset, yet it shares several of the characteristics of the thousand plus year old gold. Is there a chance for Bitcoin to bite into this 7 trillion dollar stack?
In his seminal white paper about Bitcoin, Satoshi Nakamoto stated:
“A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.”
This definition is focused on Bitcoin as a digital-era payment tool which does not require third parties — not a definition that in any way resembles gold. However, a decade after Bitcoin’s creation (albeit hardly a long stretch in financial terms), it has yet to fulfil this goal. Transactions are slow, and sometimes very expensive, and they do not scale well. Innovations such as the Lightning network are supposed to solve this challenge, but at the moment no one considers Bitcoin to be a tool for payments.
However, given its incredible increase in value, from mere pennies in its early days, to the approximate $9,000 USD mark of today, Bitcoin community members are suggesting that it could be more suitable as a store of value, much like good old gold (see Figure 3 below).
Figure 3, Bitcoin Price Log
With this in mind, it is interesting to examine the similarities and differences between Bitcoin and gold, to see which fares better or worse as a tool for savings, and hedging against other assets.
Gold and Bitcoin: Similarities
Fungible, Portable, Divisible and Durable
The fundamental properties of money are that it:
- has interchangeable units
- can be carried from place to place
- can be divided into smaller units that allow a variety of amounts
- can retain its shape even after intensive usage
Without these properties, neither gold and Bitcoin could function as a form of money. They are actually superior to other forms of money, as they are particularly durable, which is what makes them especially qualified to store value for long periods of time.
The most significant thing that makes both gold and Bitcoin different to other forms of money is their limited supply. Gold is a rare metal. The World Gold Council estimates that the total of all the gold ever mined is 190 thousand tons. The remaining unmined gold totals an approximated 57 thousand tons, according to the US Geological Survey. The maximum supply of Bitcoin is 21 million coins, of which there are already almost 18 million Bitcoins in circulation today. The supply of Bitcoin will decrease over the years, with the last Bitcoin expected to be mined in 2140.
In Part 1, we discussed how a limited supply is an alternative to today’s popular fractional reserve monetary system. Scarcity could also create a shortage, which would likely raise the price. Unlike fiat money that is printed indefinitely by governments, the limited supply of gold and Bitcoin creates an enhanced potential for maintaining value in the long run.
The legendary Warren Buffett, considered by many to be one of the best investors in the world, is a longtime opponent to investments in gold. He constantly expounds his anti-gold agenda; one of the best-known instances of which was in a letter to Berkshire’s shareholders in 2012, where he described his perceptions of the shortcomings of gold (which can also be seen as relevant today):
“If you own one ounce of gold for an eternity, you will still own one ounce at its end. What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As ‘bandwagon’ investors join any party, they create their own truth – for a while”.
To demonstrate his approach, Buffet suggested a hypothetical thought experiment where all the gold in the world would be melted down into a cube. He calculated that this cube would fit into a baseball infield, and would be worth $9.6T USD, according to its value at the time. But what could be bought with such a huge amount of money? Buffet’s suggestions included purchasing all US corpland, 16 Exxon Mobiles, and even then, there would still be $1T USD remaining.
Following this, Buffet’s hypothetical question was “Can you imagine any investor with nearly $10T USD who would choose to buy gold instead of this productive property?” to which there are two possible answers:
- Over the last 20 years, gold outperformed the stock market, which does not prove that it is a productive asset, but it does show that it is a profitable one.
- As a form of money, gold and Bitcoin shouldn’t be judged by their productivity, like stocks or bonds which fuel various industries, and represent a share in a company or funding of its activity. Gold and Bitcoin serve as part of the tools that enable the actions of markets themselves, buying and selling. This isn’t production, but no production is possible without it.
The Differences Between Gold and Bitcoin
As mentioned earlier, the price of gold has fluctuated considerably over the years. Yet this is nothing compared to the crazy volatility of Bitcoin, which can spike up or down by 10% or more within weeks, days and even minutes. With such a high volatility, it is hard to consider Bitcoin a store of value, according to the standard by which gold is judged – although it is important to note that over the years, the volatility rate has been moderated. Superior asset: Gold
As mentioned earlier, portability is one of the properties of any money. Gold is portable, but it is also a heavy object which is difficult to carry and store. By contrast, Bitcoin is completely digital, can be carried on a disk-on-key or even juet with a piece of paper – and therefore it is better than gold as a tool for storing value in the digital world. Superior asset: Bitcoin
The novelty of Bitcoin is that it answers the search for a digital money which is censorship-resistant, and can’t be confiscated by governments or commercial entities. One can hide gold in a cellar – as many do – and it has proved to be a useful precaution in troubled times of wars and other disasters. That said, Bitcoin as a solution is far smarter. Bitcoin uses online capabilities to gain an advantage that no physical asset can hold. It’s not that you can’t catch, or steal, Bitcoin – but it is definitely much harder. Superior asset: Bitcoin
This is the most abstract characteristic, and is also a circular definition: people trust a certain asset to have value, if other people trust it as well. But unlike national fiat money, that is backed up by powerful central authorities – gold and Bitcoin are in no-man’s land, supported only by the degree of trust gained on their own. Since trust is an aggregate feature, with the nature of a network effect, the thousands of years of gold are an unquestionable advantage over Bitcoin’s decade. This is an advantage that Bitcoin will find difficult to overcome, but it will surely try. Superior asset: Gold