How did Bitcoin go from the laughing stock of the investment community to become described as a safe haven asset that has been compared to gold? In this article, we’ll take a look at whether investing in Bitcoin is really a modern version of investing in gold.
Is investing in Bitcoin is similar to investing in gold?
In order to understand whether investing in Bitcoin is similar to investing in gold, it’s important to understand why people invest in gold in the first place. Gold has been recognized globally as a valuable asset throughout history both because of its aesthetic appeal as well as its unique chemical properties making it an important metal across important industries such as electronics and medicine. But your average investor isn’t usually buying gold for its chemical properties.
Even though it doesn’t produce income and is illiquid, gold is seen as a valuable investment asset due to the following reasons.
Firstly, scarcity.
Gold is available in low quantities in nature meaning large amounts of rock need to be processed in order to extract just a small amount of gold. This makes production costs high and means that gold is produced at a much slower rate relative to other precious metals.
Having regard to competing demand for gold from industry and from investors, this increases gold’s value.
Secondly, currency devaluation or an Inflation hedge.
Because gold production has always occurred at a low rate, this means that the supply of gold is relatively fixed. Meanwhile, governments around the world are printing more and more money otherwise known as quantitative easing to try to lift struggling economies.
As more money chases approximately the same amount of gold, each ounce of gold becomes worth more money as money becomes less valuable. The reason this is often referred to as an inflation hedge is that printing more money is historically associated with higher inflation as the value of goods increases because there is so much more money in the economy to purchase the same amount of goods.
By buying gold, means that purchasing power can be retained. Political uncertainty also drives people towards gold. When governments can no longer be trusted to manage their own currencies, people flock to gold as its supply is not managed by one central authority.
You only need to look at countries like Venezuela to see what can go wrong with currency. Diversification away from stocks is also a reason why people invest in gold. When stock prices go down, gold prices have historically gone up meaning their price movements are typically negatively correlated with stocks.
This means that gold serves as a hedge against the volatility of the stock market, helping manage risk. People also just like physical gold. In many cultures, it is the norm to buy gold including in India and China, perhaps due to historical political turmoil.
Looking at the above reasons why people buy gold you can see that these are often the same reasons why people buy Bitcoin. Bitcoin is also scarce - possibly more scarce than gold. In fact, its scarcity is mathematically guaranteed.
The total supply of bitcoins is fixed at 21 million. There is also significantly less in circulation as people and institutional investors start holding onto them long term or HODL-ing Secondly, similarly to gold, it follows from scarcity that Bitcoin also acts as an inflation hedge.
The number of Bitcoins is capped at a fixed number, therefore, being worth more relatively to fiat currency when billions of dollars of currency are being printed. Bitcoin’s distributed network also means that it is not under central government control which gives investors safety away from political uncertainty.
The one area in which Bitcoin doesn’t perform as strongly as gold is diversification. So far in its short history Bitcoin is positively correlated with the stock market so it doesn’t act as an effective hedge. Whilst you can’t touch or feel Bitcoin in the same way you can gold, there are plenty of fans in the technology particularly millennials and younger.
You can see from this comparison that Bitcoin really does have a lot of similarities to gold as an investment asset. So why are many people still so uncomfortable with classifying Bitcoin as a safe investment? It probably comes down to a few reasons. Bitcoin is still relatively new and there has been a lack of time to establish its value.
In particular, it is something intangible that makes it hard for people to acknowledge its value. Also, the software and technology behind bitcoin are incredibly complex and difficult to understand. Whereas gold has enjoyed a high status for centuries. And also, it’s shiny. Secondly, the overall cryptocurrency regulatory framework is still unclear.
With the SEC pursuing ICOs and more recently Ripple XRP and question marks around stablecoin Tether many investors remain cautious about legislative risks associated with Bitcoin. Meanwhile gold does not have any of those concerns. The crazy volatility in Bitcoin prices also makes investors suffer severe emotional swings.
Investors like certainty and whilst gold can also be volatile, it comes nowhere near the volatility of Bitcoin. Bitcoin also comes with cybersecurity concerns. Whilst gold bullion is safely stored away at home or in a vault under physical security, bitcoin is floating around in cyberspace.
Reports of exchanges being hacked, passwords being stolen or worse forgotten can make us feel that we can simply lose all of our Bitcoin just through mistakes and circumstances outside of our control.
So it’s perfectly normal to take the view that whilst Bitcoin is like gold, it comes with additional risks. Whether Bitcoin is a safe haven asset depends on what you mean by a ‘safe-haven’. If you mean a safe haven from government actions such as currency devaluation and political turmoil then that is true. However, investors should not equate this with Bitcoin being a safe investment.
If you’d like to find out more about the blockchain technology that makes Bitcoin work, I have an article here with an incredibly simple explanation for total beginners wanting to understand how blockchain and cryptocurrency works.
