In late October, Olivier Garret, a Forbes contributor, put out the piece All the Reasons Cryptocurrencies Will Never Replace Gold As Your Financial Hedge.Below I detail the six proposed reasons and my counterarguments to each. In comparing gold to cryptocurrencies, I will focus on bitcoin because I believe it is the cryptocurrency most likely to replace gold.
1: Cryptocurrencies Are More Similar To A Fiat Money System Than You Think
Garret argues that because cryptocurrencies are not backed by a physical commodity, they are more like the U.S. dollar than gold. This is a naive view of what is required for something to be a commodity; mainly that it has to be backed by something physical.The U.S. dollar is not a commodity because it derives its value from its use as a (1) unit of account, (2) means of exchange and (3) store of value. This use is backed by the full faith and credit of the U.S. government rather than the physical value of paper bills.Gold, on the other hand, is a commodity because it derives its value from its use as raw material to meet a fundamental need . This use is backed by its inherent nature of being scarce, fungible, divisible, durable and transferable. Therefore, it is gold’s physical properties that give it value rather than another entity, like a government.[1] For these reasons, I would argue that a cryptocurrency like bitcoin is more like gold than the U.S. dollar because it derives its value from use as raw material on the Bitcoin network, which allows for a peer-to-peer, borderless, fast, secure and cheap way to send value across the globe. Although bitcoin is not physical, it is the inherent nature of bitcoin (albeit digital), that gives it value and makes it a commodity. Therefore, its not helpful to say that bitcoin is more like fiat money than a commodity simply because it isn’t backed by something physical.Garret also cites bitcoin’s “artificial” supply and how it cannot compare to gold’s physical constraint. This statement is simply another example of the misconception that things must be physical to be commodities and a further misconception about the Bitcoin protocol. One of Bitcoin’s most important innovations is the invention of digital scarcity. Before Bitcoin, anything digital could be duplicated for free an infinite amount of times.[2] The Bitcoin protocol, in contrast, is programmed in such a way that only approximately 21 million bitcoins will ever exist. And while this number may be arbitrary, it is no less arbitrary than the amount of gold in the Earth. It is irrelevant that bitcoin’s supply is artificial and gold’s is natural. The point is that supply is limited, which leads to value.The misinformed often assume that Bitcoin’s code can be changed to increase or decrease the 21 million number, but this would require consensus from the entire Bitcoin community of developers, miners, users and applications, all of whom have invested millions of dollars and thousands of hours under the assumption that only 21 million bitcoins will ever exist. Changing the bitcoi supply would completely alter than economic analysis, and the years it took to make necessary upgrades to Bitcoin to improve its scalability alone shows that this is a highly unlikely scenario. We can therefore assume that Bitcoin and gold are equals in their promise of scarcity.
2: Gold Has Always Had And Will Always Have An Accessible Liquid Market
Garret argues that cryptocurrencies cannot replace gold because gold is global, accepted everywhere and therefore has a huge liquid market. The same can be said for bitcoin.Bitcoin is global, and even more global than gold because it can literally be transferred across the globe in minutes. How easily can a bar of gold be transferred from a U.S. bank safety deposit box to Australia? Or for that matter, simply another safety deposit within the same bank? It is true bitcoin is not accepted everywhere as a currency today, but it is being accepted as an investment and viable store of value at an increasing rate. Bitcoin is also less than 10 years old. Mainstream acceptance will simply take time. As bitcoin gains in acceptance, it’s market will become more liquid. But even today bitcoin’s market is quite liquid, as it does approximately $13 billion in volumeon a daily basis. To further illustrate bitcoin’s liquidity, and as of this writing placing a trade for 100 bitcoins (currently worth $1.9 million) on the world’s largest exchange, Bitfinex, would move the market less than 1%.I agree that right now cryptocurrencies are nowhere near as liquid and widely accepted as gold. But I believe that can and will change.
3: The Majority Of Cryptocurrencies Will Be Wiped Out
Garret compares cryptocurrencies to the dot com bubble and how only a few companies, like Amazon and Google, survive to this day. Garret notes that with gold, there’s no need to pick the winner.I don’t disagree with the dot com bubble analogy but to this I say, so what? If and when the bubble pops there will be a few survivors that will have the potential to replace gold as a financial hedge. As previously mentioned, I and most believe that survivor will be bitcoin.There’s no guesswork in gold today, but again, gold has been around for thousands of years whereas bitcoin was invented less than 10 years ago.
4: Lack of Security Undermines Cryptocurrencies’ Effectiveness
Garret cites the various multimillion dollar cryptocurrency hacks and contrasts this with how rarely (if ever) gold depositories robbed.This argument mistakenly focuses on the centralized holders of cryptocurrencies being hacked, mainly the exchanges, rather than any insecurity inherent in bitcoin. Most cryptocurrency holders make the mistake of storing their cryptocurrencies on exchanges for convenience. By doing this they are exposing themselves to third parties, many of which are startups that lack effective security and are easy targets for hackers.In contrast, the Bitcoin network itself has has never been hacked, nor have most people who store their cryptocurrencies in hardware wallets, such as Ledger or Trezor, or even in Coinbase’s digital wallet (provided they use two-factor authentication). All of these measures are the most advisable way to securely store cryptocurrencies.Rather than a lack of security, it is instead the lack of convenience in securely storing cryptocurrencies that is the biggest impediment. But this is slowly changing. For instance, Coinbase is beginning to offer custodial services to institutional investors. I also believe that over time the exchanges will become more secure and people will become more comfortable with personally storing their own cryptocurrencies on hardware wallets.
5: Hype and Speculation Continue to Drive Cryptocurrencies’ Value
Garret notes the enormous increase in bitcoin’s value in 2017 alone and the assumption that it must be a bubble. To this I again say, so what? Bitcoin’s market cap is currently $300 billion, a drop in the bucket compared to gold’s $100 trillion market cap. If bitcoin is to replace gold then it only makes sense for its market cap to increase as more investors see it as a replacement.I agree that the cryptocurrency market cap has increased by too much too soon, but keep in mind that this was the year governments and media around the world started to seriously take note. Governmental intervention in the U.S., China, Russia, Japan and South Korea (to name just a few) tells people that these things may have real use cases. So naturally more people will invest and information will spread. The increased media coverage contributes to this information feedback loop that further increases the hype. All of this leads to speculative investment that values the cryptocurrencies beyond their utility value.At some point the bubble will pop and the cryptocurrencies that remain will have to justify their value based more on utility value than speculative value. At the point in time I believe bitcoin will be more likely to replace gold.
6: Cryptocurrencies Do Not Have Gold’s History As A Store Of Value
Garret cites bitcoin’s infancy in contrast to gold’s long history as a store of value and low or negative correlation to stocks and bonds, which makes gold a powerful hedge.At the risk of being redundant, I’ll again point out that bitcoin’s limited history precludes it from being a replacement to gold today. But that does not mean it can’t be a replacement for gold tomorrow. The Generation Y and Millennial investors of tomorrow are living in an increasingly digital world and are open to new and less traditional forms of investment.In response to cryptocurrencies’ correlation to other assets like stocks or bonds, I also note that bitcoin, like gold, has historically responded to “risk off” events such as Greece’s bankruptcy, the surprise Trump election and the North Korean missile crisis by increasing in value.
Conclusion
Despite being digital in nature, cryptocurrencies, and mainly bitcoin, have many of the same properties that make gold a financial hedge. It may take another economic recession to truly see bitcoin’s hedging abilities, but I believe in time bitcoin will justifiably earn the designation of “digital gold”.
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[1] While some argue that the fundamental need gold meets is its use in industrial applications and jewelry, I would argue that the fundamental need is instead the human need to have something precious. Its value is therefore backed by other people believing it is such. For this reason, gold jewelry is valuable because it is made of gold, rather than the other way around.
[2] Digital management rights (DMR) software allows for scarce digital goods, but this scarcity is controlled by a central authority. Bitcoin, in contrast, is not controlled by a central authority.