In 2017 the price of gold rose 13%, a creditable performance. In the same period, bitcoin delivered a 13-fold increase in value, prompting some to claim that cryptocurrencies could replace gold as an asset class.
However, though these digital assets may develop into an established part of the financial system, they are no replacement for gold, a dependable investment tool.
Gold is a highly liquid asset, and trades in an established regulatory framework. Its supply and demand dynamics are unique. These characteristics underpin gold’s status as a mainstream financial asset.
Gold has appreciated by an average of 10% per year for more than 30 years, with relatively little volatility. Bitcoin is markedly different. Last December it soared to almost $20,000 per unit, though it never exceeded $1,000 before 2017, and has fallen back to around $10,000 this year. Such volatility potentially limits bitcoin’s use as a transaction token and is hardly characteristic of a mainstream currency, let alone a store of value.
The cryptocurrency market is said to be worth more than $800bn. But there is no clear two-way market, sales are said to be costly and time-consuming, and trading volumes are low. Bitcoin trades $2bn, on average, each day. The gold market trades roughly $250bn per day.
With a 7,000-year history as an asset and a long-standing role as money, gold is owned by central banks as well as institutional and retail investors. As a tangible asset, gold has varied technical applications, including in the computer chips that ‘mine’ bitcoin.
Cryptocurrencies are designed to be used as tokens in electronic payment systems, but limited spending opportunities hamper their widespread use. Furthermore, genuine cryptocurrency transactions are usually quickly converted into fiat currencies.
The volume of bitcoins increases by around 4% per year and is engineered to decline to zero growth around the year 2140. This diminishing growth rate and finite quantity are attractive attributes, but bitcoin is not alone as a blockchain application. Given the many cryptocurrency alternatives, new and better blockchain-based coin applications may be seen as equivalent to increasing supply, not unlike fiat currency.
Trade in gold is widely authorised and regulated in many markets, while most countries have yet to approve cryptocurrencies, even if they have stopped short of banning them outright. Bitcoin and other cryptocurrencies may be subject to sudden restrictions, particularly if governments become concerned about their impact on economic policy. South Korea, for instance, in January announced increased regulatory measures, while in the UK investors face hurdles to convert cryptocurrencies.
Some commentators claim that gold prices and demand are suffering at the expense of cryptocurrencies. However, there is no quantifiable evidence to suggest this is true, and the factors that propelled the gold price in 2017 appeared little changed from the previous year’s, however there are some positives aspects to cryptocurrencies.
Blockchain, the distributed ledger technology that underpins cryptocurrencies, is genuinely innovative.
Various players in the gold market are exploring how blockchain might transform gold into a ‘digital asset’, tracking provenance across the supply chain and introducing efficiencies into post-trade settlement processes. Such applications are typically built on private blockchains rather than using bitcoin or other ‘public blockchains’.
Unlike gold, cryptocurrencies are yet to be tested across economic cycles. The market is young and liquidity is scarce. How prices, returns and sentiment may respond if stock markets become more volatile is open to debate. Gold, however, sees demand in good times and in bad.
John Reade is Chief Strategist at the World Gold Council.