The currency of the future. The biggest scam in history. The digital gold. The worthless bits of computer data. The great invention and investment. The tool for speculators and criminals. There are as many opinions about Bitcoin and its future as there are people. This explains divergent price expectations and substantial volatility. But what is really Bitcoin and what are its links to gold?
Bitcoin is a distributed digital currency established by an individual or a group of people known by the pseudonym Satoshi Nakamoto in the aftermath of the Great Recession. As it is open-source peer-to-peer currency relying on cryptographic principles, it is the cryptocurrency. Bitcoin uses a revolutionary technology called blockchain that has the potential to impact even non-monetary industries and the way business is being done. Bitcoin emerged in 2009, but became well known in early 2013 when its price increased significantly amid the Cypriot banking crisis. From the economic point of view, Bitcoin is a private fiat money. This is because it is not a commercial commodity (it has only monetary value; it does not have a non-monetary value like gold which has always been used in jewelry or industry). However, contrary to national fiat currencies, which were imposed on society as a result of legal tender laws and central banks’ monopoly on issuing money, Bitcoin has a private character, as it is not issued by any government institution and it is used and transacted in voluntarily.
Bitcoin and Gold
What is the link between Bitcoin and gold? Many people believe that Bitcoin is a substitute for gold. After all, the former asset has been conceived as the digital gold from the very beginning – the process of generating bitcoins is called “mining”, while the supply of bitcoins is programmed to never surpass 21 million (in order to limit inflation). It means that somewhat like gold, the supply of bitcoins is rare and grows at slow and ever-decreasing fixed rates. Moreover, both Bitcoin and gold question the current monetary system, being alternatives to fiat currencies issued by the government. Bitcoin is, thus, said to be “gold for Millenials”, the safe-haven asset for people who don’t trust governments and central banks, but in a digital form. Some analyst go even further, claiming that Bitcoin will replace gold, or that the strong demand for the former hits the latter.
However, the chart below suggests lack any significant negative relationship between these two assets. As you can see, since late 2016 to the early 2019, the price of Bitcoin went on a crazy journey from around $600-700 to $13,000 and then to $3,400. Meanwhile, the yellow metal remained in a sideways trend and traded in a relatively narrow range of $1,150-1,350.
Chart 1: The price of gold (yellow line, left axis, London P.M. Fix, in $, monthly average) and the price of Bitcoin (red line, right axis, in $, monthly average) from January 2009 to April 2019.
The bottom line is that although the shiny metal and Bitcoin have some similarities, they are not substitutes, at least not perfect ones. It should not be actually surprising. After all, gold has a long history of being a monetary asset and the gold market is well established, very liquid and relatively stable. Meanwhile, the market for bitcoins is young, with small liquidity and high volatility. Although Bitcoin also challenges the US dollar, it is not a safe haven, given its instability, but rather a speculative vehicle. Hence, we would say that Bitcoin can complement bullion within the investors’ portfolio rather than being a substitute for gold.