Is Bitcoin Really ‘Digital Gold’?
The Essential Guide To Bitcoin vs. Gold
If there’s one market that everyone’s talking about right now, it’s Bitcoin.
But, like trying to get a straight answer to the question 'what is the cloud?', it’s a quagmire of jargon.
With Bitcoin’s value increasing by 79% since the start of the year, it’s been the talk of 2021. Plus, companies like Tesla and MicroStrategy have made large investments into Bitcoin (BTC). So it’s no longer a fringe asset.
But is it worthy of the title of ‘digital gold’? Well, that’s why we’ve come up with this useful guide to break Bitcoin down for you.
What is Bitcoin?
Before we go comparing it to gold, let’s start simple - what even is Bitcoin?
‘Bitcoin is a bank in cyberspace, run by incorruptible software.’
Michael J. Saylor, CEO of MicroStrategy
Bitcoin is a digital currency, enabled by a technology called ‘blockchain’. Blockchain is like a public ledger (without one central administrator) that records all the transactions.
Bitcoin, specifically, was introduced back in 2009. It was based on ideas set out in a whitepaper penned by Satoshi Nakomoto (a pseudonym). Although, there had already been previous attempts at cryptocurrencies.
So How Do You Buy or Get Bitcoin?
Well, for most us looking to trade Bitcoin we’d probably only be able to afford part of a coin. You can buy Bitcoin on apps like eToro and Coinbase (which is one of its benefits - but we’ll get to that!)
The other way to earn Bitcoin is to ‘mine’ it. Now before you go buying a pickaxe and growing a Yosemite Sam moustache, hear us out.
Bitcoins are generated by the computing power of miners solving ‘hashes’ to verify Bitcoin transactions. It’s a competitive, decentralised market and, if successful, miners are rewarded with Bitcoin.
If that sounds like a lot, it’s because it is. Theoretically, anyone could get into mining Bitcoin. But, unless you have some serious computing power and a knowledge of coding, it’s not something people just ‘fall into.’
How Does Bitcoin Operate?
The thing about Bitcoin specifically is that when Nakamoto created it, they limited the total supply to 21 million tokens.
This means that about every four years Bitcoin undergoes what we call a ‘halving event. This is where the reward for mining Bitcoin transactions is cut in half.
These ‘halvings’ mean that Bitcoin inflation is also halved as well as its rate of circulation. In turn, this has caused the massive rise in Bitcoin’s value.
Even subsequent price bubbles (and bursts) have resulted in a higher value for Bitcoin than its pre-halving price.
At the current rate of mining, this system will continue till around 2140. After that, miners will be rewarded with fees for processing transactions. The hope is that this will keep them motivated to keep the network alive. All whilst competition keeps these fees low.
Which raises a couple of questions, like:
Is it Safe?
The blockchain is like a ledger of all transactions. But what about your Bitcoin?
Bitcoin is stored in a digital ‘wallet’. But there’s still the potential risk of having your account hacked. Although the blockchain has made this difficult, someone could still get access to your ‘wallet’.
Just look at Mount Gox, for example. This Japanese exchange was hacked and customers lost around 850,000 Bitcoins. At the time, this was valued at around $450million (USD).
Even if you store your Bitcoin wallet on an external hard or flash drive, there’s still the risk of losing that.
And that’s where your public and private keys come into play. Your public key is a set of numbers like an account number and sort code. Your private key is a recovery phrase. Your Bitcoin wallet only stores these keys, all currency is still stored on the blockchain.
So, if you do lose your wallet it’s just a simple process to restore it with your private key. Plus, with the addition of more miners and nodes with the capacity to download and verify the blockchain, the more stable the network should become.
Is it Ethical?
Although Bitcoin is technically anonymous, all transactions are available on the blockchain. Plus, if you’re buying Bitcoin with another currency there are traceable elements like your IP address.
So ethics comes into question. Has the anonymity of cryptocurrency allowed for things like billion-dollar card fraud empires? Or for the Silk Road to exist, and murders and even terrorism to occur on the dark web?
On the other hand, the blockchain can’t be edited, either by individuals or companies, so there’s less chance of fraud.
Whether it’s the system itself or the use of it that’s ethical or not - we’ll leave that up to you. What we do want to get into, though, is ‘why cryptocurrency?’ and why now?
A decrease in mining rewards has correlated with an increase in demand and value thus far. (Credit: Investopedia)
At the moment, Bitcoin is in the midst of what we call a bull market - where prices are rising and investors are generally hopeful.
Just consider that Bitcoin reached parity (was equal to) the US dollar back in 2011 and surpassed the price of an ounce of gold in 2017. Then we can begin to understand the reasoning behind this.
But the upsides don’t end there, there’s also the fact that:
There’s a finite number of Bitcoin - with the context of rising inflation (plus the possibility for even more stimulus): people are seeing Bitcoin as a hedge against a decrease in dollar value
It’s not easily manipulated. Like gold, Bitcoin has a weak relationship with other assets and is also non-politically manipulatable.
Publicly traded companies are buying Bitcoin - showing confidence in its future value
Millennials are investing. Much like companies with decreased costs and increased cash flow. There’s been an increase in economic activities and general interest.
It’s getting more accessible. It’s easy to send and store (unlike physical commodities like gold) and is accessible via apps. Increased adoption by companies like PayPal is giving even more people access.
There’s no exchange costs like there are between currencies. And it’s de-centralised so it doesn’t rely on banks.
On top of that it also makes sense in countries where fiat (government-issued) currency doesn’t have the people’s confidence.
Take Nigeria, where there’s systemic inflation and poor access to banking services. Cryptocurrency trading could be a way to gain access to traditional means of finance.
Hence, why it’s no joke that Nigeria is trying to ban cryptocurrency trading. At the same time, they’ve limited traditional banking withdrawals to $100.
In its purest form, Bitcoin investment incorporates the scarcity of gold with the upsides of big tech. And the blockchain itself has value as an operating system and experiment in social trust.
And even though there are thousands of other cryptocurrencies out there (about 6500 historically and 4000 to date), Bitcoin is the clear market leader. Michael Saylor says it's fifty times better than the alternative!
But that doesn’t mean there aren’t risks associated with Bitcoin.
Dangers of Bitcoin
Bitcoin's true potential as a means of banking, both for people without access to traditional banks and on a global scale is yet to be fully realised.
That makes the situation in Nigeria, where around a third of the population use or own Bitcoin (the second largest market only to the US), even more worrying. Even without governments outright banning cryptocurrencies, there’s still the fact that you’ll receive no aid if you do lose your Bitcoin somehow.
There’s no backup like federal gold reserves - there’s no central bank. And, cryptocurrencies could be the first things to get dumped by investors during a financial crisis. However, there is some stability in the fact that Bitcoin can’t be created in the same way that money can be printed.
But the most common argument levelled against Bitcoin is that it’s volatile.
At the tail end of 2017, Bitcoin reached a price of about $20,000 per coin. Just a year later, the price of one Bitcoin was at a low of just above $3,000. Its volatility in short periods has even prompted JPMorgan analysts to label it 'an economic sideshow'.
The question is - what’s the alternative?
Just imagine you’re a trading company in the US with hundreds of millions of dollars at your disposal. So, you’re wondering what to do with your treasury funds.
The Covid-19 situation has meant that, luckily for you, your product/service’s demand has remained high. On top of this, your costs have decreased. Because of the 15% increase in the money supply (the volume of printed money to stimulate the economy), yields and interest rates are down.
With your money just sitting there it can not only depreciate in real value but lose value in your investor’s minds. This is the exact situation that companies like MicroStrategy found themselves in.
And what did they do?
Doubled-down and invested a further $650 million (USD) in Bitcoin whilst offering 0% coupon bonds. These are bonds that don’t pay interest but trade at a big discount. So when the bond is redeemed at maturity it’s worth more than the discount face value you bought it for.
And guess what - investors were oversubscribed to this plan. So their stocks went up too - win-win.
But let’s be clear - not every CEO is doing this. And that’s because Bitcoin may not be the ‘digital gold’ that it appears.
You want to know what is what it appears? Gold.
So Why Gold?
There are some good reasons why we’ve been trading gold and measuring currency against it for thousands of years.
For a form of money to function, it needs to:
Be a medium of exchange that’s widely accepted. (There’s no point trying to buy a Kit Kat with shells these days!)
Be a unit of account, i.e,. have a numerical value set against the market values of goods and services.
Be a store of value. It needs to be able to be saved, stored, and retrieved. And it needs to be at least somewhat valuable over time.
And gold has ticked all three of these boxes against currencies for a long time. What worries most people about Bitcoin is point number 3 - what does the future hold?
You could argue that, like Bitcoin, gold doesn’t have much intrinsic use. It’s only valuable because of the value we apply to it - i.e. gold jewellery trumps silver jewellery. Some exceptions to this might be for its specialised applications in, say, dentistry and electronics.
But the reason gold retains value is that it’s a standard against which to measure the value of fiat currency (namely, USD). That’s why before 1971 everything was measured against ‘the gold standard’.
But since then, gold has remained a safe haven asset - a safe way to hedge against an otherwise volatile stock market. And there’s nothing more volatile right now than Bitcoin.
And while it might not be as ‘sexy’, it’s relatively stable (despite an YTD 8.4% decline). It’s also somewhat self-serving - as more investors flock to gold as a safe bet, its value goes up.
The difference between ‘digital gold’ and real gold is also that there’s already an established system for tracking, weighing, trading, and legitimising the latter.
On a side note, though, gold’s value because of its finiteness may not ring true if we find a way to mine the gold on S-type asteroids.
Now, we don’t want to put 2 and 2 together, but what sort of eccentric entrepreneur has both access to space travel and an interest in hedges like gold and Bitcoin?
Can Bitcoin be classed as ‘digital gold’ if it doesn’t act like it? (Credit: Reuters)
What Do We Mean When We Say ‘Digital Gold’?
When we talk about Bitcoin being ‘digital gold’ we don’t just mean that it’s a goldmine of opportunity. Face it, the fact that we’ve written this article and that you’re reading it means the cat’s already out the bag.
What we mean by ‘digital gold’ is: does it have the same inherent values (remember those 3 functions) as gold and behave in the same way?
Let’s take a look:
Mining. Earning Bitcoin is called mining because the work done to get Bitcoin out of code is comparable to that done to pull gold from the earth. There are outlays for both.
Both assets are rare - with a finite and predictable supply
Where the two differ is the issue of being a safe haven asset of not. Even a lot of businesses that have invested in Bitcoin have only done so for speculative purposes.
Heck, even Elon Musk said that Bitcoin was only a little better than holding cash. He also warned everyday investors against putting too much on the line with Bitcoin!
So, as an individual, why not invest in stocks in a burgeoning industry like fintech? Or does Bitcoin simply speak to the thrill of the chase - much like the recent GameStop stock saga?
For businesses, that same risk is still there.
But it wouldn't be surprising if more CEOs start having conversations about what to do with their company’s cash reserves. With Tesla recently investing $1.5billion in Bitcoin, the cryptocurrency has seen its biggest inflows ever.
Companies like Mastercard, BNY Mellon, and Paypal also all have plans to allow consumers to trade in Bitcoin. So with newfound legitimacy and a floor set by more institutional investment, it’s arguable that the price of Bitcoin could soar to six-figures. At least, JPMorgan seems to think so.
Better Than Gold?
One of the first questions that pops up with any new asset is: is it comparable to gold?
As we’ve pointed out, there are similarities. But there are also big differences. These range from something as small as one being tangible and the other digital to Bitcoin’s sheer volatility.
So before we can answer whether or not Bitcoin is better than gold, we need to ask: is it ‘digital gold?’. And the answer, we think, is: it’s too early to say.
We’re not saying it’s not worth investing in. If your investment goals align with a potentially risky portfolio or holding onto Bitcoin for a long time before it becomes the new currency norm - go for it!
But, Singapore Bank’s Chief economist Mansoon Mohi-uddin has a point. Bitcoin’s security and volatility needs to change before it can displace traditional fiat currencies. Until that happens, it’s likely that a lot of big companies and government’s will err on the side of caution.
Whether we’ll see more of the gold market funnel into Bitcoin, though, remains to be seen. Already, the Grayscale Bitcoin Trust has seen this shift in outflow from gold and inflow into Bitcoin.
And while JPMorgan analysts might denigrate the cryptocurrency’s ability to rival gold, they still agree that it’s here to stay!
So there’s still a long way to go before Bitcoin is fully legitimised. Prices for everyday items quoted in Bitcoin and a better network whether it’s accepted in brick-and-mortar stores would be big steps.
And there’s nothing to stop a different cryptocurrency altogether outperforming Bitcoin, though it seems unlikely now. There’s always Stablecoins (a mixture of fiat and cryptocurrency-based assets) that might even be the way forward.
But as to whether Bitcoin is a ‘category killer’ or simply a unicorn, we hope this article helped sway you one way or the other. And with the scope of Bitcoin’s growth, it might be more risky not to invest and find yourself missing out later!
And if you ever want to learn more about tech in a straightforward manner, whether you’re a student or a professional, we’re ready for a chat today.