Recently, we have received many questions about digital currencies and in particular, bitcoin. The queries range from our general opinion to concerns that bitcoin might displace gold demand. We think that distributed ledgers, in simple terms the technology underlying digital assets, have the potential to revolutionise finance and trade and will continue to be integrated into the broader economy. However, we believe gold is unlikely to be replaced by digital assets that are an investable asset class in their own right.
There are several important similarities between gold and bitcoin. Both are outside of the mainstream financial establishment. Both are not issued or controlled by governments and they are traded around the globe across borders. Supply of both gold and bitcoin is limited, so they are sound forms of currency. For most transactions to be utilised in the economy, they must be converted into paper currency.
Gold is physical, bitcoin is digital
However, there are a range of significant differences between gold and bitcoin:
- Gold has been established as a store of wealth throughout human history. Gold’s market capitalisation is roughly $8trn, of which $3trn is in coin and bar form. Approximately $50bn worth of gold trades each day. Bitcoin is microscopic in comparison with a market capitalization of approximately $45bn and $1.5bn in daily trading volume.
- Gold can be stored anywhere. If stored at home, it can be used for barter the next time a hacker or solar flare takes down the grid. Digital currencies are worthless without electricity. Taking delivery will always be impossible with digital currency.
- Bitcoin mining is a difficult concept to fathom. Bitcoin miners use computer programs to solve complex math problems and receive in exchange new bitcoins. What does this activity have to do with creating a store of wealth?
- Most bitcoin markets are lightly regulated and are located outside of the US. A major potential drawback to digital currency is their use for money laundering, illegal trading, computer ransom attacks, tax avoidance, and to subvert exchange controls. Expect governments to intervene heavily if any of these activities become significant. Over the past year the People’s Bank of China (PBOC) forced the three biggest bitcoin exchanges to adhere to antimony laundering rules, implement trading fees, and then forced them to halt bitcoin withdrawals.
- Distributed ledgers are promoted as unhackable. However, police were recently able to find the digital keys to an online criminal’s accounts and seize approximately $8m in digital currencies.
- Digital currency has yet to stand the test of time. We do not know if a digital currency that is secure today will be secure under new technology. Distributed ledger passwords could be broken if quantum computing becomes a reality.
Distributed ledger technology is game changing
The most significant development that has come out of the digital currency development is validation of distributed ledger technology. This technology has the potential to revolutionize many aspects of the financial system, trade, and essentially anything where records are maintained. A secure system that eliminates middlemen has obvious advantages. Imagine trading stocks without brokers, transfer agents, and custodians – a scenario where fees are likely to disappear.
Equally as significant, digital currencies have caused many to question what exactly a currency should be and whether there is a better alternative to fiat currency. The monetary system is broken. Central banks seem powerless to prevent the economy from going through busts that destroy wealth and create hardship. Currency volatility under the fiat system has been extreme. Politics, corruption, and mismanagement are a constant concern.
Technology likely to improve gold ownership efficiency
Combining distributed ledger technology with an established sound and solid currency may provide the best alternative. To this end, later in 2017 the Royal Mint in the UK is set to launch Royal Mint Gold (RMG). RMG will be a digital record of ownership for gold stored at its vault, while CME Group will operate the product’s distributed ledger platform. It will carry the option to convert to physical gold. It is not clear whether this product will enable consumer purchases with some type of RMG credit card. Regardless, technology is accelerating towards the day when gold can be used both as a store of wealth and an efficient medium of exchange.
Digital currencies are not likely to replicate gold’s unique role
Bitcoin and other digital currencies have attracted the attention of programmers, speculators, and early adaptors. Given the fundamental characteristics of gold and digital currencies, we do not believe digital currencies will ever replicate or replace gold’s unique role as a form of portfolio insurance and as a hedge against tail risk. It is my opinion that governments will not allow digital currencies to reach the critical mass needed to challenge the utility of fiat currencies. At best, digital currencies may eventually occupy some middle ground as a niche product. At worst, they become a failed experiment that ends in tears. For now, the only thing we can forecast with confidence in the digital currency space is more volatility.
Joe Foster is a portfolio manager at VankEck