Gold has been a medium of exchange for thousands years with an indisputable store of value, which, however, yields no return and has a high opportunity cost compared to assets such as bonds or equities. On the other hand, the Internet Age has brought about a fierce competitor, known as bitcoin. Since its launch in 2009, the digital currency has been in the middle of attention, whether because its value declined close to the $240 level, after having surpassed the $1,000 milestone in 2013, or because regulatory agencies are trying to figure out whether a sustainable regulatory environment should be fostered.
What Drives the Value of Gold?
The value of gold is driven by its converse relationship to inflation. Since the collapse of the Bretton Woods monetary regime in August 1971, which temporarily suspended the convertibility of the U.S. dollar into gold, gold has been widely used as a hedging tool against inflationary pressures as well as a tool to lower public debt and boost export growth.
Since 2013, inflation has been preventing gold from rising as shown in the chart below, but the two indicators are moving towards the same direction. In spite of the latest strong narrative about Fed’s potential interest rate hike to control fluctuations in the financial markets, the underlying driver of the value of gold is inflation.
Rising interest rates boost the U.S dollar, which trades in the opposite direction of the gold prices (as shown in the following chart), but when interest rates rise in an inflationary environment, gold prices will move in the same direction with inflation and not with interest rates. Gold is a hedge for inflation in the long run.
Bitcoin, the New Entrant Breaks the Bank?
Both bitcoin and gold are mainly operating outside the banking system. However, the lack of a framework that could support excess savings deposits in the banks, has directed investors from gold investment to digital currency. But there is more to it.
Bitcoin’s ease of use and convenience of small transactions allows users with a regular access to the Internet to make money transfers that would, otherwise, be impossible, especially in countries with repressive regimes. For instance, small businesses in Argentina are turning to bitcoin to overcome strict capital controls. Furthermore, bitcoin transactions are cost-effective, and they might be used in countries with high transaction fees to reduce poverty.
The price of bitcoin can experience sharp fluctuations over a short period of time and compared to gold, is a high risk asset. On the other hand, the limit of the bitcoin supply is set at 21 million, whereas there is no specified amount of gold that can be mined. Even if bitcoin is more volatile, it is expected to offer a higher store of value than the gold, after hitting the milestone of 21 million.
Dodging the current monetary system: is it possible?
Bitcoin is widely regarded as an inherently speculative asset that cannot dodge the current monetary system. Due to its unregulated and anonymous nature bitcoin is blamed for funding terrorist activities, including money laundering and drug trafficking. Additionally, it is used as a speculative asset with no valuation guarantee. If a large group of investors/users decides to massively sell their bitcoin, the value of the digital currency will decline sharply, thus having an immediate impact on the users’ wallets. The chart below shows the volatility of bitcoin.
So, gold or bitcoin?
Currently, gold trades at $1.106.05 an ounce. The value of gold may soar, pending effective political and economic decisions that could restore stability in the global monetary system. Yet, the same applies to bitcoin. For the moment, there are countries that have banned, or consider banning bitcoin, in the fear of destabilizing their financial system. Its decentralized nature has raised a red flag on whether it should be regulated towards the prevention of fraudulent and criminal activities.
On the other hand, customer confidence increases as a growing number of bitcoin startups, like the Bitrated, provide consumer protection services and a leading bitcoin reputation management system to overcome the previous lack of consumer protection mechanisms. Given the current uncertainty in the global financial markets, if bitcoin can become widespread to convince certain governments to accept it and regulate it, a potential rise in its price is expected due its wider acceptance that will boost investor confidence, going forward.