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Friday, 19 February 2021

Is Bitcoin Digital Gold?


Is Bitcoin Digital Gold?

If you paid attention to the news around Bitcoin these last few months, you’ve probably heard this comparison more than once. It is a very interesting comparison to make because of the financial implications of the answer. If Bitcoin is indeed the digital successor of gold, then its current valuation is much lower than it could be.

Gold as a financial asset

Gold is estimated to have a 10 trillion USD market capitalization. That is an absolutely staggering amount of money for a special kind of rock we find beneath the ground. Certainly, we can use it to make jewelry, it is certainly quite resistant but there isn’t anybody in the financial world who will try to defend that gold’s value is due to its real-world uses.

The reason gold is worth this much money is because the supply is predictable. While some policies or geopolitical events can change the steady supply of gold entering the financial markets, this supply is just plentiful enough that it’s possible to use it as a mean of payment but not so much that it would be worthless.

This is the particularity of gold. The idea that gold is valuable because it’s rare isn’t exactly correct. Gold is valuable because it’s exactly the right amount of rare. If it was too rare, it wouldn’t have become popular as a store of value because it wouldn’t be used for trade. The metal chosen to translate wealth into an asset couldn’t be too rare which would have made coins too small – else it would have been difficult to give everyone even a fraction, nor too big – as that would complicate the transportation and exchange.

The rest is what is referred to in finance as a network effect. Some people decided gold had value and gladly accepted it in exchange for goods and services which led others in turn to do the same – and this phenomenon has only amplified through the centuries. That is why gold is worth a lot of money.

Bitcoin’s claim to the gold throne

Gold’s position as the most important asset in the global economy has been challenged in the last decades. While it was originally used to back many currencies, the US$ included, it is poorly adapted to the modern economic system. It is nevertheless a testament to its strength and investor’s faith that gold has largely outperformed many markets since then.

Bitcoin is threatening this position though. Since its inception, it has vastly outperformed gold going from less than a cent to its current status, hovering over $30k. There is an argument to be made that Bitcoin is very much a competitor to the gold market, easily exchangeable, an excellent narrative of decentralization that appeals to millennials and robust security with cheap transactions.

At its peak in early January, Bitcoin was estimated to be worth anywhere between 2% to 7% of gold’s market cap. A sharp jump in ten years, but still relatively insignificant. In comparison to the $10 trillion number, cryptocurrencies as a whole have only just crossed over $1 trillion market cap. While some consider it plenty of room to grow, others disagree and point out the differences that will guarantee in the long term gold’s dominance as a store of value. So who’s right?

Bitcoin is still too young

Analysis from CryptoQuant, an analyst of the crypto markets, shows that the realized market cap of Bitcoin is actually much lower than one might expect. It takes into account that many coins are lost forever, and some haven’t moved in years. In regards to this, Bitcoin is still only around 2% of gold’s estimated market cap. If it were to move to 10%, the price per Bitcoin would be $154,000.

So we are still very early in the life of Bitcoin and undeniably it is not replacing gold just yet. Gold still has centuries behind it as the store of value asset and as we’ve seen, what actually matters with gold isn’t the real world use-cases as much as its long tradition of a secure asset individuals, states and corporations use to store their money on the long term.

Bitcoin is twelve years old. There simply hasn’t been enough time to declare Bitcoin to be the next store of value. Is it better adapted to the digital age than gold? Certainly. Is it easier to exchange and transform to actual dollars? Absolutely. Will it outperform gold over the next year? Very possible. But to become the de facto store of value, it needs something that price action and technology cannot replace. The trust of investors. And that takes a lot of time to build.

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