Investing in CryptoCurrencies: Bitcoin vs. Gold vs. Fiat Money
How to compare gold and bitcoin? What are the advantages and disadvantages of gold and bitcoin? Is bitcoin a fraud or a bubble? Should people prefer gold over bitcoin?
From the perspective of a trader, the comparison between bitcoin and gold is not that difficult: you should look at the volatility, the liquidity of the market and whether there is a trend etc..
But for an investor who tries to figure out the value of gold and bitcoin, the comparison is not easy.
How to Determine the Value of Bitcoin and Gold:
First of all, we should clarify what is “a value” of an asset in a very brief examination:
A value is subjective because it is determined by a motivation or a purpose. But a price, on the contrary, is objective and dictated by the market, as a result of the balance between supply and demand.
If an investor predicts the price of an asset in the future then his prediction is subjective, it is his estimate. But the predicted price is not the value of the asset. Because the prediction is not a “sure thing”, it involves certain risk. The value of an asset correlates positively with the potential gain and decreases proportionally to the risk:
Value = potential gain / risk or Value = ( potential gain ) * ( possibility of the gain )
For example: Suppose a bitcoin has a potential to have a price of $100K and the current price is $1. The potential is $99.999 but the possibility is 0.01%, so the value is
$99.999 * 0.01% = $10
Suppose the bitcoin has the price of $1000 but the possibility of $100k has risen to %10 because the adaptation rate of the bitcoin has surpassed the threshold and begun to establish itself in the mainstream finance world, so, the value is:
($100K – $1K) * 10% = $9.9K
In the second scenario, bitcoin has more value despite the higher price because the risk is dramatically decreased. But the important issue here is that the estimated potential and also estimated risk are subjective. Otherwise, there wouldn’t be any potential profit for the investors.
But the important issue here is that the estimated potential and also estimated risk are subjective. Otherwise, there wouldn’t be any potential profit for the investors.
Determining the value of a financial asset is not a science, it is an art. Therefore, it needs to be mastered with skill and experience.
The Scarcity of Bitcoin and Gold:
Bitcoin is limited to 21mil. coins and Gold as an element is limited to the existing resources of the world.
Gold is continuously produced and the production increases when the value of the gold rises or technological innovations makes the mining of gold cheaper. But there is also a consumption of gold, in jewelry and in electronics.
The scarcity of Gold and Bitcoin is one of the major advantages against fiat currencies. Paper money has to lose its value because it is continuously created from thin air by central banks. Being scarce is not a guarantee to have a value but it is a necessity to protect the economic value.
A disadvantage of the gold is that a part of demand on gold is satisfied by gold certificates which are not backed up by physical gold but by derivatives.
When a bank writes a put option, the bank can also issue a gold certificate at the same time, sell it to a gold investor and take the premium of the put-option and the commissions without taking the risk of the gold price:
For example, the premium of the put option is $10 which equals to 3% increase in Gold price. If the price rises 3% bank takes the premium and gives it to the owner of the certificate. And at this point, the bank can write another put option and repeat the process. But if the price declines 3%, the bank owes $10 to the owner of the put-option but also less $10 to the owner of the certificate and at this point, the bank can write another put-option to repeat the process. So, the bank can print “gold” from thin air.
One can say the same process can be done to the bitcoin too. Not exactly, why should I buy a certificate and take an additional risk of the bank when I can directly purchase the bitcoin and easily store it in a digital wallet? Gold is a physical entity and storing Gold is risky. Therefore, some investors trust a bank and not surprisingly, their trust is abused. Bitcoin is on the contrary digital. And of course, the cryptocurrencies have their own risks, i. g. hackers, but it is safer than banks or warehouses (a bank account can be hacked too).
The Wall Street is about to issue Bitcoin ETFs. The certificates and ETFs will promote the adoption and diffusion of the Bitcoin. And sooner or later, people will prefer Bitcoin to them, especially at the time when Bitcoin really begins to replace the fiat currencies, then we will see Gold EFTs in Bitcoin. The Bitcoin EFTs can be used by foreign investors who cannot easily purchase cryptocurrencies.
If an asset’s supply and demand remain constant in a growing economy then the real value of this asset will increase:
Suppose there is an island which can produce only bananas and has a currency limited to only 10 tokens. And production of bananas increases every year: in the first year 10 bananas, in the next year 20, 30, 40 … If the price of a banana in the first year is one token then the price in the following years will be more than 1 token: i. g. 2, 3, 4 … If someone saves his money, one token, he can buy more bananas with his token, so, his wealth will grow because the real value of one token continuously rises. Therefore, Gold and Bitcoin can gain value just because of economic growth.
One can say, everybody can issue a cryptocurrency and there are plenty of them already. This is true but it is a “winner takes all” game. Like social media platforms, the cryptocurrencies have to pass a certain threshold of the adoption rate, also reach a minimum user base and then they are subjected to the network effect. Therefore, only one cryptocurrency will dominate. Innovations and competitions in cryptocurrencies are an advantage. There are plenty of ICO scams and crypto bubbles but soon, the competition of cryptocurrencies will be almost only in innovation. The fiat currencies have also competition but in devaluing themselves – currency wars.
Because of the reasons mentioned above, the owners of gold and cryptocurrencies can grow their saving in real value.
The High Volatility of Cryptocurrencies:
When the banksters criticize bitcoin, they immediately point out the high volatility of cryptocurrencies and claim that people don’t want to keep their savings in a very volatile asset, therefore cryptocurrencies are only for the traders to speculate.
(1) The market capitalization of bitcoin is rising and therefore its volatility will decrease. But the real reason for the high volatility is that the price of the bitcoin rises very fast because the fast adoption rate cannot exhaust the remaining huge potential of Bitcoin.
(2) When bitcoin begins to replace fiat currencies in the real economy, the volatility of bitcoin will calm down but the volatility of fiat currencies will become wild:
The fiat currencies are stable because the goods are priced in fiats, in USD, EUR etc. but never in BTC. So, for example: if a hamburger costs $1 its price will not change in a day. But if you try to buy it with Bitcoin, at first, you have to convert BTC to USD and then you can buy the hamburger but BTCUSD market is very volatile. So, every day, the burger will have a very volatile price in BTC! But suppose, the seller demands BTC and ignores USD, so, you wouldn’t have to convert. He will not change the price every day. In the second scenario, USD would be the one with high volatility or unstable currency. Those days can come to us.
(3) Every intelligent one prefers an appreciation in value with a high volatility over a diminishing value with low volatility. Fiat currencies are doomed to lose value because of the central bank system.
The Intrinsic Value of Cryptocurrencies and Gold:
The intrinsic value of Gold comes from its usage in electronics and in jewelry but also from its reputation as a safe haven. Therefore, it is very unlikely that the price of gold falls to $0. But we can say that the value of gold heavily depends on being a safe haven because gold is usually stored in the vaults rather than consumed in jewelry or in electronics.
The value of a cryptocurrency comes from the trust of people on its ability to function as a currency. Like fiat currency, the network effect is very crucial here.
On the contrary to some social media posts, the cost of Bitcoin mining has nothing to do with the value of Bitcoin because you cannot recover the cost. For example: if you make a jewelry from gold the jewelry has the minimum value of the used gold because you can recover the gold.
Some people understand the technology of cryptocurrencies but they don’t know the economics. They intuitively know Bitcoin has a value but they can not express it or they communicate in a wrong way. The high electricity cost of bitcoin is the price for making the blockchain very secure and also decentralized which increase the value of Bitcoin. The fiat currencies have their electricity cost too but if you only think about bank bailouts and inflation by central banks the difference is huge. Fiat money is far more expensive than Bitcoin.
One of the best advantages of the Bitcoin is its supporting community which provides solutions and innovations with its collective intelligence. Some people are trying to label Bitcoin as a fraud or associate Bitcoin with money laundering and terrorism in order to harm the community.
Is Bitcoin a Bubble?
Usually, the bubbles cannot easily be spotted before the crash. Even a crash and a failed recovery are not enough to categorize an asset as a bubble.
What is a bubble?
Remember the formula of value:
Value = ( potential gain ) * ( possibility of the gain )
If there isn’t any potential but the only rising price then there is a bubble. Not every possible potential can be realized (therefore: the possibility of the gain). It doesn’t matter whether the speculators drive the price to the higher levels. They do it to all assets gaining value.
The success of the Bitcoin is not a sure thing! If it fails people would say the bubble was obvious but if it replaces the fiat currencies or even become an established currency they will tell you how efficient the market was. Remember the Warren Buffets statement about Amazon:
“I was too dumb to realize. I did not think [Bezos Amazon CEO] could succeed on the scale he has,…. really underestimated the brilliance of the execution… [we] miss a lot of things, and we’ll keep doing it.”
Every financial asset is subjected to challenges. For example, Netflix will be challenged by Google’s Youtube – Can Alphabet’s Youtube be the next Netflix? – or – Why Apple’s self-driving car plans are very important for the Company’s future?. And of course, Bitcoin has several challenges too, for example, it can be banned by the governments like China’s recent ban. During Gold’s bull market before 2012, there were plenty of rumors that governments will confiscate gold and the central banks are trying to suppress gold but now, some governments, i. g. Russia, China, Iran, are replacing US dollar with gold in their international trade contracts and their central banks are hoarding gold: for example, Petrodollar end looming as China & allies dump it in oil trading – Jim Rogers
You should make your own valuation and imply your own risk management.
Why does Bitcoin not shine?
The known history of money begins from 3000BC with bartering surplus goods. Even Cowry shells were used as exchange medium in coastal areas.
The metal coins have dominated the history of money and even paper money was backed by gold for a long time. The Gold has a special place in money’s history. One can say because Gold is an element which cannot be produced from converting other materials and it is scarce, as mentioned before, but so are the other metals too, especially silver. The big plus of gold is its shininess has a special effect on our human psychology – reward system in our brain.
Suppose you have gold. And the world experiences an worldwide disaster like in the movie mad max. Your gold will survive the disaster and if you can survive too you will be able to buy goods with your gold because there would be always someone who is “rich” and has goods in surplus. The shiny metal would have a demand but not a purchase power like before. Maybe, the gold could lose its 99% purchasing power but the net worth of goods would be also highly increased like in the movie mad max, especially food. You will able to buy far less but what you can buy would be very precious for you.
The movie Mad Max has never happened but too many real disasters instead, and Gold has always confirmed its feature as a safe haven. The “shininess” has given to the gold its most important competitive advantage against other metals, especially against its rival silver.
The advantage being shiny has to be attached to being a physical object and that can be a very bad disadvantage. Before Bitcoin, people had not an alternative.
Suppose your country experiences a political disaster, not a worldwide Armageddon but a regional calamity as it is usual in history. And the government decides to confiscate the citizens’ wealth. Sometimes, they do this directly but usually, they have indirect methods: for example, in a turbulent time, people buy gold and the government knows it. The government can force you to declare your gold or store it in a state bank otherwise you would have to declare where your gold comes from which would be made very hard for you. Storing gold in a state-owned bank or declaring it to the government will lead to “donating” it to the government. And if you don’t follow the orders you would be accused of money laundering or tax evasion etc.. This kind of scenarios is usually what happens when governments want to size citizens’ savings.
In a case like above, being a physical object like gold is a disadvantage. Hiding and storing would be more difficult and risky. A bitcoin owner has to hide only his digital keys. Maybe, only in converting to a fiat currency, a gold owner can have an advantage. But the gold owners and bitcoin owners, all of them, would have to make it illegally.
One can say Bitcoin is not completely anonym. This is true and the reason for exchange “bans” is to regulate them in order to have full information of bitcoin owners. But Bitcoin is just a beginning and the cryptocurrencies will change very fast and very much. Here is the main advantage of being an abstract product which can be always technology innovated. Regardless of which government, i. g. the USA, China or Nord Korea, try to control or regulate the cryptos there would be always a solution or a new idea to cope with it. For example, China also prohibits foreign social media, how effective are their bans? Controlling or regulating the cryptos will be more difficult. I would not be surprised when governments will give up the fight and rather adapt.
Cryptocurrencies can be more than being a currency:
The investors of cryptos usually consider only the replacement of fiat money by cryptos but the biggest part of the demand on cryptos would eventually come from their technical attachment to digital products and services:
Suppose there is a product, a decentralized Blockchain Twitter BTwitter that cannot be censored or controlled by governments.
Using BTwitter would require computing power which can be paid, for example, with Etherium.
Twitter has also own cost because we use the company’s servers and personal. But all costs can be covered by advertisers.
With a proper protocol, BTwitter can also take advertisements which can be paid in a certain Ethereum address. This can make the use of BTwitter cheaper or maybe free.
Suppose BTwitter has replaced the Twitter, then we would have a digital social media service that is technically attached to Ethereum unless there is a consensus to change the protocol of BTwitter.
The more people would use BTwitter the more demand on Ethereum would rise and so, Ethereum would gain value.
One can say “the rising price of Ethereum would make the use of BTwitter more expensive and therefore, economically harm the BTwitter”. No, the fees, whether for use or advertisement, would be adapted to the real costs, i. g. electricity, and therefore they would be lowered in Ethereum price if the Ethereum gains value. But if someone holds Ethereum his wealth would grow.
One can also say “the Revenue of Twitter is also “attached”/converted to USD”, yes, but it is only a management decision which can be changed, it is not a technical necessity. And even if USD gains a value from US products it is immediately destroyed by the central banking system.
The extra demand on Ethereum which comes from using the BTwitter is not created by the replacement of fiat money, but by an innovation in the Ethereum Ecosystem.
to be continued….
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