Over the past few years, the exponential rise and increasing popularity of bitcoin has sparked the interest of many investors. Moreover, some experts question whether bitcoin (BTC) can play a similar role to physical gold within an investment portfolio. Others even venture to attribute the fundamentals of gold to the popular cryptocurrency. But can we really compare the metal, a tangible asset, to a virtual asset? Despite some similarities between the two assets, including their limited supply and their role as an alternative to fiat currencies, there are, nevertheless, fundamental differences that potential investors should carefully consider.
According to a generally accepted economic definition, money is an asset that fulfills three functions: unit of account, medium of exchange, and store of value. Bitcoins and other cryptos only partially and imperfectly meet this definition of money.
Where physical gold is superior to any other financial asset is in its durability. Gold has been used as a currency for 5,000 years and is the only one to have survived in its original form. If a currency has been able to survive through so many eras and crises, it clearly proves that it has strong attributes. Anyone who wants to argue that bitcoin or other crypto-currencies can assume the role of gold after only a decade of existence is a few millennia wrong. Crypto-currencies are so new that even if they survive, they will mutate over time. Their sustainability is therefore highly unlikely.
Until now, bitcoin has been unregulated. If, in the near future, institutions decide to allow it and regulate it, the rules of the game will change: there will no longer be anonymity and a black market for bitcoin. This can also greatly affect its value. Gold, in comparison, will remain more stable. Central banks could also ban it when introducing their own digital currencies (CBDCs). Since bitcoin is not backed by any asset or central bank, it would not be worth much if it were banned.
Gold has been recognized as a store of value, an important and tangible medium of exchange for thousands of years. It is held not only by individual investors, but also by institutional investors and central banks around the world. It is increasingly used in technology, electronics, and is extremely popular in jewelry, especially in China and India where it has strong cultural and religious connotations. This dual nature of gold, which is both an investment and a consumer good, distinguishes it from other assets. It has also often resulted in a strong performance of the yellow metal both in times of economic hardship and in times of economic growth.
In contrast, bitcoin is, of course, digital - not tangible - and the source of its demand is more concentrated, primarily for investment.
The recent volatility in the price of bitcoin may suggest that it responds primarily to speculative price dynamics rather than a means of storing wealth over the long term.
The price of bitcoin has risen dramatically in recent years, with a fourfold increase in 2020. This price increase has captured the attention of many individual investors and even encouraged some institutional investors. However, such performance often means a great deal of risk-taking, and the rise in bitcoin's price has also been accompanied by significant volatility. Over the past two years, bitcoin has been four and a half times more volatile than gold.
Some tout bitcoin as a way to diversify one's portfolio, but it has so far shown higher correlations with stocks than gold, especially during periods of stock market stress.
Massive orders from "whales", i.e. holders of more than 1000 BTC, can also cause high volatility. Critics of the cryptocurrency ecosystem say that whales make this space centralized, perhaps even more centralized than traditional financial markets. A Bloomberg report estimates that two percent of accounts control more than 95 percent of bitcoin. This makes the bitcoin market potentially easily manipulated.
For five millennia, physical gold has represented constant purchasing power in grams or ounces. The same can hardly be said of bitcoin, whose price volatility is wholly inappropriate for it to be called a "money," or even used as such.
At times, bitcoin has exhibited safe haven-like behavior as it has seemed to move in the same direction as some traditional hedges, including gold. However, there is no consistent pattern to this behavior. For example, in March 2020, the price of bitcoin fell more than 40% and ended the month with a 25% drop. In contrast, while the price of gold initially fell 8% in March, it quickly rebounded back to its starting level and continued its upward trajectory as investors continued to add gold as a safe haven to their portfolios.
In addition, a strong positive correlation seems to have developed between bitcoin and traditional investment assets such as stocks. The correlation with the Nasdaq reaches about 0.80, while it hovers around 0.50 with the S&P500. This phenomenon worries both crypto investors and stock marketers, who feel that it distorts the trend of one or the other. This is the flip side of bitcoin's popularization within the mainstream financial market. It is now subject to the same risk-averse movements of large investors. The IMF has highlighted the growing interconnectedness between crypto and equities, underscoring its concerns that crypto could stimulate financial instability. According to Morgan Stanley Bank, "the correlation between bitcoin and equity indices has remained high and will continue to do so unless bitcoin becomes widely used as a medium of payment - which looks unlikely to happen soon."
Taking this correlation into account should be paramount in your investment logic.
Furthermore, tech stocks and cryptocurrencies are among the most sensitive assets to central bank policies, especially the Fed. Globally, in the 2020s and 2021s, central banks injected heavy liquidity into the markets to support pandemic economies. This has caused the cryptocurrency and Nasdaq markets, as well as other risky assets, to rise. But the economic environment is changing. In the face of tightening monetary policy by the US central bank, investments are in decline. There is less money flowing into the financial markets, and this is penalizing the Nasdaq and cryptocurrencies.
Gold has been considered an effective store of wealth for millennia. It has offered returns that rival equities over various periods and has traditionally performed well in inflationary or geopolitically tense environments. Its market is highly liquid and well established. The yellow metal has played an important role as a portfolio diversifier and has frequently demonstrated a negative correlation with the stock market during economic downturns.
The crypto-currency market is still developing and its price behavior seems to be driven by momentum around investors' expectations of high returns. Bitcoin has been much more volatile than gold over the past few years, which adds additional risk to investment portfolios.
Fundamentally, investors view gold and crypto-currencies as having very different roles in an investment portfolio. A 2019 survey by the World Gold Council reveals that investors view crypto-currencies as a more speculative investment and value them for their ability to generate short-term returns. Physical gold, on the other hand, is valued for its strategic role in long-term wealth preservation and its hedging position against riskier investment options.
Since both gold and bitcoin are limited in quantity, the law of supply and demand suggests that their respective prices will rise.
In the end, the two assets are perfectly complementary in a diversified portfolio: physical gold meets a quest for security, while bitcoin meets a taste for risk.
"The Bitcoin aficionados will tell us that BTC is modern money and superior to any other currency. Well maybe they are right, but history must prove that. The 11 year history of Bitcoin is hardly sufficient to prove that it will fare better than any other money. We must remember that so far in history no currency has ever survived in its original form except for gold. And the 5,000 year history of gold as money certainly makes it superior to all fiat currencies as well as cryptocurrencies. The reasons for recommending gold as the ultimate form of wealth preservation cannot be fulfilled by Bitcoin. Having said all the above, BTC has been and might continue to be a superb speculative investment which is totally unsuitable as money. History will tell if I am right." — Egon von Greyerz, Founder and Managing Partner of Matterhorn Asset Management AG (MAM)
"Gold and silver have been stores of value and mediums of exchange for at least 4 millennia in every civilization in every corner of the world. It has unmatched accessibility to people of all economic standing and technological knowledge. And gold is the ultimate currency of central banks, silver of the people. There is room for cryptocurrencies too since their digital nature is a fundamental difference from gold and silver. But that characteristic also ensures that cryptocurrencies will never replace gold and silver and will ultimately improve the metal's value." — Phil Baker, President and CEO, Hecla Mining Company
"Based on the trajectory of this digital gold path and use cases globally, we believe bitcoin will be a mainstream asset class in the future. While gold has clear value and safety, the upside in bitcoin is eye-popping if it stays on its current course over the next decade." — Daniel Ives Managing Director and Senior Equity Research Analyst at Wedbush Securities
"My vote would be for gold because it has thousands of years of a historical record as a store of value, has one-fifth the volatility of bitcoin, and doesn't face the same competition risk. The day that Queen Elizabeth trades in the five pounds of gold in her crown for crypto is the day I'll shift course." - David Rosenberg, former Chief Economist and Strategist for Merrill Lynch Canada and Merrill Lynch in New York
"One of the assumptions underlying bitcoin's bull case is its limited supply, but the supply of cryptocurrencies, on the whole, is theoretically unlimited. Some extol bitcoin as a portfolio diversifier, but it has so far exhibited higher correlations to equities than gold, particularly during periods of equity market stress when diversification tends to add the most value. The demand for bitcoin may be over its skis relative to its likelihood to carve out a significant economic or financial use case." — Michael Reynolds, Investment Strategy Officer at Glenmede
"Both crypto and gold have passionate investor bases… However, there are very clear differences. Gold's history as a basic building block of global money is 5,000 years old and time-tested; Bitcoin is ten years old and has existed in only one monetary regime. The standard deviation of bitcoin's price is 75%, making it a horrible store of value. Recent price history shows a large bias toward speculative interest, so much so that companies are tempted to include bitcoin on corporate balance sheets to help grow assets in excess of corporate performance. Crypto is a poor monetary substitute. In the US, filing your taxes requires a voluntary disclosure of your cryptocurrency profits. If a crypto trade automatically generated a statement to the IRS as a brokerage transaction does, the speculative outlook could dim." — Robert Minter, Director of Investment Strategy, Aberdeen Standard Investments