The 2017 Bitcoin Frenzy has led to quite a debate on which is better, Gold or Bitcoin? Some are even calling Bitcoin Digital Gold. I see two ways of addressing this question: Which makes the better money and which makes the better investment. Let's start with the first question:
Which is the Better Money? Bitcoin or Gold?
For a currency to work, the quantity must both be fairly low and fairly stable. If the currency is too abundant, then huge quantities would have to be used for everyday purchases. If the quantity fluctuates too much, it becomes difficult and speculative to price goods or form contracts.
What makes Bitcoins usable is its elegant, indestructible self-regulation. Bitcoins cannot be created at the whim of a computer developer. Actually, no one even knows who created it. It isn't regulated by a single party, but by the entire system itself (decentralized) and the computer code is open source for all to inspect. You can't hack your way to Bitcoin creation because the way to create Bitcoins is essentially using your computer to figure out numbers that fits an increasingly difficult sequence. That number is part of the coin. If you and your computer can figure out a usable number, then you have legitimately mined the coin. You can't modify the structure, because it is continuously validating itself and checking for problems. Because the release of bitcoins is asymptotic, there will never be more than 21 million coins released. The supply is scheduled (by an adaptive level of mining difficulty) and limited.
Although Bitcoin itself is scarce, there is an infinite number of other cryptocurrencies that can be created and popularized. Over a thousand types have been created already! Litecoin, Bitdeal, Beatcoin, BipCoin, Bit20, BitBTC, Bitcloud, Bitcoin 21, Bitcoin Cash, Bitcoin Planet, Bitcoin Plus, Bitcoin Unlimited, BitcoinDark, BitcoinFast, BitcoinTX, Bitcore, Bitcurrency, Bitdeal, bitEUR, Bitgem, bitGold, Bitland, Bitmark, BitSend, BitShares, bitSilver, BitTokens, bitUSD, BTCGold, BritCoin, Bytecent, and Bytecoin are all trading on the market. Some are bringing in millions or even billions of dollars. For this comparison, we will only consider Bitcoin itself and make the VERY poor assumption that if Bitcoin were to be used as a currency, it would be the only cryptocurrency to do so.
One of my friends humorously stated that gold is so rare that you can buy it at any pawnshop in any city. It is true that there's a lot of gold out there, roughly 165,000 metric tons of it (what that looks like). It is still scarce though because the available gold supply grows more slowly than the demand for it. Unlike Bitcoin, there is no substitute for gold. No other material in existence has the same useful material properties (nearly impossible to corrode, extremely malleable and ductile, efficient at transmitting heat and electricity, and very pretty).
If there is a sudden breakthrough in lowering mining costs, especially if it allows us to mine deeper or in the ocean cheaply, then we could see a supply jump. That would lower gold's credibility as currency, but I think the yellow metal will always be aggressively sought after.
Winner: a protected Bitcoin
I know, it's a funny word. Fungible means non-unique. If someone pays me a dollar, I am not worried that they gave me a 2016 dollar instead of a 2014 or a serial number ending in a lucky 7. For something to work as currency, each piece must have a standardized value and not require a collector's evaluation.
Bitcoins are identical. Sure the strings of numbers vary to identify the coin, but the users don't know what those strings are. They are hidden within the code. All the user sees is a quantity on the screen. It could be any Bitcoin, or more likely, fractions of many Bitcoins. By lacking a physical form, I don't think you can get any more fungible without also being easily counterfeited.
Gold is a little more collectible. People are more willing to pay top dollar for rare or flawless coins, nuggets, and intricate jewelry. When that happens though, it isn't being used as money. Those coins and trinkets are effectively outside of the money supply and are a product of themselves. When gold is melted down, refined, and made into uniform pieces, fungibility is not a problem. Right now though, gold tends to be special and people care what form it is in.
It us useful to have a currency with enough precision to represent the finest subtleties of worth. This allows for transactions of tiny amounts, or slight differences in value. Imagine if there were no subdivision to the US dollar. Buying produce by the pound would be a game of "The Price is Right" as you try and get the most tomatoes without tipping it to the next dollar. Sales taxes would be difficult for stores to directly pass on to the buyer. Stock market values would be more stair stepped. It is also important that the sum of the divisions equal the whole. Four $0.25 pieces cannot be worth more or less than $1.
Bitcoins can be subdivided in to a hundredth of a millionth of a Bitcoin, also known as a satoshi (0.00000001 BTC). In other words, Bitcoins would have to reach a value of $1,000,000 USD per coin before it is less precise than pennies (1 satoshi = $0.01 USD). My understanding is that it is also possible to open up more decimal places if needed.
Gold is also highly divisible. It has been pounded to 0.000002 inches thick for coating astronaut visors. That is so thin that it is actually translucent! A single ounce of it can be stretched 50 miles (5 microns thick). It can be divided into such small particles that you would get more gold scooping up a random cup of dirt. At some point the divisions of gold will get too small to handle properly or see clearly and counterfeiting would abound. Imagine trying to buy something small like a candy bar. It would be hard to weigh out tiny flecks of gold. It could become standard to use volumes of a standard gold solution or use "gold bills" with tiny flecks laminated inside. At that point counterfeiting becomes much easier though. Copper or other metals could be used for smaller quantities, but then your small coin to large coin rates would fluctuate with the relative metal prices.
There have been societies that operated off food as currency. It is a great system because what is more inherently valuable than food? I guess water and air, but usually those are both available without cost in these situations. One problem is almost all foods are poor long-term stores of value. To invest your life energies into a currency, you need some assurance that it won't be destroyed or made worthless.
Bitcoins are difficult to destroy, but easy to lose. Since the beginning of Bitcoin, there have been just over 10 coins destroyed on creation. It turns out, it is possible to earn a block of coins, but not claim them all. If you claim fewer than the reward, the remaining coins disappear forever.
It is much more common to lose them. You could send coins (not very likely to happen by accident) to a bogus receiving address, never to be used again. Thousands may have already been lost to this method. Another method is to put an OP_RETURN script on them (I don't know what that means either), which paralyzes them from future use.
Probably the biggest problem is if one loses access to an account via computer crash (with no backup or paper record), forgetfulness, or dies without passing it on. There is no third-party you can call to open the account for you. Likely the largest holder of Bitcoin is its creator with about a million coins. There is also speculation that this mysterious person has died with those coins never to be circulated.
Gold, on the other hand, is here to stay. It cannot be destroyed. I guess you could chemically dissolve it and disperse it to the point where it is no longer economically practical to mine again, but that's about it. It is also possible to lose gold, but unlike Bitcoins where there are more combinations than the entire energy of the sun could go through with a perfectly efficient computer, I imagine gold usually eventually gets found. In any case, you'd never accidentally lose it to shelf-life or damage.
You must be able to easily exchange the currency to properly use it in commerce.
Bitcoin has a great advantage in that it can be digitally transferred. I can pay someone from across the globe with Bitcoin. In person it is just as easy. All you need is your smartphone with a specialized app.
Of course Bitcoins are not widely accepted yet. Sure you can use Bitcoin for Overstock.com, Newegg, Subway, Microsoft, Dish Network, and Virgin Galactic as well as anything from charities, to local shops, but I don't think anyone pays their rent in Bitcoin. I believe most of the companies that do accept Bitcoin trade for their preferred currency as soon as possible. They don't actually want the Bitcoin, they just want to tap into the paper assets the Bitcoin owners have. If the Bitcoin volatility settles off, we could see a change here.
Another problem Bitcoin is facing is it is expensive to transfer and very slow. Users are repeatedly suprised by extreme and varying transaction fees and sometimes loose access to their coins for days as they are stuck in transactions.
The other restriction to Bitcoin exchange is the requirement of hardware and internet. If the power goes out or service is disrupted, you are stuck.
Gold, unfortunately, loses ground here. The advantage to gold is that you could use it in a pinch even without electricity. It has been used as money for thousands of years, so even if they are not set up to take gold, they might make a deal.
I don't think physical gold could ever return to the normal currency status though. Imagine if you had to mail out gold pieces before ordering anything online! That would be even more expensive and slower than Bitcoin. Even in person it could be a pain. As mentioned earlier small denominations could prove problematic. In order to make tiny fractions usable, they will have to be packaged. That could get bulky or counterfeitable.
There is a solution though! GoldMoney Mastercard lets you preload your card with a certain amount of gold you buy out of their vault. You can then use your card just as any other prepaid card. You simply are selling back your gold at whatever the current market price is and GoldMoney sends the dollars to the seller. The physical gold is also available for your request at any time if you'd prefer to cash out in gold. Of course, you are still limited to companies that take Mastercard and you'll have internet and hardware restrictions.
In theory this system is brilliant. Just be careful because this is a major tax grey zone and the company is unproven. Similar companies such as e-gold and MtGox have failed and the users lost. I think this company will do fine, but do your homework first.
Overall, is Bitcoin or Gold best as a Currency?
Both mediums of exchange do very well on most categories and MUCH better than the US Dollar when it comes to scarcity. I think the transfer of gold is just too crippled in the digital era and Bitcoin was designed as an attempt at a perfect currency. Bitcoin takes the overall best currency win.
Note: This is still taking into consideration the HUGE assumption that Bitcoin has a monopoly on cryptocurrency and other variations are barred from the market or fail for other reasons.
Unfortunately, just because Bitcoin is a more useful currency than gold doesn't necessarily make it a good idea to buy.
Which is the Better Investment? Bitcoin or Gold?
Bitcoins don't exist! They are just a blip on the screen and are as real as Pokeballs. Just because they don't exist, doesn't mean they aren't valuable. A Picasso painting is only useful for looking at, yet they can be worth millions. The same can go for other unique and rare virtual items. Americans spend billions of dollars every year purchasing pixels. Some even flip-sell in virtual markets. When all is said and done though, there is nothing of value in the Bitcoin except its clever novelty.
Gold actually is fairly similar in this aspect. Most gold isn't productive either. 52% is used in jewelry, 34% is reserved as money (government holdings, individual retirement, etc), and only 12% is used industrially. The remaining 2% is unaccounted for. In the extreme case where all "pretty" or "hope to resell" gold was dumped on the market as people need money, the industrial demand should still command a fair price in the growing technological world. This isn't a very great way to look at it, but I'm not going to devote more time to the study: 12% of $1,330 (Feb 2018 price) is $160 per ounce, so you could probably expect that much as a bare minimum.
First off, Bitcoin's price passing gold's price (and even trading in 5 figures) means nothing. If twice as many Bitcoins were released in each block, then the price per Bitcoin would be roughly half the current amount. If we wanted to look at gold in pennyweight, Bitcoin would have passed its price in 2013.
What does matter is market cap, or how much money are people willing to collectively dump into that investment vehicle. Most experts agree that in all of history roughly 165,000 metric tons of gold has been mined. That is 5.4 billion troy ounces. With the current market price of gold of about $1,330 USD (Feb 2018), that is a market cap of about $7 trillion US dollars. As of 5 Feb 2018, there are a total of 16,845,938 Bitcoins mined. With a Bitcoin price of $8,271 USD, the market cap is about $139 billion USD (over 50 times smaller than gold).
That is actually quite impressive considering cryptocurrency has only been around for a few years. It is amazing that something so new could capture that much market. There are three problems with this picture though.
1. The Bitcoin market cap changes pretty dramatically day to day. Since Jan 2017, the weekly Bitcoin price spread has averaged at 22%, whereas the weekly gold price spread has averaged at 2.3% in the same time period. Bitcoin's record weekly change since 2017 could be as high as 80%, but gold only had one instance over 10% in many years (when President Trump was elected) and quickly resumed it's normal pace. Bitcoin is extremely volitile.
2. Bitcoin isn't the only cryptocurrency out there. Ethereum, the second largest cryptocurrency as of writing, was only released in July 2015. At initiation, its market cap was about 3% of the size of Bitcoin's. A year later it was 10% the size of Bitcoin, 11 months later (June 2017) it peaked at 83% the size of Bitcoin. If there were no other cryptocurrenies, Bitcoin would have lost almost half of its market to Ethereum. Of course there are over a thousand other cyrptocurrencies that are also trying to eat Bitcoin's market. Although Bitcoin has gained some of that market share back (Ethereum's market cap is about 60% the size of Bitcoin's), it is easy to imagine another currency disrupting it's position in the future.
3. Bubbles always grow... until they don't.
(here's my Cryptocurrency Excel Spreadsheet, dated 5Feb2018 ,if you want to play with the data yourself)
I love the idea of cryptocurrency, but I just don't know that Bitcoin is going to be the winner. Something I learned from Peter Lynch's Beating the Street is a company gaining market share in a depressed industry is generally a great buy. Bitcoin was losing share in a booming industry. In other words, we might be paying top prices during the hype for something that won't last.
Another Lynch rule Bitcoin breaks is that if your shoe shiner is telling you to buy a particular stock, it is time to get out of that market. We are to the point that people who have never bought precious metals, foreign currency, or even an individual stock in their life have heard about the millions some have made in Bitcoin and are advising on the matter. Even as Jannet Yellen gave a testimony to congress in July of 2017, a man held up a "Buy Bitcoin" sign in the background.
Here's a place where you can listen to up to date podcasts about the financial markets, he almost always does a few minutes at the end on Bitcoin: Peter Schiff Show
Winner: not Bitcoin
Bitcoin's position is precarious when it comes to government. Bitcoin is legal in most countries, but rules and restrictions vary by country and are still evolving. In the swish of a pen, Bitcoin could become illegal, deemed a "security" and have massive regulation, or be heavily taxed. The anonymous nature of the coin would make it difficult to enforce, but companies would not be able to offer Bitcoin as a payment option, restoring it to its original limited peer to peer nature.
Gold could also come under condemnation. Particularly since WWI, governments have been manipulating gold away from the people. The good news is that, as a physical commodity that has been around for longer than human law, things change less frequently and there is a long list of precedent cases to draw from.
Definition of a Bubble
If people are buying an item solely for the purpose of reselling due to a climbing market, you can bet you're in a bubble. If you buy whatever is going up in stocks instead of researching the actual company or at least the dividend history, you need to rethink your strategies. I think most people who buy Bitcoin buy it because they see huge gain numbers that previous holders have seen and get dollar signs in their eyes. They don't actually want the Bitcoin, they want profits.
In contrast, I think many people who hold gold don't do it because they think gold's value will skyrocket, but because they think the dollar will tank. They aren't looking to flip-sell. They are looking to protect.
Overall, is Bitcoin or Gold the better Investment?
Although the argument for Bitcoin as a currency is extremely compelling, I don't recommend it as an investment choice. If you are dead set on Bitcoin, don't just buy it because it is gong up, but because you believe it is the future of money. Or even better, invest in a company that facilitates the transactions and benefits from Bitcoin volatility, whether up or down.
Gold does provide a decent hedge against the dollar and is a sound investment. Of course, in a future post, I will show you something even more powerful. Subscribe to my newsletter in the left sidebar so you don't miss it!
Disclaimer: I am not a licensed or certified financial coach, planner or adviser, just an enthusiast. Anything I recommend should be personally analyzed and discussed with your financial adviser.