The World Gold Council says cryptocurrency volatility makes them unsuitable as a store of value and extremely limited as a transaction token. They lack liquidity and are also likely to suddenly distort investment portfolios

Content sourced from the World Gold Council*

Bitcoin’s parabolic price rise was the big story of 2017 – putting the spotlight on the cryptocurrency market. While gold’s performance was a solid 13%, it was a fraction of the 13-fold increase of bitcoin by the end of the year. Some commentators went as far as to claim cryptocurrencies could replace gold. Cryptocurrencies may become an established part of the financial system.

But, in our view, gold is very different from cryptocurrencies, as gold:

• is less volatile
• has a more liquid market
• trades in an established regulatory framework
• has a well understood role in an investment portfolio
• has little overlap with cryptocurrencies on many sources of demand and supply.

These characteristics underpin gold’s role as a mainstream financial asset that will likely continue to resonate in today’s digital world.

Gold is less volatile

When gold was used to back currencies, the gold price appreciated roughly at the rate of inflation. Since the collapse of Bretton Woods in the 1970s, gold has appreciated 10% per year, on average. While its price increased rapidly in the late 1970s, its price volatility has been relatively tame over the past four decades.

Bitcoin, the most widely recognised cryptocurrency, has had rapid price growth over the past few years – increasing 13-fold in 2017 alone (Chart 1). Its price has also been extremely volatile – some 10 times that of the dollardenominated gold price. Bitcoin’s high volatility was evidenced by the sharp price correction it has experienced since mid-December 2017 – falling by more than 40% in a month.

Bitcoin moves, on average, 5% each day, a level that is nearly as high as the realised volatility of the VIX itself (Chart 2).

While this is good for investors looking for extremely high investment returns, it is hardly a characteristic of a currency, let alone a store of value, potentially limiting bitcoin’s use as a transaction token.

Gold is more liquid

Cryptocurrencies do not have a clear two-way market. Reports suggest their volume is driven by buy-and-hold investors, but, so far, they lack the characteristics common to most liquid markets with the ability to short large quantities. In addition, anecdotal evidence suggests there are high transaction costs for selling positions – both in monetary terms and in the time it takes for the transaction to settle.

Despite the current size of the cryptocurrency market, which has been estimated to be valued at over US$800bn, volumes are very low compared to gold and other currencies. Bitcoin trades US$2bn, on average, a day, which is roughly equivalent to the world daily trading volume of gold-backed exchange-traded funds (ETFs). This volume, however, is less than 1% of the total gold market that trades approximately US$250bn a day.

Gold demand is diverse

The sources of demand for gold are very different from cryptocurrencies. Gold has a 7,000-year history as an asset and a long-standing role as money. It is owned by central banks, as well as institutional and retail investors. Yet, it also has a large and diverse attraction as jewellery, which remains the largest source of demand – typically representing between 50% and 60% of annual demand over the past 20 years (Figure 1). Large parts of gold’s demand are deeply embedded within cultural and religious beliefs, especially in India and China. Also, gold is a tangible good, with real technical applications – gold is even used in the computer chips that ‘mine’ bitcoin.

In contrast, bitcoin and other cryptocurrencies are designed to be used as tokens in electronic payment systems. These may have potentially useful characteristics. For now, however, the opportunities to spend bitcoin are rather limited, and genuine transactions are quickly converted into fiat currencies due to bitcoin’s price volatility.

Gold supply is responsive

At a high level, there are some similarities between the supply profile of gold and cryptocurrencies. The stock of bitcoins, for example, increases in number at a rate of approximately 4% per annum, and is engineered to slowly decline to zero growth around the year 2140. While gold can be mined without a date limit, its production rate has been quite small and steady. Approximately 3,200 tonnes of gold have been mined on average, each year, adding about 1.7% to the total stock of gold ever mined. Bitcoin’s future diminishing growth rate and ultimate finite quantity are clearly attractive attributes, as is gold’s scarcity and marginal annual growth (Chart 3).

Gold, however, benefits from a price-responsive recycling market. Since 1995, recycled gold – that is primarily jewellery sold by consumers for cash – accounts for around a third of total supply. When gold prices rise, some consumers take advantage of the appreciation by selling their gold. This helps maintain balance in the gold market and contributes to lower price volatility.

Another similarity between gold and cryptocurrencies is that they are not government-issued units of exchange. However, unlike gold, bitcoin is not unique as a blockchain application. The many cryptocurrency alternatives beg the question of whether a newer, better blockchain-based coin application may be equivalent to increasing supply, not unlike fiat currency.

Gold is regulated

Trade in gold is widely authorised and regulated in many markets. Cryptocurrencies are broadly permitted, in that most countries have deferred granting them approval, while not banning them – although there are a few outliers at both extremes – Japan appears to have granted approval, and China has greatly restricted their use.

Some commentators have suggested bitcoin and other cryptocurrencies are at great risk of sudden restrictions from countries concerned about capital flight, investor protection, or loss of seigniorage. For example, South Korea, one of the world's largest cryptocurrency markets, has announced more regulatory measures. And in the UK, investors are facing hurdles to convert cryptocurrencies.

Monetary policy is a key central bank tool today. If people choose to transact in cryptocurrencies instead of fiat currency, it might make monetary policy less effective and undermine the tools used by the Fed and other central banks to influence the economy and prompt the government to regulate these products.

As it stands, from a US tax perspective for example, each transaction of cryptocurrencies is considered an asset sale according to US Internal Revenue Service (IRS) rules and should be reported as a gain or loss. This complicates transactions with retailers like Amazon, Target and WalMart, which do not currently allow cryptocurrencies for transactions. In fact, many retailers have dropped support for bitcoin because so few people are using it to transact. This brings us to the point of whether cryptocurrency is being used for transactions or if it is traded and held more as a speculative investment.

Competitors...

Despite anecdotal comments from well-regarded financial commentators that gold prices and gold demand are suffering at the expense of cryptocurrencies, there isn’t any quantifiable evidence that gold holdings are directly suffering from competition from cryptocurrencies. The weakness in physical demand in 2017 – for example, the paltry sales of US Eagles – is largely explained by the steady march higher of the S&P 500. Other established gold markets – such as China – saw healthy levels of demand. Overall, the level of the gold price in 2017 appears to be consistent with drivers of the past few years and is showing no signs of suffering from crypto-competition.

Another factor to consider is competition within cryptocurrencies themselves. There are currently over 1,400 cryptocurrencies available (Chart 4) and, while bitcoin is the largest by far, new technology could have devastating effects on the value and supply of any of the cryptocurrencies, including bitcoin.

…or complements?

Blockchain technology, the distributed ledger mechanism that underpins cryptocurrencies such as bitcoin, is genuinely innovative and could have wide-ranging applications across financial services and beyond. In the gold market, various players are exploring blockchain in the context of transforming gold into a ‘digital asset’, tracking gold provenance across the supply chain, and introducing efficiencies into post-trade settlement processes. Such applications are typically built on private blockchains operated by trusted parties rather than using bitcoin or other ‘public blockchains’.

Gold as a strategic asset

In our view, bitcoin and cryptocurrencies more generally are not a substitute for gold. Gold is a tried and tested effective investment tool in portfolios. It has been a source of returns rivalling that of the stock market over various time horizons; it has performed well during periods of inflation; it has been a highly liquid, established market; and it has acted as an important portfolio diversifier, exemplifying negative correlation to the market during downturns.

Cryptocurrency’s performance has, until recently, been remarkable, but its purpose as an investment seems quite different from gold. Cryptocurrencies have yet to be tested in multiple markets. Since bitcoin’s inception, the stock market has been in an incredibly low volatility, trending, bull market, with very few pullbacks. The crypto-market is young, and liquidity is scarce. Its price behaviour at this point, while still attractive to many investors, seems to be driven by high return expectations.


This article is a re-post from here.


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15 Comments

Damn !

... I should've launched my Gummybeariums onto the market before the bubble burst , before folks started wising up to the fact that these are just Cr*ptocurrencies ... about as useful as a bunch of year 2000 dotcom stocks ...

Still enough time for another fake Telegram ICO, https://www.financemagnates.com/cryptocurrency/news/breaking-telegram-ce... Saw a couple new ones in past few days on www.reddit.com/r/CryptoCurrency/ Set up a website & post to a few blogs and the money can start rolling in.

My pick is they will fall as quickly as they have gone up. Pure speculation and greed driving it.

I think most of that has already happened, now its the long slow decline while the religiously entrenched swap between whatever is currently receiving the pump and dump treatment and whichever coins/token actually have a real business case start to slowly appreciate and solidify into worthwhile assets.

While sentiment and FOMO may have driven it up, sentiment and faith can allow it to hold out longer than merely greed would sustain it.
You can have exchanges with such poor security that hundreds of millions in cryptocurrency can be stolen and the faithful crowd will treat the news as only fake news FUD and drive the prices higher (with the previous owners having to repurchase their coins on the exchange for a higher price & with the exchange fees). At this point exchanges can pretty much abuse the customer relationship and the crowd will cheer them on. So while you think the greed is the only thing holding it up even with negative returns the sentiment of the faithful will keep the fraud and market crawling longer than it should. It is an interesting case study in the market but also a depressing lack of integrity and ethics. If there were more ethics and integrity in the market that would actually being closer to the idealist view. Yet the crowd will abuse "the banksters" for being corrupt and then jump into bed with sharks with an even worse track record. There is so much corruption, manipulation and poor technical work that any one normally crashing story is just a drop in the ocean that mostly gets ignored. Exchanges are raking in billions from customers by withholding updates & security that improve the ecosystem.
If anything the drive towards regulation in a few countries can at least provide better protection for their citizens.

FWIW, I've owned gold ETFs on the ASX since 2006. CAGR has not been much better than the cash rate. Doesn't particularly bother me personally, even though gold ETFs are the spawn of the devil for the real goldbugs and should be as well for the crypto cult, regardless if they involve technology or not.

Several problems with gold, first is that there's a 6% roundtrip cost of holding physical, and if you're not holding physical then there's no point. If you are holding physical then it's authenticity could be called into question as it might have a lump of tungsten in it. (That being said I recently spoke to a bank manager over here in Germany who said they'd happily accept gold at the spot price for a loan on a house, crazy huh!)
Another problem is that it's pretty well know that the gold price is manipulated downwards, and in the world of bubbles do you really want to hold the one asset that's tied down? Sure if the economy goes pear shaped then Jim Rickards could be right and gold will go to 10K per ounce but if that happened would you even be allowed to own it?

Coming back to opportunity cost, Check out the return on ETF's last year 20-30% across the board... Weapons ITA XAR PPA, International equities SCHF ... Healthcare XLV IBB CHT IHI ..... Minimum return on all of those ETF's last year was 21%. look what happened to bitcoin! Are shares really overpriced? or is the same thing that happened to bitcoin beginning to happen with the stockmarket? It's not at the stage yet where every man and his dog is only talking about one thing and that's the stockmarket.

Coming back to opportunity cost, Check out the return on ETF's last year 20-30% across the board... Weapons ITA XAR PPA, International equities SCHF ... Healthcare XLV IBB CHT IHI ..... Minimum return on all of those ETF's last year was 21%. look what happened to bitcoin! Are shares really overpriced? or is the same thing that happened to bitcoin beginning to happen with the stockmarket? It's not at the stage yet where every man and his dog is only talking about one thing and that's the stockmarket.

Which is why I don't mind owning gold ETFs. They're not on the radar of the sheeple. Don't forget the NZX50. That was up 20% in 2017. Barely a peep about it from the media. A2 Milk was up 200+%. Chances are that this will not be the subject bandied around at the BBQ. Cryptos and house prices will be for sure.

2018 will be very interesting. Warm fuzzies are everywhere, yet it all seems quite superficial.

This is an awful article. It's comparing apples with oranges. Crypto currency was not created as a substitute to gold. Gold, as a store of value, has been in existence for thousands of years and Crypto 5 minutes in comparison. Crypto is very much in its infancy in terms of its uses. Jump to conclusions at your peril.

Yes I very much agree that gold is very much a store of value. Crypto isn't really on the same level, since it is a digital currency and nothing more.

The reason why crypto currencies such as Bitcoin have become so popular so quickly, is due to many reasons but one of the main reasons is the ability to make some what anonymous transactions that can be hidden from the prying eyes of governments. Hence why a lot of governments are looking to create and enforce their own controlled crypto currencies with the use of block chain.

BBC radio article: The Inquiry; What’s The Point Of Bitcoin?
http://www.bbc.co.uk/programmes/w3csvsyh

This is an awful article. It's comparing apples with oranges. Crypto currency was not created as a substitute to gold. Gold, as a store of value, has been in existence for thousands of years and Crypto 5 minutes in comparison. Crypto is very much in its infancy in terms of its uses. Jump to conclusions at your peril.

The article does not suggest crypto is a substitute for gold. In fact, it points out the differences between the two. Kind of like "apples and oranges". However, If both gold and crypto share common elements, such as store of value of means of exchange relative to fiat currencies or other assets, they are not necessarily "apples and oranges." Thr article explains some of the differences so there is nothing "awful" about the article.

Question is where crypto currencies could evolve from the current technology and how it impacts larger society? Which helps to explain why crypto currencies are so volatile and unstable.

To shed some light on this, would recommend watching a tv drama; 'Start Up'.
http://www.imdb.com/title/tt5028002/?ref_=tt_mv

I'd rather hold bitcoins than "paper gold" options. When a pension fund owns gold I very much doubt they'll have a vault full of it rather they'll own shares in a ETFs backed by some vaults in London like HSBC. There are many more paper gold claims than real gold so you know someone isn't telling the truth. Even gold dealers in NYC with good reputations have sold bullion full of tungsten.

So you think a digital IOU from the internet with a highly volatile value backed up by nothing is more trustworthy than a IOU from a major Bank backed by some amount (possibly less than face value) of real gold?

I'd rather hold bitcoins than "paper gold" options.

I wouldn't. Gold ETFs are bought and sold on stock exchanges and can be exchanged instantaneously. That is not necessarily the case with cryptos. Furthermore, the gold ETF tracks the value of the price of gold. The price of a crypto is based on something more ephemeral, typically demand from people who have no idea of the value of what they're buying.