Innovation

Bitcoin is Like Gold, But It’s Superior

By November 1, 2018 No Comments

bitcoinThe image of a gold coin with the bitcoin symbol imprinted on it has become synonymous with everything to do with bitcoin, to the extent that almost everyone around the world uses this type of image when they write about bitcoin. In the event that you are not sure what I’m referring to, glance at the image to the right.

The gold-like coin images, as well as the ‘digital gold’ analogy, have been used widely for much of bitcoin’s 9-year lifetime. An analogy can be very useful when you want to explain something that is not easy to understand. It makes sense, therefore, that people often use analogies to explain various things about bitcoin. Bitcoin is, after all, something that very few people in this world understand in great depth.

Taking into consideration the consistent and widespread use of the ‘bitcoin is digital gold’ analogy, you’d expect that it would be delivering positive assurances for people new to bitcoin. However, this is not always the case. I’ve witnessed times when the analogy has done more harm than good because: (i) the relevant similarities haven’t been explained well; and (ii) the areas in which bitcoin is superior to gold have not been highlighted.

This article will introduce some of the things about gold that can help anyone understand more about bitcoin. In addition, I’ll highlight in what respects bitcoin is superior to gold and how those attributes should enable bitcoin to overtake gold and any other monetary good in the future.

The Makeup Of Gold’s Market Value

Gold is trading on the market at about 1200 USD per ounce. However, if you use gold for the material uses that you can, such as in dentistry or for electronics components, you’ll only be able to recover anywhere between 100 and 200 USD per ounce. The reason why you’ll only be able to recover this lesser amount when using gold for these purposes is that there are other goods that can also fulfil these purposes, but which can be purchased for this lesser amount. Therefore, market forces dictate that gold’s ‘use value’ is anywhere between 100 and 200 USD an ounce.

The difference between gold’s use value (of 100-200 USD per ounce) and its market value (of around 1200 USD per ounce) is about 1000 USD per ounce. This difference is termed a ‘monetary premium’, and 80% of gold’s market value is attributable to this monetary premium.

A monetary premium is a premium that the market gives a good that has the ability to perform the functions of a money. Money’s primary function is to serve as a medium of exchange. However, before society will use something as a medium of exchange, the good must first be able to function as a store of value. Therefore, one of the functions of a money is to store value.

By definition, something is a good store of value if the holder can sell the good on the market at any time and recover at least the same value that the good had when the holder received or acquired it.

Practically speaking, people store wealth in gold because they expect others to accept it from them in the future in exchange for a value equal to at least the same price that the gold had when that holder received or acquired it.

Every person in the world needs to store value and some of these people believe in gold’s ability to fulfil that function. The resultant demand for gold, matched against the available supply of gold, dictates that gold has a monetary premium of approximately 1000 USD per ounce.

The fact that a large part of gold’s market value is attributable to a monetary premium goes a long way to helping anyone understand that it is not completely out of this world for something like bitcoin to have value even though it is not a company with cash flows or a physical good like oil that can be consumed in production.

Why Gold Can Function As A Store Of Value

Saifedean Ammous, who is a professor of economics at the Lebanese American University, has written a book titled The Bitcoin Standard: The Decentralized Alternative To Central Banking. One of the many valuable things to take from the book is Saifedean’s analysis of the goods that have functioned as stores of value in history and what common attributes these goods have.

Saifedean has identified that stores of value all have one common attribute; namely that it has been hard for humans to increase the total supply of the good and dilute the value of the existing supply. If it has been hard for humans to increase the total supply, then the good has held its value well over an extended period of time. A money whose supply is hard to increase is termed ‘hard money’, while a money whose supply is easy to increase is termed ‘easy money’.

Gold achieves its ‘hardness’ in a unique way. Physical gold is indestructible, and the effect is that all the gold that has ever been mined in history is still with us on earth today. The knock-on effect of this ever-increasing stockpile of gold is that even if society chooses to mine a lot of gold this year, it would only be a very small portion of what already exists. In fact, if you look at the rate at which gold has been mined over the last 70 years, only an additional 1-2% is being added to the existing supply each year. The result is that units of gold have held their value well over a long period of time.

Why Bitcoin Can Function As A Store Of Value

Bitcoin is incredibly ‘hard money’. This is because the supply of bitcoin is capped at 21 million bitcoin and the rate at which new bitcoin enters the system continues to slow down. At the moment, there are about 17,4 million bitcoin in circulation and the total supply of bitcoin is increasing at about 4% per year. By the second quarter of 2020, the rate at which the total supply will be increasing will have decreased to below 2% per year and the rate will continue to slow until all bitcoin has entered circulation in about the year 2140.

Bitcoin’s supply cap and deflationary monetary policy mean that it has similar attributes to gold. Bitcoin is therefore well placed to be able to function as a store of value in the future, much like gold functions as a store of value today.

Bitcoin’s More Disruptive Features

In addition to being ‘hard money’, bitcoin has some other attributes which separate it from the rest.

Portability

Bitcoin’s portability is second to none. This is because you can store the private keys that you need to spend bitcoin on something as small as a USB flash drive, and you can carry this hardware device with you wherever you go.

Importantly, this portability is not affected by the amount of wealth being stored. Irrespective of whether you are storing 50 USD, or 500 million USD of wealth in bitcoin, you’ll still be able to store the private keys that you need to spend that wealth on this small hardware device.

This is not the case with gold because the more wealth stored in gold, the harder and more expensive it is to transport gold from one location to another.

Censorship Resistance

As a result of Bitcoin’s decentralization and the economic incentives that are inherent in the network, a system that is resistant to censorship is created. The result is that: (i) anyone can send any amount of money to any person anywhere in the world and the transaction will be cleared and settled in under an hour; and (ii) without physically attacking a person who is storing wealth in bitcoin, there is no way to confiscate wealth from that person.

Other than Bitcoin, there is no other asset in the world that has these attributes. This is because of the fact that with traditional assets, we are reliant on institutions to recognize, protect and enforce the ownership of the asset. By way of example, ownership of government money (USD, Euro, Rand) is facilitated by a bank, ownership of stocks is facilitated by an ecosystem of financial services providers, and ownership of immovable property is facilitated by a government institution. From time to time, these centralized institutions can be influenced to do things that are not in your best interests.

Due to gold’s physical nature, in almost all instances people storing significant amounts of wealth in gold have to rely on service providers to store the gold for them. Having to rely on a service provider introduces a risk that people storing wealth in bitcoin do not have to take if they do not wish to do so.

Divisibility

There are 100 million bits in every bitcoin and bitcoin can be spent in such tiny amounts. In contrast, it is not easy to use gold as a medium of exchange when you’ve had to divide the gold into smaller amounts to facilitate prior exchange. Gold’s divisibility therefore hinders its ability to perform the primary function of a money – to function as a medium of exchange. Bitcoin does not suffer from this shortcoming.

Gold Once Performed the Functions Of A Money

By 1900, about 50 nations were using gold as a store of value and a medium of exchange. When gold was being used as a medium of exchange between countries and within societies, its portability and divisibility shortcomings had to be addressed.

The answer that the powers that be came up with at that time was to centralize all gold at locations controlled by the state and to issue paper to represent the gold. The logic was that the paper would be far more divisible and portable.

This solution was fine for so long as the amount of paper issued was backed or supported by gold being held in reserve. However, soon after this arrangement was put in place the governments let their self-interest get the better of them and the amount of paper issued soon exceeded the amount of gold being held in reserve. As a result of money’s role in society, humans will always be incentivized to create more of it… Fast forward about 100 years and we have government money backed by debt and as we’re experiencing, there seems to be no limit to the amount of debt that can created.

Government money is incredibly ‘easy money’ and there will always be more of it. The unfortunate thing about the increasing supply of government money is that it does not benefit everyone equally. If you would like to know more about the increasing supply of government money and why it does not benefit everyone equally, my article “The Big World Problem For Bitcoin To Solve” should be a good introduction.

Bitcoin’s Potential To Be The Best Money Ever Invented

With the invention of Bitcoin, the world now has a good that has the potential to sustainably function as a store of value as well as a medium of exchange. I say this because bitcoin is incredibly ‘hard money’ and it doesn’t have the portability and divisibility shortcomings that gold had and still has.

It is estimated that bitcoin should be able to function as a store of value in approximately 10-15 years’ time. The path towards becoming a store of value and then the medium of exchange used by people all over the world will be the subject of a future article.

 

Disclaimer: The comments, views, opinions and any forecasts of future events reflect the opinion of the quoted author, do not necessarily reflect the views of Switch or other professionals at Switch, are not guarantees of future events or results and are not intended to provide financial planning or investment advice.