Both bitcoin and gold offer opportunities to diversify away from corrupt financial system
What’s going on with bitcoin?
Last week the bitcoin price hit $2,700. A 500-fold increase in five years and a doubling in price since the start of the month.
Most people are aware of bitcoin tangentially, few are really conscious of it day-to-day and even fewer people are actually in bitcoin. Other significant cryptocurrencies, such as Ether and Ripple have also been going great guns and these are even less prominent in the public domain.
If something such as bitcoin with such a small market cap and very little public awareness is doubling in price in less than a month, what does it mean? Why is it behaving like this? Is it in a bubble? Is it a scam? Does it means that you should be getting in on the act? And what does it mean for its contemporaries, such as gold?
We take a brief look at why the price has been climbing, what this means for the future of cryptocurrencies and, most importantly, what this says about gold.
Why the spike in the bitcoin price?
I was asked this question recently on question-and-answer site Quora. I include the answer below, with some edits and further information. It does not focus on specific events but instead on both the short and long-term drivers of the bitcoin price. It should be noted that whilst the price of bitcoin has fallen back from it’s highs of last week, it has not taken the same tumble it has done previously following price-spikes.
- FOMO (aka Fear of Missing Out) and hype – there are some who are worried that they missed getting in on bitcoin every time it has climbed like this and they want in, in order to profit from what could be a bubble or to profit from further climbs. Like most investment opportunities or just trends elsewhere, people are always searching for the next big thing. Inevitably this leads to speculation and a feedback loop…
- This leads to the increased number of trades, which economics tells us will drive up the price. In early 2013 the number of bitcoin trades was around 40k, today it is closer to 330k. According to the Cambridge Center for Alternative Finance, speculation is the biggest driver for the recent price climb.
- Acceptance – as the currency is accepted in more places, this is further sign of validation. This is not good for the price just because there will be more transactions, but it is good for the price as it means more key stakeholders in the financial, banking, legal and regulatory industries will be paying attention.
- Policy changes – with each policy change that is in favour of bitcoin this brings validation to the currency and the overall blockchain network. One of the biggest examples of policy change recently has been in Japan, where the government formally recognised the currency.
- Following on from above, future expectations: The more the currency is accepted, the harder it is to control and for governments to ignore. This gives more faith in the future of the currency, which drives demand based on future expectations not just the current environment.
- Economies of scale – as we see more policy changes, more payment processors accepting bitcoin, more news stories etc covering the rising price then the overall market for bitcoin becomes more stable. Each time we have a price climb like this (I can think of two earlier ones) the marketplace is increasingly stable (n.b. I say marketplace and not price) this gives consumers more confidence that bitcoin isn’t going to just disappear
- First mover advantage – this isn’t news, in the same way 21 million bitcoins isn’t news, but the fact that bitcoin was the first currency does give it an increasing advantage as early adopters have sought to ensure and protect the strong community, ecosystem and industry that supports bitcoin activity. Again, this is gives new adopters confidence.
- Hackers – We’re all aware now of the horrendous attacks that have happened around the world. The most recent of which demanded payment in bitcoins. Many may see this as bad press for the cryptocurrency but in response to this (there are rumours that) large organisations are buying up bitcoin in preparation for future attacks.
- Obstacles for arbitrage – usually when there is a big spread between currency markets traders capitalise on the arbitrage opportunity. In bitcoin where there are major premiums on the bitcoin price in both Japan and South Korea, over the US Dollar price, regulatory and legal barriers are preventing traders who buy USD priced bitcoins from selling them in Asian markets, quickly enough to meet surging demand. This drives the price further.
Before I go on to the other reasons why the bitcoin price is rising, gold investors should note that the following reasons for bitcoin’s price climb are exactly the same reasons why gold has value and climbs in price.
- It’s being treated like an actual currency – this where all the usual stuff applies that we normally refer to when we talk about fiat currencies, gold and silver. Bitcoin is another currency that gets traded according to demand for other currencies and perceptions surrounding them, this is affected by:
- Geopolitical risks – in the UK alone consider terrorist attacks, Brexit uncertainty, UK elections. Then consider North Korea etc
- Demand for the dollar – investigations and rumours surrounding Trump are not helping.
- Global debt concerns – Greek debt concern is now a thing again (it has always been a thing but it gets pushed to the sidelines occasionally).
- China – for many people this is the big reason why the price is climbing. China has been struggling for a while now, with the Shanghai Composite down by 10% and bitcoin demand climbing as a flight of safety away from the yuan. However, Chinese bitcoin trade volume is only 10%, compared to around 90% back in January.
But what about gold?
I have written and tweeted extensively about the gold versus bitcoin issue. In short, I believe that it is a non issue in terms of the fact that I do not believe they are competing assets. I’m in the minority, as the mainstream continue to compare the two assets. This is inevitable given the reasons for both bitcoin’s creation and for some investors are to mimic gold’s unique combination of characteristics.
Many on Twitter have accused those of us who believe that they are not competing assets, as trying to prop up gold and that we’re in denial about bitcoin usurping gold as the ultimate reserve currency. This isn’t the case at all, both gold and bitcoin are alternative assets. Despite this, physical gold is the clear safe haven on account of it’s history, physicality, proven value and reduced-exposure to modern technologies.
As explained above, some of bitcoin’s price performance can be attributed to geopolitical events, however a CoinDesk survey at the beginning of the year shows that only a small percentage of those surveyed pointed to macroeconomic factors as the reason for the price climb, many in the crypto world still consider technological improvements within the ecosystem to be the greater support for higher prices.
This suggests that for now, gold remains the ultimate safe haven when it comes to great geopolitical and financial issues. Bitcoin’s volatility makes it difficult to for investors to place their faith in the currency due to the uncertainty of whether or not it will still ave value (let alone where it’s price will be) in a year from now. With physical gold there is far more certainty both in terms of its value and its security, when stored in a segregated, allocated manner.
As we wrote back in January:
Currently bitcoin plays a different role to gold. For want of an analogy, bitcoin is more the cash, whilst gold is more the savings. It is likely that we will see those looking at securing their wealth across both assets. This is likely to be done in a similar way that we see gold investors also buy silver, and divide holdings between stored bars and coins kept at home.
It is possible for us to take any asset and demonstrate staggering returns over a perfectly chosen period. The fact is that for now, the bitcoin investment market is too new and under reported to know what role the currency may play.
…owning bitcoin directly can bring its own security risks and this is something there is little education and understanding about.
In contrast, holding gold as part of a balanced portfolio and as a safe haven asset has been part of the public consciousness for centuries and remains understood by many today – especially in Asia.
Conclusion – Nothing to see here
Speculation and volatility is bitcoin’s weakness at present, or so believe the mainstream. It is worth remembering that speculation in and of itself is not a bad thing. Cryptocurrency markets should not be criticised for the fact that this is going on. Speculation is the product of a free market, it is also evidence of organic growth and a growing user base. Spikes such as these do a great job of drawing in awareness of the space in the early years.
Unsurprisingly supporters of cryptocurrencies remain un-phased by this latest fall in price. As with those who invest in gold, it is the wider outlook, the ecosystem and the real value which gives supporters confidence that there is little to worry about here.
All markets have a dynamic where by seasoned traders and speculators use price spurts to lock in profits, as new demand enters the market (generally thanks to a small price increase, announcement or geopolitical event) the price is bid up and profits are taken. The difference with bitcoin and the like is that they are much, much smaller and newer markets and so we see far greater volatility.
We shouldn’t be surprised by the mainstream’s distaste or uncertainty surrounding the currency, in fact we should be hardened and assured by it. This is the same treatment we see for gold, something which humanity has held faith in for thousands of years.
The attention towards bitcoin and its recent price performance is not only validation for itself but also for gold and silver. Whilst bitcoin’s price rise might mainly be down to speculation it is also thanks to a growing desire to hold investments outside of the financial system. This, validates the role of precious metals. In time, we will see speculators become investors and investors become diversifiers. This is good for those holding gold and silver, as explained in January:
Increasingly, gold and bitcoin may be seen as very much complementary assets, but bitcoin buyers should be aware of the volatility of bitcoin and of how speculative it remains today. Those considering buying should only own a very very small percentage of their wealth in bitcoin. While gold and silver can constitute as much as 20% of a diversified portfolio – bitcoin should be less than 3% or 4% of one’s wealth.
Also, if buying bitcoin, it is prudent to apply the same logic to owning bitcoin as they do for gold – diversify, own the currency in the safest ways possible – including some offline in secure ‘cold’ storage and monitor the wider political, financial and monetary environment.
News and Commentary
Here’s What It Would Take for Gold to Hit $2,000 (Fool.com)
Hedging Against Political Volatility With Gold (Bloomberg.com)
Government Silver Sales Have Totally Dried Up… WHY? (SilverSeek.com)
Gold’s Days of Glory Beginning As Dollar’s Are Ending (GoldSwitzerland.com)
RBC’s Louney Says Gold Exposure Is Key Amid Risky Markets (Bloomberg.com)
Gold steady near 4-week highs as geopolitical worries support (Reuters.com)
Gold books highest settlement in a month, 3rd straight weekly rise (MarketWatch.com)
Gold Prices (LBMA AM)
29 May: USD 1,265.00, GBP 983.41 & EUR 1,127.87 per ounce
26 May: USD 1,265.00, GBP 983.41 & EUR 1,127.87 per ounce
25 May: USD 1,257.10, GBP 969.48 & EUR 1,119.57 per ounce
24 May: USD 1,251.35, GBP 963.29 & EUR 1,119.58 per ounce
23 May: USD 1,259.90, GBP 969.62 & EUR 1,119.17 per ounce
22 May: USD 1,255.25, GBP 967.17 & EUR 1,123.07 per ounce
19 May: USD 1,251.85, GBP 962.17 & EUR 1,122.03 per ounce
Silver Prices (LBMA)
29 May: USD 17.29, GBP 13.45 & EUR 15.41 per ounce
26 May: USD 17.29, GBP 13.45 & EUR 15.41 per ounce
25 May: USD 17.15, GBP 13.23 & EUR 15.29 per ounce
24 May: USD 17.03, GBP 13.14 & EUR 15.22 per ounce
23 May: USD 17.14, GBP 13.22 & EUR 15.25 per ounce
22 May: USD 16.95, GBP 13.04 & EUR 15.10 per ounce
19 May: USD 16.77, GBP 12.90 & EUR 15.02 per ounce