Bitcoin, Gold and the Risks of Bum Comparisons

(Bloomberg View) -- One simple chart is creating a lot of buzz in markets. It shows that for the first time in history, one bitcoin is worth more than one troy ounce of gold. Despite the flurry of discussion this factoid has generated, many are stupefied, not quite knowing what to do with this information or how to trade on it. Maybe it's because they have little to do with each other. 

In fact, gold and bitcoin don't even represent the same asset class. Comparing them is not like apples and oranges (both fruit). Better said, it's akin to comparing the prices of soybean futures and Intel stock. Many may argue that both gold and bitcoin are currencies as they can be used to purchase goods and services. Or, they may say both are commodities in that they have strict rules around meeting specified minimum standards and have associated futures and options contracts. But economics 101 argues that gold is a commodity and bitcoin and blockchain are technology.

THE CURRENCY ARGUMENT:
Neither are currencies. By definition, a currency is used as a medium of exchange and a widely accepted and circulated means of payment. Gold's classification as a commodity-backed currency is largely a relic of history from the early days of capitalism when one could exchange gold for a cow. But that model didn't work because there was often a gold shortage. Gold is surely a tradeable instrument and an asset-backed currency, as it can be exchanged for a given quantity of dollars, but try buying groceries with a nugget. Unless another Bretton Woods-type fixed exchange rate is enforced, gold is not tied to anything.

Undoubtedly, bitcoin is becoming a more accepted means of payment by stores such as Home Depot, for online transactions, or Expedia.com, and more nations, such as Estonia and Denmark. But it's still not widely accepted worldwide -- at least not yet.

A currency is defined as valuation through fiat, meaning nations use it in monetary policy. The Federal Reserve can print as many dollars as deemed necessary to stimulate the economy. While more than 50 banks have joined the R3 consortium to incorporate blockchain technology, bitcoin is not reliant on third parties such as governments and banks.

Unlike currencies, both gold and bitcoin have finite supply. The earth's supply of gold is limited by to what remains underground while the creation of bitcoin is capped at 21 million.

THE SUBSTITUTION ARGUMENT:
The first use of gold was around 700 B.C., and since then, no one has discovered or created anything that has gold's exact characteristics. Metallurgists have blended alloys to look and feel like gold, but their results are not gold and do not meet the standards for physical delivery. Bitcoin, on the other hand, has many substitutes as myriad “altcoin” cryptocurrencies have sprung up to challenge it, such as ethereum and its beta model, Casper, an alternative to the mining-based model, and ostensibly more secure.

According to cryptocoincharts, there are 3,694 cryptocoins with a $27.8 billion market cap. Granted, bitcoin has an overwhelming share of the marketplace, but who knows what the future holds should other cryptocurrencies gain ground with technologies that challenge or disrupt the current marketplace. It was't that long ago that Mt. Gox Exchange had many of its bitcoins stolen. Even last summer, a project running on a blockchain technology was hacked and lost millions of dollars. So yes, there's room for improvement.

THE COMMODITY ARGUMENT:
Point blank, gold is a commodity, bitcoin is not. Gold is a classic commodity, defined as a basic good or hard asset used in commerce and as an input in the production of other goods. One can take physical delivery of a commodity, which can then be smelted, crushed, blended or refined to some other form for use. While bitcoin is storable, it's not physical and cannot be held, felt or transformed in anyway.  

THE INFLATION/HAVEN ARGUMENT:  
For centuries, gold has been considered a haven as well as an inflation hedge. These qualities are not necessarily steadfast as alternatives came about (e.g. Swiss franc, Treasury Inflation-Protected Securities), the argument still holds. One cannot say the same for bitcoin. In fact China's three biggest bitcoin exchanges recently suspended withdrawals after pressure from the People's Bank of China over concern that bitcoin was being used to move money out of the country. And bitcoin hasn't been around long enough to make the inflation hedge argument, seeing as there has been no inflation to speak of in its history, until now.

Surely there are similarities. Both bitcoin and gold are rare, their prices can be volatile and each serves as an alternative investment for those lacking faith in fiat currency and monetary policy. Trading bitcoin is not as easy as gold, as one has to open a bitcoin wallet, then purchase bitcoins via online exchanges, or invest in an over-the-counter Bitcoin Investment Trust, often at a hefty premium to the cryptocurrency. Soon there may be a bitcoin ETF, as the Winklevoss twins await the SEC's approval deadline of March 13. With that go-ahead, bitcoin will become an easier trade.

Their relative values, nevertheless, are not revealing much of anything barring validation of the thrill of speculation. The recent rise in bitcoin's value is in part attributed to tighter currency restrictions in countries such as China, India and Venezuela in addition to investors betting on a more relaxed regulatory environment under President Donald Trump. Thus, with emerging market currency instability, legitimate uncertainty around Trump's policies, and expectations for a stock market correction, there's certainly good reasons to buy gold too. Well, so much for that spread.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Shelley Goldberg is an investment adviser and environmental sustainability consultant. She has worked as a commodities strategist for Brevan Howard Asset Management and Roubini Global Economics.

To contact the author of this story: Shelley Goldberg at shelleyrg3@gmail.com.

To contact the editor responsible for this story: Robert Burgess at bburgess@bloomberg.net.

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