Why cryptocurrencies are no substitute for gold

Gold performed well in 2017, with its value improving by 13 per cent in US dollar terms over the year.

The precious metal’s price rise was, however, no match for bitcoin, which enjoyed a 13-fold increase in value by the end of the year.

Despite the meteoric rise of bitcoin in 2017, which has since dropped significantly in value this month, the World Gold Council (WGC) has outlined why it, and other cryptocurrencies, should not be considered by investors as a replacement for gold.

WGC, which has released a report on the topic, believes there are several reasons why cryptocurrencies “are no substitute for gold,” including it is less volatile, has a more liquid market, demand is more diverse, supply is responsive, and it is regulated.

Here, Australian Mining breaks down each of WGC’s reasons for why investors should support gold:

Gold is less volatile
According to WGC, gold has appreciated 10 per cent a year, on average, since the 1970s and its price volatility has been “relatively tame” over the past four decades.

Bitcoin, meanwhile, has enjoyed rapid growth in recent years, particularly in 2017 as mentioned. However, WGC explained its price has also been extremely volatile, falling by more than 40 per cent in a month since mid-December.

“Bitcoin moves, on average, 5 per cent each day,” the WGC report said.

Gold is more liquid
Cryptocurrencies do not have a clear two-way market, according to the WGC. In fact, bitcoin trades around $US2 billion in volume, on average, a day, which is less than 1 per cent of the total gold market at around $US250 billion/day.

“Reports suggest their (bitcoin) 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,” WGC reported.

Gold demand is diverse
Gold has a 7000-year history as an asset and a long-standing role as money, WGC reinforced. It is owned by banks and investors, while also being used as jewellery — still the largest source of demand.

Bitcoin and other cryptocurrencies, in contrast, are designed for use as tokens in electronic payment systems, a potentially useful characteristic, WGC reported.

“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,” it added.

Gold supply is responsive
There are some similarities between the supply profile of gold and cryptocurrencies, WGC conceded. Bitcoin stocks increase by around 4 per cent a year, while the average 3200 tonnes of gold mined each year adds about 1.7 per cent to the precious metal’s stocks.

However, WGC believes gold wins the supply battle because it 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,” it said.

WGC also questions if bitcoin will be disrupted by a superior blockchain application, saying: “The many cryptocurrency alternatives beg the question of whether a newer, better blockchain-based coin application may be equivalent to increasing supply.”

Gold is regulated
While cryptocurrencies are broadly permitted, but not yet widely approved, WGC pointed out that trade in gold was authorised and regulated in many markets.

“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,” WGC reported.

The marketplace has recently seen an example of this in South Korea, which plans to introduce more regulatory measures.

Gold as a strategic asset
In summary, WGC believes bitcoin and cryptocurrencies are generally not a substitute for gold as an investment. It described gold as 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,” WGC reported.

In contrast, WGC said the purpose of cryptocurrencies as an investment seemed quite different from gold.

“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,” WGC concluded.

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