VANCOUVER (miningweekly.com) – In the wake of cryptocurrencies last year emerging as a market darling, delivering extreme gains to risk-tolerant investors, the World Gold Council (WGC) has come out in defence of gold, saying that, while cryptocurrencies may become an established part of the financial system, gold remains fundamentally different.
Last year saw the rise of cryptocurrencies such as bitcoin and ethereum from the cyber underworld into the mainstream economy, with bitcoin gaining about 13 times its value in 12 months.
While gold gained a solid 13% in the year, the WGC maintains that the yellow metal is by far less volatile, has a more liquid market, trades in an established regulatory framework, has a well understood role in an investment portfolio, and 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," the WGC said in a new report published on Thursday.
According to the WGC, cryptocurrencies were at least ten times as volatile as gold in 2017, as has been demonstrated by bitcoin's dip since mid-December – 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 volatility index itself, the council pointed out.
"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."
Despite the current size of the cryptocurrency market, which has been estimated to be valued at more than $800-billion, volumes are very low compared with gold and other currencies. Bitcoin trades an average of $2-billion 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, which trades about $250-billion a day.
SIMILAR, BUT DIFFERENT
The WGC agrees that, at least 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 about 4% a year, 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. About 3 200 t/y of gold have been mined on average, 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 yearly growth.
However, gold 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.
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, argues the WGC. 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.
There are currently more than 1 400 cryptocurrencies available 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.
Further, also counting in gold's favour, is that it is heavily regulated, whereas 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.
This is seen as a major crypto risk factor, given that bitcoin and other cryptocurrencies are at great risk of sudden restrictions from countries concerned about capital flight, investor protection, or loss of seigniorage.
The WGC also points out that 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 US Federal Reserve 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 rules, and should be reported as a gain or loss. This complicates transactions with retailers like Amazon, Target and Wal-Mart, which do not currently allow cryptocurrencies for transactions.
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, the council argued.
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.
"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," the WGC said.