Should you own Gold or Cryptocurrencies?

Mark Pey

March 21, 2018

In some ways they are very similar.

And in some ways they are completely different.

But overall they were designed to do different things.

Gold and cryptocurrencies: a look at the similarities

They are Both Outside the System

Both gold and cryptocurrencies are a way to hold assets completely outside the banking system.

Since the start of the GFC, when most of the biggest banks in the world were near insolvency and some actually did go belly up, some people have looked for forms of wealth that are not reliant on banks. According to the Wall St. Journal an estimated $15 trillion in wealth was lost in the GFC. For those keeping count, that’s 15 thousand thousand million, and understandably people would like to avoid the risk of that happening to them again. While today we all need money in a bank account in order to pay our bills, some people sleep easier knowing that if GFC Mark 2 arrives at least some of their wealth is completely outside of the banking system. Both gold and cryptocurrencies can tick this box.

They are Both Directly-owned

Both gold and cryptocurrencies represent direct ownership of an asset.

Most people are not aware that when you deposit funds at a bank you are no longer the owner of those funds; you have legally granted your funds to the bank, and the bank owes them back to you (see How A Deposit Account Works). Of course this arrangement is covered by things like government guarantees (up to certain limits).

But with gold and cryptocurrencies, by contrast, you are the direct outright owner of the assets in question. For gold this applies to physical gold buried in your back yard and to systems like SendGold based on outright physical gold ownership, but it does not apply to gold-related investments like gold ETFs and gold funds which own the gold on your behalf. For cryptocurrencies you are the direct outright owner, but only if you actually store the cryptocurrency keypairs on your own computer. If you simply have an account at a crypto-exchange (like Coinbase or Coinjar for example) then the exchanges are the direct owner, and they in turn owe that value back to you.

                                                 INVESTMENT HIGHLIGHTS

They are Both Assets, not Debts

Every balance sheet or ledger shows “Assets” on one side and “Liabilities” (debts) on the other. Both gold and cryptocurrencies are assets.

Most people are similarly unaware that Australian dollars are not created by the Reserve Bank of Australia! They’re created by commercial banks like CommBank and ANZ when they lend money out. (The RBA does create about 3% of Australian dollars as physical cash notes). These commercial banks create brand-new Australian dollars by issuing new debt (loaning money to people and businesses) in what’s called a “debt-based money system”. Every dollar (except the ones printed by the Reserve Bank) was created by someone borrowing money: the debt is what creates the money. (The Bank of England offers a longer explanation here: Money Creation). Some people, worried about another GFC(where the problem of too much debt was addressed by issuing more debt) have criticised our debt-based money system as unsustainable.

Things like gold, real estate, shares, art works, and cryptocurrencies by contrast are assets, not debts. When they are fully-owned (with no real estate mortgage loan for example) there is no debt attached to them. Their existence does not require anyone to owe money to anyone else. Most cryptocurrencies are currently classified as “property” which means that like gold they fall into the “asset”, and not the “debt” category.

The Value of Both is Related to their Scarcity

Both gold and cryptocurrencies are seen as valuable in part because they are scarce.

Consider the Mona Lisa; it’s priceless because it represents the ultimate in scarcity; there is only one of them. It’s unique. A few months ago another wooden frame with canvas and paint on it was exchanged for $450 million dollars. The new owner also knew it was the only one of its kind in the world (The $450 Million Leonardo).

Now consider the items that the investor exchanged for the Leonardo painting, all 450 million of them: U.S. Dollars. Are they scarce? Are they as scarce as they used to be, prior to the start of the GFC? The chart below shows the “monetary base”, in other words the “quantity of money” in the system.

In this case the increasing “un-scarcity” of U.S. Dollars was no match for the unique scarcity of the Leonardo painting, especially as banks reacted to the GFC in 2009 by dramatically increasing the supply of money. But why not ask a similar question about the scarcity value of any asset, like houses or Facebook shares or even avocados?

The prices in dollars of houses and Facebook shares and avocados have recently gone up. A lot. Could that be, at least in part, because the quantity of dollars has gone up faster than the number of houses or shares or avocados has? If dollars are not as scarce as they used to be then it may be that it simply takes more and more of them to buy that same house or share or avocado.

Both gold and cryptocurrencies are viewed by some people as an antidote to this dilemma with our evergrowing debt-based money system (and increasing money supply) because, unlike dollars that can be created by governments and banks in practically unlimited amounts, they are scarce. Their quantity is limited. The chart below shows the annual increase in the supply of money in recent years as compared to the annual increase in the supply of gold.

We discuss the How’s, Why’s and comparisons of the scarcity of gold and cryptocurrencies in more detail below.

SO HOW DO CRYPTO AND GOLD COMPARE, AND HOW ARE THEY DIFFERENT?

Let’s look at how gold and cryptocurrencies compare across a few different categories: Price, Track Record, Volatility, Liquidity, Scarcity, and Trust.

Price

Both assets have impressive “hockey stick” price charts.

Track Record

Cryptocurrencies have a track record going back 9 years, whereas gold has been a store of value for more than 2000 years. Gold has survived every war, calamity, and economic recession in history, but it’s not yet clear whether cryptocurrencies (and which ones) will survive the next 1, 3, 5, 10 or 50 years.

This week Goldman Sachs issued a report stating they believe the price of most cryptocurrencies will fall to zero (see below). While we think this is probably an alarmist headline by a company with large vested interests in the current money system, it does highlight the dilemma for cryptocurrency investors: choosing which ones might survive.

By contrast there is only one asset known as “gold”, and it has a track record of survival that exceeds everything else mankind has put up against it: currencies, companies, and even countries have come and gone while gold has survived.

Volatility

Volatility is a measure of how much prices move, both up and down, and the chart below shows the daily volatility of Bitcoin and gold for comparison purposes. This does not suggest that all volatility is bad! And certainly cryptocurrency investors are happy when their prices go up 100% or more. As of the writing of this paper, Bitcoin is down around 70% in the last two months, which merely serves as a reminder that volatility is a two-way street.

The price of gold is also volatile, but gold price volatility has historically been within a much smaller range. According to Perth Mint figures the largest daily price drop of gold price in the last 40 years was just under 13%.

Liquidity

“Liquidity” is defined as the ability to buy and sell an asset whenever you need to. Real-world cryptocurrency liquidity is still unknown: most exchanges limit the quantity that can be sold per person per day, and it’s not yet clear how cryptocurrency prices will respond should large numbers of people attempt to sell simultaneously without an offsetting demand.

Gold by contrast is one of the most liquid assets, with daily trading volumes that exceed the S&P 500. Gold trades in every country and in almost every currency.

Scarcity

The first thing to note is that cryptocurrencies overall are not scarce at all, as dozens of new ones are created each and every month (this link shows just some of them: Map of Coins). Individual cryptocurrencies like Bitcoin, however are considered scarce because of various mechanisms that determine how many of them are created. These mechanisms are all computer software code, and while the Bitcoin algorithm that limits the supply (shown below) has operated successfully it should be noted that additional cryptocurrency amounts can still be created due to “forks” (splits in the blockchain, like Bitcoin Cash) or simply as a consequence of software coding errors (like Ethereum Classic).

Gold supply by contrast is limited by its nature as a rare natural element, and its available supply is limited by the costs of finding, mining, and refining it. Mining adds approximately 2% per year to the supply of gold, and according to the U. S. Geological Survey the remaining mineable global supply is equal to approximately the contents of one Olympic-sized swimming pool (USGS Gold). In the short run the gold supply and price can be and is often influenced by financial intermediaries, but history demonstrates that these supply and price influences have always failed in the medium and long term.

In 2015 Goldman Sachs prepared a report called “Peak Gold” (discussed at this link Peak Gold Report). One chart in the report shows the overall drop in new gold discoveries, and Goldman estimates that peak gold discovery occurred in 2015.

Gold mines eventually run out, and one does not need to rely on projections to see real-world examples. The Witwatersrand region in South Africa is estimated to have produced almost half of all gold in the world, and its production has since been in decline since peaking in 1970.

Trust

A lot has been written in the press about how cryptocurrencies are “trustless”. In our experience there is no such thing, and cryptocurrency owners have simply chosen to trust a different set of providers or technologies other than banks or funds managers.

cryptocurrency enthusiasts must trust:

  • Blockchain networks and their operators, often anonymous entities
  • Crypto wallet developers
  • Crypto exchange operators (unless they hold the keypairs on their own computers)

If they do hold keypairs themselves they must also trust device manufacturers, including desktop, laptop, mobile phone, and USB key storage manufacturers and distributors.

We applaud the efforts to create more “trustworthy” financial and payments systems, but we also think it’s important to be clear about the actual nature of “trust” when evaluating options.

Trust also enters the equation with regard to owning gold. Some of the top considerations include the following:

1 Is it real gold?

History abounds with schemes to produce fake gold, and YouTube has plenty of videos ( Fake Gold Bars) of disappointed customers who bought fake gold on eBay and elsewhere.

BUREAU VERITAS

Bureau Veritas is a company founded in 1828 that provides a service to gold industry companies to ensure that their gold is real gold (Bureau Veritas Precious Metals Assay). Bureau Veritas are a provider to SendGold.

2 How pure is it?

Gold from mines is typically around 80% pure and is called “dore” gold. Reputable gold dealers offer gold for sale at two main purity levels, .9995 pure and .9999 pure.

LONDON BULLION MARKETS ASSOCIATION

The London Bullion Markets Association certifies providers of precious metals and requires that they maintain strict minimum standards for the purity of the gold they sell (London Bullion Metals Association). All SendGold gold is from LBMAcertified dealers only.

3 Is the gold stored safely?

Safely storing a physical product like gold has entirely different considerations than safely storing snips of computer code like cryptocurrencies. The “dig a hole in the ground” approach has been used for centuries (Buried Anglo-Saxon Gold) but has many practical drawbacks.

BRINKS GLOBAL SERVICES

Brinks Global Services was founded in 1861 and specialises in the logistics and safe handling and storage of valuable items including precious metals (Brink’s Precious Metals Storage). Brink’s provide bullion storage for SendGold.

4 Is it insured against damage or theft?

Different forms of gold ownership may be covered under different kinds of insurance. Gold stored at home, for example, may be covered under homeowner insurance policies. Some people are surprised to learn that gold in the most popular gold ETFs does not carry insurance (Gold ETF Insurance), so it’s best to check that your gold provider or fund does carry insurance.

LLOYD’S OF LONDON

Brink’s Global Services work with Lloyd’s of London (Lloyd’s of London) to provide insurance against damage or theft for gold stored in Brinks’ vaults.

5 How do I know I own it?

With gold investment there are different forms of ownership. The simplest is outright ownership of the physical metal, whether by buying bars from a gold dealer or through a platform like SendGold that is structured so users are the outright owners of their gold. Some gold dealers offer “pooled gold”, where users own a share of a pool of gold bars (users should be careful to read the details of the legal agreement). As mentioned above, with gold funds (like ETFs) users own a share of a fund and may or may not have rights to the actual gold owned by the fund.

So while gold and cryptocurrencies are often compared, they are designed for very different objectives given their very important differences. In either case, buyer beware.

SendGold points out that while blockchain technology over the long term is very promising, current investment in the tokens themselves remains a speculative activity.

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