Same, same but different?
Gold and Bitcoin share many similarities. Both are supply constrained and their demand is not exposed to the ups and downs of the economic cycle. Even the ways they are held by investors are quite similar, up to the point where the introduction of exchange-traded funds has become a major success story for both assets, enabling broader adoption.
However, gold and Bitcoin could not be more different. Gold is a natural asset and has earned its reputation as a safe haven and store of value over thousands of years. It has been used as money in the past and is even experiencing a renaissance as a sought-after central-bank reserve asset. Bitcoin, in contrast, is a technical asset that emerged at the end of the Global Financial Crisis, when trust in the traditional financial system was at an all-time low. While its ambition is to be a sound form of money, it has exhibited excessive volatility during most of its comparably short history. Some still see gold as a sound form of money as well, reminiscent of the times of the gold standard that ended in the 1970s. During the Global Financial Crisis, the lack of trust in the financial system also propelled gold prices to a series of record highs.
Gold and Bitcoin have constrained supplies
Both assets are also supply constrained. For gold, these constraints are geological. It is a rare resource, with few big discoveries made during the past couple of years. Mining it has become ever more complex in terms of the depth of the mines and number of rocks that need to be moved. Ore grades are in structural decline, pushing up production costs. Simply speaking, if the ore grade of a mine halves, its production then costs double. For the past 10 years, the average costs of gold mines, including investments to sustain production, have risen from around USD 1,000 to around USD 1,400 per ounce.
Bitcoin’s supply constraints are technical. They are hard coded into the blockchain, limiting the total supply to 21 million tokens and dictating a halving of the block reward every four years, roughly speaking. Bitcoin mining is technically difficult and involves a self-regulating mechanism to avoid issuing more Bitcoins than the protocol’s growth rate. Essentially, the more computing power miners employ, the more the network makes it difficult to mine a Bitcoin, stabilising the blockchain’s supply growth. Miners have a broad overhead, including the data centre infrastructure they develop, where they not only need to optimise their energy supply, but also their hardware efficiency.
In short, the energy needed to solve Bitcoin’s cryptographic puzzles is equivalent to the energy needed to mine gold. Both assets are – to a certain degree – backed by the enormous amount of energy that is required to produce them.
Investor-driven demand vs. exposure to the economic cycle
There are also similarities on the demand side. Neither the demand for gold nor the demand for Bitcoin are exposed to the ups and downs of the economic cycle, but rather investors’ appetite to hold these assets in their portfolios. The way they are held very much depends on an investors’ preference in terms of safety, security, and convenience.
Hedging characteristics - the main differences
Considering the similarities between gold and Bitcoin, investors often ponder the question: To what extent do both assets also share similarities in terms of performance? Or, more specifically, considering gold’s reputation as a safe haven and store of value, they ponder whether Bitcoin possesses the same characteristics. We will now look at various risk factors and provide our assessment of gold and Bitcoin’s hedging characteristics.
Systemic risks in financial markets: First, both assets should serve as hedges against systemic risks in financial markets. In case of a breakdown of the financial system, they should be a safe haven. While not tested since the Global Financial Crisis, gold has demonstrated this characteristic multiple times in the past, while Bitcoin is designed to provide robust security and a high degree of decentralisation.
Dedollarisation: Second, there is a risk of dedollarisation, a reduction on reliance on the US dollar as a reserve currency. It has been debated more intensively as of late, fuelled by the weaponisation of the US dollar in the context of growing geopolitical tensions as well as concerns about the United States’ ballooning deficits and rising indebtedness. Priced against the dollar, both gold and Bitcoin can be seen as ‘anti dollars’. Therefore, they should hedge against the demise of the dollar as the world’s global reserve currency.
Inflation: Third, gold and Bitcoin could serve as hedges against inflation. Both are supply constrained, in contrast to fiat money, which can be ‘printed’ by central banks and is therefore in unlimited supply. That said, not all inflation is created equal. Gold and Bitcoin should hedge against ‘bad inflation’, which results from reckless fiscal and monetary policies, leading to a loss of trust and massive devaluation of a currency. They should not hedge against ‘good inflation’, which emerges from strong economies and is countered by central banks with more restrictive monetary policies.
Equity market corrections: Finally, there is a risk of economic shocks and equity market corrections. During such shocks, gold typically demonstrates its safe-haven status, holding its value or even increasing it. It is very much a risk-off asset, in contrast to Bitcoin, which remains a risk-on asset. Bitcoin tends to move with the equity market, exposing it to material downside risks in case of a correction. Hence, when it comes to equity market corrections, gold is a hedge, unlike Bitcoin. Nonetheless, outside of such shock periods, including a small share of Bitcoin in a well-diversified portfolio tends to add value via improved risk-adjusted returns.
Excellent hedges in times of systemic stress
Based on the similarities between gold and Bitcoin, we have a lot of sympathy for the ‘digital gold’ analogy. Nonetheless, we believe it is very important for investors to be aware of the fact that as of today, Bitcoin often behaves as a risk-on asset. It tends to suffer quite strongly when risk aversion spreads in financial markets, resulting in reduced diversification benefits. This is different for gold, which typically tends to keep its value during such risk-off periods. Where both should excel as hedges and where Bitcoin comes close to being ‘digital gold’ is in times of systemic stress in financial markets or doubts about the stability of the domestic currency.
Please note: the information provided is for educational purposes only.