UK Edition
Many people – rightly or wrongly – don’t trust central banks. They believe these institutions will devalue their wealth by manipulating the value of money to suit the whims of the state. Even worse, the whole “fiat money” set-up depends on people maintaining trust – some would say a blind faith – in the system as a whole. That’s because fiat money isn’t actually backed by anything that is material or real.
Previously, people of this mind set would be the archetypical gold bug. The metal is regarded as a store of wealth – just like it was during the years of the gold standard. The mysterious founder, or founders, of cryptocurrency Bitcoin were likely to have a similar attitude. They have created a “currency” that is free from interference from central bankers and other state actors, which they distrust. So are Bitcoin and its ilk the new gold?
Even a cursory look suggests they are not. The Bitcoin price has soared stratospherically this year – into almost certain bubble territory. This indicates that the coin is actually a speculative asset and not a store of value in turbulent times.
The supply of gold is also limited. It has been suggested that if all the gold in the world that had ever been mined were made into a cube, it would have sides of just 20m. Of course there are gold mines currently mining gold, but supply remains a relative trickle.
Cryptocurrency is “mined” too, but this is a digital process. Anyone with knowledge, an internet connection and suitable hardware can participate in mining Bitcoin. The process involves solving an electronic puzzle, the difficulty of which is adjusted to keep the rate of new coin formation constant. If more computer hardware is employed in mining, then the puzzle difficulty will adjust upwards to make mining harder.
This means, like gold, the supply of Bitcoin is limited. Also, rather like the gold industry, the power to mine coins is hugely concentrated amongst a few – those clever enough to know what to do, and also have sufficient computing power. This has similar characteristics to the gold market. However, there are many competing, almost interchangeable, cryptocurrencies – not just Bitcoin. There are 1,343 different types currently available online, according to coinmarketcap.com, which tracks the sector. There are likely to be rival currencies launched on a regular basis and gold is not subject to competition from alternatives.
This presents another issue – perhaps the biggest ones that cryptocurrency bugs will have to solve. The computing power needed to solve the increasingly complex puzzles is utterly astonishing and this takes lots and lots of power – mostly generated from dirty coal and oil. Because of the complexity of the processes involved in mining, it has been estimated that Bitcoin uses more power than Serbia. If this power issue cannot be resolved then the future of cryptocurrencies is highly questionable. Current processes for creating the “coins” – are not really that efficient.
But perhaps the biggest problem with Bitcoin is that it has no intrinsic value. Gold has alternative uses in jewellery and decoration, with some of the metal even fashioned into gold coins. Bitcoin is also electronic, which means it is vulnerable to hacking. Earlier this month almost $64m in Bitcoin was reportedly stolen by hackers who broke into Slovenian-based Bitcoin mining marketplace NiceHash. Also, cryptocurrencies don’t really exist in the real world, so can potentially be destroyed, where gold is regarded as “indestructible”.
So, right now, Bitcoin does not resemble gold at all. Its price is astonishingly volatile, there are competing currencies that mean supply of cryptocurrencies is not really limited in a real sense, and the energy and computing power needed to create the coins is environmentally damaging and costly. No sensible asset manager would use Bitcoin in a multi-asset portfolio.
Regulators and many professional investors are therefore wary. Anyone putting money into Bitcoin has to rely on its blockchain technology and keep their keys safe to access their holding. There are no deposit guarantees and no bank regulations to fall back on if something goes wrong. There is also no lender of last resort. Regulation is almost certain too; as governments get concerned about their tax take diminishing, as ownership is largely anonymous.
Indeed, earlier this week Jay Clayton, chairman of the Securities and Exchange Commission, said: “Just as the SEC has a sharp focus on how US dollar, euro and Japanese yen transactions affect our securities markets, we have the same interests and responsibilities with respect to cryptocurrencies.”
The price has recovered from any sharp falls due to the speculative frenzy. Early adopters are sitting on astonishing profits and this is encouraging more buyers seeking to get rich quick. It looks and feels like a bubble, many recent buyers are likely to see painful losses when the bubble bursts. When the buying frenzy turns into a selling frenzy – as ultimately it will – Bitcoin owners need to hope there are willing buyers on the other side when they want to sell. Stop-loss levels don’t mean a thing if there aren’t any bidders on the other side of the transaction.
It is no coincidence that the cryptocurrency community have called the creation of new coins “mining”. They want purchasers to feel they are similar to the precious metal, as both are outside “the system” so can be a hedge against the actions of politicians, central bankers and state authorities. However, whatever the longer-term future of these immature digital currencies, they are not the new gold. They remain a speculative punt.
Garry White is the chief investment commentator at wealth manager Charles Stanley
Glittering run for Bitcoin, but it is not the new gold