Can bitcoin overtake gold as a store of value?

While gold and bitcoin are far apart in terms of how long they’ve been treated as asset classes in the global financial system, both meet several criteria required to be considered as stores of value: scarcity, divisibility, portability and durability. In some circles, bitcoin is even referred to as ‘digital gold’- and not just by the Web3 community.

The purpose of this article is to delve into this comparison, exploring the similarities and differences to understand whether bitcoin could ultimately replace gold as the ultimate store of value and, equally importantly, the implications for its price.

Since King Croesus of Lydia (now part of Turkey) minted the first gold coins in 550 BC, gold has played an integral role in the global financial system. Even after getting replaced with paper money, many countries fixed their currency’s value to a specific amount of gold, and the gold standard remained in use until the early 1970s.

Gold has several characteristics which helped to establish it as a reliable store of value (meaning it holds its value over time):

• Scarcity: There’s a limited supply of gold. Nevertheless, according to the US Geological Survey, 30% remains in the ground.

• Divisible: Gold bars can be split into smaller pieces and used as a medium of exchange, although this process generally requires specialist equipment. However, it's important to note the physical limitations and inherent complexity associated with achieving very minute divisions of gold, often accompanied by significant costs.

• Portable: With one kilo of gold worth $62,214 (as of September 19th 2023), gold offers an established means to transport wealth. Again, obvious physical limitations still apply, especially for large amounts.

• Durable: Gold doesn’t degrade over time- one of the world’s oldest artefacts dates back to around 4,500 BC.

Bitcoin, in contrast, is a relatively new asset class. Satoshi Nakamoto, the pseudonymous founder, proposed the idea of a peer-to-peer electronic cash system in a whitepaper published in 2008. The first transaction took place at the start of the following year between Nakamoto and Hal Finney, a contributor to the project, and by October 2009 an early crypto exchange called New Liberty Standard had established an exchange rate against the dollar (at the time, $1 was worth 2,300 BTC).

While bitcoin may not share gold’s longevity, it shares some of the characteristics that make it a store of value, which is how it earned the moniker of digital gold.

Bitcoin is scarce because Satoshi capped its supply at 21 million. 19.49 million as of September 19th 2023] million are already in circulation, but the remaining 1.6 million will take around 120 years to be issued because the rewards for mining- the process of verifying transactions by solving mathematical puzzles- halve every four years.

Bitcoin is also durable. As long as the blockchain recording its transactions exists, so does bitcoin. The blockchain’s uptime- a measure of reliability expressed as a percentage of the time a system has been operational- is 99.98%, and it hasn’t experienced an outage in 3844 days (as of September 19th 2023).

A key benefit of blockchain technology is the immutability of its records. Once a block of transactions has been approved, it’s nearly impossible to alter. That would require control of a majority of the network’s mining power- known as a 51% attack- costing an estimated $1,165,892 million an hour (as of September 19th 2023).

And finally, bitcoin is portable and divisible. It can be stored in a hot wallet (connected to the internet) or a cold wallet (offline hardware device), and transactions are largely frictionless. Its smallest denomination- a Satoshi- is equivalent to 100 millionth of a bitcoin.

Sources: USGS.gov, buybitcoinworldwide.com

Market capitalisation is a common metric used in the investment industry to measure the value of an asset available on the open market. It’s typically applied to a company, calculated by multiplying the total number of outstanding shares by the price of a single share, but the concept can be applied to commodities and digital assets.

Predictably, gold’s market cap is much bigger than bitcoin. As shown in the chart below, which calculates a monthly valuation, the total value of above-ground gold is $12.905 trillion, compared with $529.5 billion worth of bitcoin in circulation (as of September 19th 2023).

Source: In Gold We Trust

While this chart highlights the significant gap between the two market caps, it also emphasises the scale of the opportunity for bitcoin.

Bitcoin doesn’t just share many of the characteristics of gold, it arguably serves as a more efficient and effective store of value based on the analysis above. The gap in valuations could easily close if bitcoin gains traction, which seems imminent thanks to regulatory clarity, like the EU’s Markets in Cryptoassets regulation, and adoption by institutional investors who will benefit from greater accessibility through exchange-traded products (ETPs).

Goldman Sachs, one of the biggest players in mainstream finance, supports this thesis. As reported by Reuters, analyst Zach Pandl published a research note at the start of 2022 predicting that bitcoin would erode gold’s share of the ‘store of value’ market as it becomes more broadly adopted.

"Bitcoin may have applications beyond simply a "store of value" - and digital asset markets are much bigger than bitcoin - but we think that comparing its market capitalisation to gold can help put parameters on plausible outcomes for bitcoin returns."

Pandl also outlined the implications for the price of bitcoin: he calculated that accounting for 50% of the ‘store of value’ market would lift it to $100,000 (from $46,000 at the time).

Before analysing volatility and correlation, let’s briefly explore the factors driving the price of these two assets, starting with gold.

• Uncertainty: gold rises during periods of political or economic uncertainty because investors consider it a safe haven.

• Inflation: gold has traditionally been considered a hedge against inflation.

• Interest rates: gold tends to drop when rates rise because interest-bearing securities become more attractive.

• Market forces: demand for gold rises at certain times of the year, such as during the Indian festival of Diwali in October.

• Central banks: Central banks hold around 20% of above-ground gold, so the price can fluctuate when they trade.

In comparison, while investors also turn to bitcoin during economic and geopolitical uncertainty, as a relatively new technology its price is affected by a different set of criteria:

• Adoption- the growing network effects of bitcoin push up its price, particularly demand from institutional investors.

• Market forces- the supply of new bitcoins slows as mining gets more difficult, increasing its scarcity.

• Regulation- supportive regulations encourage adoption, although stricter regulations have the opposite effect.

• Tech developments- improvements to the scalability (such as transactions per minute) and security of bitcoin boost credibility and consequently drive demand.

One of the main arguments against using bitcoin as a store of value is its volatility. After all, investors hold gold because it retains its value over time.

Bitcoin has experienced its fair share of price swings, most recently dropping by 64% in 2022. Research by Bloomberg shows bitcoin’s intraday price changing by an average of nearly 5% between 2018 and 2021, compared to 1.6% for gold.

However, gold isn’t immune to volatility. For instance, the gold volatility rose to 90% in the early 1980's, following the hyperinflationary period of the late 1970s.

Furthermore, bitcoin’s volatility should ease as it matures as an asset class. This effect is starting to materialise as institutional investors get involved and the crypto derivatives market develops.

With gold and bitcoin both serving as stores of value and subject to some overlapping driving forces, are their prices correlated?

Not necessarily. The graph below shows the correlation between the two asset classes, measured over rolling periods of 60 days. It has bounced around a lot, displaying near-perfect positive and negative correlation at different stages over the last four years (one= positive correlation, minus one= negative correlation and zero= no correlation). This suggests bitcoin and gold can be held in the same portfolio.

Source: CoinJournal

In summary, while bitcoin has some catching up to do in terms of market capitalisation, it has the potential to eventually fulfill its promise as ‘digital gold’. In fact, in several respects, its design suggests it could serve as a superior store of value.

The difference in market cap also has implications for the price of bitcoin. The greater the adoption it experiences as a store of value, the higher its price will rise.

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