The traditional move would be to hedge stock volatility with gold. It has been an effective method in the past, but a new alternative is challenging the good old safe haven. Emerging in 2009, bitcoin ushered in a new era of digital currencies. As the leading cryptocurrency, bitcoin has many of the properties of a currency, but it also has some unique features that can make it a safe haven. Ultimately, however, it is up to the individual investor to determine if bitcoin is a suitable safe haven in times of market turmoil.
Below we will compare gold and bitcoin as safe haven options.
Getting Gold
There are several factors that make gold a safe haven asset. It is valuable as a material for consumer goods such as jewelry and electronics, and it is scarce. Despite demand, supply remains disproportionately low. Gold cannot be produced the way a company issues new stock or a federal bank prints money. It has to be dug out of the ground and recycled.
Consequently, gold has little correlation with assets such as currencies or stock indexes such as the S&P 500. The precious metal was tied to the dollar until 1971, when President Nixon severed the link between the U.S. currency and gold as a base. Since then, those who don’t want to take full advantage of stock market fluctuations have invested in gold. The precious metal helps soften the blow or even lock in profits when the stock market corrects or falls by at least 10 percent.
Gold tends to do well during corrections because even though it is not necessarily rising, an asset that remains static while others are falling is quite useful as a hedge. Moreover, as more and more people run away from stocks and invest in gold, the price rises accordingly.
Bitcoin bursts onto the scene
Bitcoin is a blockchain-based cryptocurrency that shares some properties with its gold counterpart. In fact, many in the past have referred to bitcoin as “digital gold” because of its weak link to all other assets – especially stocks. Market participants remember that in 2017, the price of bitcoin exceeded the value of a troy ounce of gold for the first time.1 In January 2020, bitcoin surpassed $8,700, but why is it so valuable? “2 Moreover, should those fleeing stocks consider investing in cryptocurrency?
Like gold, bitcoin exists in limited quantities. Satoshi Nakamoto, the pseudonymous creator of bitcoin, has limited the total supply to 21 million tokens. Bitcoin is also similar to gold in that it is not issued by a central bank or the federal government. As a decentralized cryptocurrency, bitcoin is generated by the collective computing power of “miners”-individuals and groups of people who work to verify transactions occurring on the bitcoin network and are then rewarded for their time, computing power and effort in the form of bitcoins. To keep the market from getting crowded, the bitcoin protocol stipulates that these rewards are periodically halved, ensuring that the last bitcoin will not be released until 2140.
A comparison of the two
For hundreds of years, gold has dominated the field of safe-haven assets, while bitcoin emerged just over a decade ago and has only become widely accepted in recent years. Below we will compare these two investment options face to face:
1. transparency, security and legality.
The current system of trading, weighing and tracking gold is flawless. It is very difficult to steal, pass off as fake gold, or tamper with the metal in any way. Bitcoin is also difficult to corrupt because of its encrypted, decentralized system and sophisticated algorithms, but the infrastructure to secure it is not yet in place. The Mt. Gox disaster is a good example of why bitcoin traders should be careful. As a result of this devastating event, the popular exchange went offline and users’ bitcoins disappeared to the tune of $460 million. Years later, the legal ramifications of the Mt. Gox situation are still being sorted out.3 From a legal perspective, the implications of this behavior are small, as bitcoin remains difficult to trace with any degree of efficiency.
2. Rarity
Both gold and bitcoin are scarce resources. The halving of the bitcoin mining bounty guarantees that all 21 million bitcoin will be out of circulation by the year 2140. While we know that only 21 million bitcoin exist, it is unknown when all the world’s gold will be mined out of the ground. There is also speculation that gold can be mined from asteroids, and there are even some companies looking to do so in the future.
3. Reference value
Gold has historically been used in many applications, from luxury items such as jewelry to specialized applications in dentistry, electronics and more. In addition to ushering in a new approach to blockchain technology, bitcoin itself also has a huge baseline value. Billions of people around the world lack access to banking infrastructure and traditional means of financing such as credit. With bitcoin, these people can send value around the world at virtually no cost. Bitcoin’s true potential as a banking medium for those without access to traditional banks may not yet be fully realized.
4. Liquidity
Both gold and bitcoin have very liquid markets where fiat money can be exchanged for them.
5. Volatility
One of the main concerns of investors looking for a safe haven asset in bitcoin is its volatility. One only has to look at the history of the bitcoin price over the last two years to see this. At its peak around the beginning of 2018, bitcoin reached a price of about $20,000 per coin. About a year later, the price of a bitcoin hovered around $4,000. Since then, it has recovered a portion of those losses, but is nowhere near its one-time peak price point.
In addition to general volatility, bitcoin has historically proven to be subject to the vagaries and news of the market. Especially when the cryptocurrency boom dragged a number of digital currencies to record prices in late 2017, news from the digital currency sphere could cause investors to make quick decisions, sending the price of bitcoin up or down quickly. This volatility is not inherent in gold for the reasons mentioned above, making it perhaps a safer asset.
In recent years, several alternative cryptocurrencies have been launched that purport to offer more stability than bitcoin. Tether, for example, is one of these so-called stablecoins. Tether is pegged to the U.S. dollar in much the same way that gold was before the 1970s. Investors looking for less volatility than bitcoin may want to look elsewhere in the digital currency space for safe havens.