Digital Gold

Gold, Bitcoin, and the need for safe havens

It’s no secret that the current market conditions have left investors with very few places to hide. Global bonds are on course for their biggest drop since 1949 and stock markets and cryptocurrencies have both already erased two years’ worth of gains with more pain potentially ahead as the dollar and inflation continue to move higher.

In such an extreme macro environment gold is commonly looked at as the asset of choice for storing value and it has a 5,000-year track record to back it up. But many have been confused over gold’s performance (down 11% YTD) with inflation running hot, particularly as it is most commonly touted as a hedge against inflation in the financial mainstream. This is because gold has historically also been negatively correlated to real rates (i.e. gold provides no yield so the opportunity cost of holding it rises as yields rise) and inflation alone is not the sole driver.

However, when looking at it in proper context, we can see gold has actually outperformed most major assets so far in 2022, including equities, inflation-linked bonds both in the US and elsewhere, and, in particular, Bitcoin.

Bitcoin is officially dead as a store of value....or is it?

Much of the TradFi commentary this year has declared Bitcoin’s "store of value" or "digital gold" properties as officially cancelled after its 70%+ declines from the 2021 all-time highs this year. However, with Bitcoin’s recent positive correlation with gold moving to its highest level in over a year, the “digital gold” narratives have started flooding back.

But at the end of the day, these characterisations are temperamental and fickle. The reality is that the strengthening dollar has resulted in most major asset classes (gold, crypto, stocks, and bonds) selling off in tandem. This means that the rising gold/Bitcoin correlation has mostly been incidental and as a result of their oscillating around key support zones ($19K for Bitcoin and $1,700 for gold).

Much more important is to understand why we can look at Bitcoin as being a form of ‘digital gold’ in the first place. It is important to understand that when TradFi characterises Bitcoin as digital gold, it is done on the basis of investment alpha, most often priced in US dollars. While it is true that long-term holders have seen huge upside to being able to trade Bitcoin, the problem with this is that it views Bitcoin exclusively through the lens of a speculative asset.

What really makes Bitcoin digital gold

What makes Bitcoin a true store of value is that hardwired into its protocol DNA are elements that ensure its stability of supply over time: Bitcoin is released approximately every ten minutes via block rewards paid to miners. This block reward halves every 210,000 blocks until the amount of Bitcoin in circulation reaches 21 million. This fixed total supply is hard coded into the protocol and cannot be changed.

What’s even more interesting is that these mechanisms are capital-intensive and energy intensive, like gold mining, and, sure enough, it is even modelled after it. Quoting directly from the white paper:

“The steady addition of a constant amount of new coins is analogous to gold miners expending resources to add gold to circulation."

A great example of this is the stock-to-flow ratio metric (new supply divided by existing supply), which is used to quantify the scarcity of commodities. BitcoinStandard adapted stock-to-flow to compare Bitcoin to commodities used for both investment and consumption in order to apply the model to digital assets.

As per the chart, gold, the most traditional store of value through the ages, has the highest stock-to-flow ratio, followed by Bitcoin, then silver (chart courtesy of Fidelity). The fact that Bitcoin's stock-to-flow is second only to gold is not coincidental and reflects the balance of new supply vs. existing supply of Bitcoin's protocol.

Bitcoin is the ultimate digital gold, but as “peer-to-peer electronic cash”

The bottom line is that much of Bitcoin's “store of value” discussions exist mostly as "narratives" within TradFi. This means that it is seen through the lens of a globally traded speculative asset, not the distributed, 'peer-to-peer electronic cash system' it was originally designed to be post the global financial crisis.

But of course, if one remembers that Bitcoin first started trading at $0.0008, it cannot be disputed that Bitcoin has been much more of a multiplier of value than a value store. A true paradigm shift where Bitcoin is both earned and used as the de facto medium of exchange for goods and services between individuals, communities, and countries, is where its true power as digital gold will be realised.