Alexander Le Grys
With growing geopolitical tensions, rising economic risks associated with higher inflationary expectations after a lost decade in the developed economies and many unstable currencies in the developing world, people have increasingly been searching for hedge investments to act as security. This has coincided with the exponential increase in the value and acceptance of cryptocurrencies, particularly bitcoin. As a result, the headlines are probing the idea that cryptocurrencies will replace gold as a financial hedge. Whether we accept cryptocurrencies as a financial product or as a financial hedge, there are serious issues to be addressed. Three notes of caution should be made when considering them as a serious option for a financial hedge which could challenge gold.
The first cautionary note is that cryptocurrencies are more similar to a fiat currency than most believe. Fiat money is any currency a government has declared to be legal tender, but is not backed by a physical commodity (and thus usually holds no intrinsic value). Although cryptocurrencies are not legal tender yet, they are also not backed by any sort of physical commodity. In addition, cryptocurrencies’ supply is artificially constrained. This opens the door to hacking and predatory coin offerings. In contrast, the global supply of gold has a physical constraint and, thus, its value provides more stability.
Secondly, gold is probably the most liquid commodity asset in existence. You can convert it to cash at its spot price on demand, and its value is not bound by national borders. This contrasts with cryptocurrencies, which have yet to achieve mainstream acceptance. Having only taken off in 2016, there is little data for the cryptocurrency market and insufficient evidence backing them to be a sound financial hedge in times of economic turmoil. A further key point is the size of the gold market. The World Gold Council values the cumulative quantity of mined gold at $7.8 trillion. In comparison, the cryptocurrency market stands at only $170 billion, with this value split over 1,170 different cryptocurrencies.
The third and final argument, and a topic of huge debate, is that speculation is driving cryptocurrencies to a value that is completely subjective. In late September, Ray Dalio, founder and manager of Bridgewater Associates, one of the world’s largest hedge funds, called “Bitcoin a highly speculative market,” and that it was “a temporary bubble”. Although gold has been known for volatility in the past, this has usually been in response to hedging, such as in times of recession, whereas cryptocurrencies’ volatility is purely speculative and thus can outweigh the price movements from hedging.
Investing in cryptocurrencies such as bitcoin is currently considered as a leap of faith. Whilst governments are looking to initiate their own cryptocurrencies and companies are looking at potential technological opportunities to revolutionise consumerism, it is equally possible that digital currencies could not develop any real-world value and crash. Much remains unknown about the future of cryptocurrencies, but what can be affirmed at this time is the fallacy that they can replace gold as a financial hedge.