Everything you need to know about the two top choices for hedging against fiat currency, and how to take advantage of the forces driving this legendary battle.
Gold and Bitcoin
Some say the rise of cryptocurrency challenges the time-tested yellow metal as the top choice for hedging against fiat currency. The “gold vs. Bitcoin” debate, though entertaining, distracts from the bigger questions we should be asking: Why do we need alternative currencies? How does crypto bring light to the structural issues plaguing the world’s monetary system? How do I protect my wealth?
Key Takeaways:
- Bitcoin is in the spotlight for good reason. A 100,000% return in a single decade is unprecedented.
- Gold has stood the 5,000-year test; cryptocurrencies have stood the 10-year test. For that reason, cryptos are still extremely speculative.
- Bitcoin rivals some of gold’s revered characteristics, such as scarcity and decentralization. Unlike gold, Bitcoin supports instant transactions across space.
- Gold stands above Bitcoin in terms of intrinsic value, wealth preservation, industrial application, and performance during market downturns.
Carthage vs. Rome; Bitcoin vs. Gold
In 218 BC, Hannibal of Carthage marched his army of men, cavalry, and war elephants through the Alps to attack Rome on its own soil, launching one of the greatest military feats in history and laying the groundwork for an equally great “underdog” allegory for challenging the incumbent.
If cryptocurrency is the Carthage of our modern financial world, gold is the Roman Empire. Cryptocurrency is marching across the treacherous financial system in a daring campaign to take its place as the authority of money. Bitcoin owns none of the elephants but all of the risk, and will likely suffer massive losses before the attack on gold can even begin. The question is, which asset will prevail?
The case for Bitcoin is clear. The technology is revolutionary. Bitcoin’s adoption rate has steadily increased since its inception, thus de-risking the mysterious asset. It is hard to ignore Bitcoin’s mind-boggling returns. Everyone is kicking themselves for not investing when Bitcoin first started making headlines. Although, that’s like kicking yourself for not buying the winning lottery ticket.
The hype surrounding crypto has pressured individuals to frantically buy into a technology they do not understand at extremely high valuations. This kind of speculative behavior has made some people very rich, but has also destroyed the wealth of those unlucky enough to catch the top of the market. Volatility is volatility. It is difficult to rewrite the rules of finance.
People should be wary of idolizing the underdog, lest we forget that Rome won the Punic Wars, forcing the Carthaginians out of Europe and establishing ultimate sovereignty over the Mediterranean for another 500 years. Pitting Bitcoin against gold makes for an exciting topic of conversation, though it misses the point. We cannot let the battle between alternative currencies distract from the common enemy – the underlying forces that will continue to push both assets into the spotlight over the next few years.
Why should we care about alternative currencies?
Modern economies function on a fiat currency system. Fiat currencies have no intrinsic value, instead deriving their worth exclusively from a government promise. Without any physical backing, governments have the freedom to print their currency to their hearts’ content.
Governments employ central banks to control the money supply and interest rates. As you can imagine, controlling the most important aspect of an economy, money, is an impossible task – which is why central banks have such a terrible track record. The U.S. dollar has lost 98% of its purchasing power since the creation of the Federal Reserve in 1913.
History is full of reasons to hedge against fiat currency. Of the hundreds of fiat currencies that have existed throughout history, few have survived longer than 100 years. Most have failed due to hyperinflation, war, or monetary mismanagement by the government.
Is the U.S. dollar any different?
From a fundamental standpoint, no. When Nixon removed the United States from the gold standard in 1971, the Dollar lost all remnants of scarcity. Scarcity is what makes something valuable – that is the entire purpose of money. When the government has complete control over the money supply, they tend to crank the money printers to 11, devaluing their own currency to pay off debts or inject credit into the economy.
Ballooning budget deficits, ultra-low interest rates, and free money hace characterized the global economy since 2008. These factors have contributed to unprecedented growth in the stock market and other risky asset classes. Unfortunately, interest rates can only go so low, debt can only go so high, and money printers can only run so fast. We have seen this pattern time and time again throughout history, and the common citizen always loses in the end.
Investors are aware of this problem, which is exactly why gold and cryptos are heating up. Everyone knows the current monetary system is wrought with structural instability. Investors want to reclaim control and pave the future of money.
A Deeper Look into Gold
Nearly every developed culture throughout history has used gold as a source of monetary exchange or a symbol of prosperity. Humans have been recovering gold from riverbanks, veins, and ore deposits on every continent (except Antarctica) for thousands of years. Humans ascribe value to the yellow metal for several reasons:
- Durability – gold does not corrode or tarnish, and cannot be destroyed
- Malleability – gold can be molded and shaped for industrial, monetary, and symbolic applications
- Aesthetics – gold perpetually holds its brilliance, shine, and natural beauty
Modern investors are interested in gold’s unique characteristics as a portfolio diversifier and storage of wealth. Portfolios with a gold allocation have historically provided higher returns with less drawdown and lower risk.
Gold provides a strategic role in any portfolio by hedging against the market. The metal is inversely correlated with equities, meaning it tends to perform well when the stock market is dropping. Gold also tends to perform well during periods of high inflation.
A Deeper Look into Bitcoin
Bitcoin started making headlines in 2009 when an anonymous person (or group of people) named Satoshi Nakamoto launched a new system of digital currency. Here are some key terms in the cryptocurrency universe:
- Decentralized: Bitcoin has no central authority. The vast network of Bitcoin investors, users, and miners collectively control the supply and value of the currency.
- Blockchain: All Bitcoin transactions are recorded on a distributed ledger called a blockchain. The blockchain allows two parties to agree on a transaction and record it in an ever-expanding chain of chronological data points. The chain, separated by individual “blocks” of information, records every Bitcoin transaction. These transactions cannot be changed or edited. The distributed ledger is open source (publicly available), so anyone can investigate the code for themselves at any time. For this reason, Bitcoin transactions are not necessarily anonymous, although it is extremely difficult to link a certain line of code to a specific person.
- Peer-to-peer: Usually an intermediary, such as a bank, must oversee financial transactions. The blockchain removes the need for such intermediaries and allows for true peer-to-peer exchanges.
- Mining: Bitcoin miners are compensated in Bitcoin to record transactions on the blockchain. Anyone can become a Bitcoin miner, although many miners organize into “mining pools” to maximize computing power. This process is intentionally difficult and time-consuming.
Bitcoin was not the first digital cash technology, and is far from the last. Tens of thousands of cryptocurrencies currently exist, although Bitcoin is the clear leader in terms of market capitalization and trading volume.
Comparing the Currencies
Gold and Bitcoin are both positioned to deliver superior returns, liquidity, and protection against fiat currencies. They both allow investors to “exit the system,” with an asset that the banks and government can’t touch. However, the assets differ in major ways.
Security:
- Gold: Investors have many options for securing their assets, which introduce certain risks and rewards in terms of security. They can store their gold in a depository or bank, a personal safe, or under their mattress. Gold bugs have an important safety net when it comes to security: if the world ends, their gold will still be there.
- Bitcoin: Bitcoin has proven itself as one of the most secure cryptocurrencies. However, no technology is infallible. The crypto universe is notorious for fraudulent activity. If investors want complete protection against theft or loss, they must set up a cold wallet, which is disconnected from the internet. Just don’t forget your password!
Liquidity:
- Gold: When you want to sell your gold, there is always a buyer. Gold is one of the most frequently traded assets in the world, providing a very high level of liquidity and supporting the price. Of course, selling your gold can be difficult if you store it under your mattress.
- Bitcoin: Bitcoin is also a very liquid asset. The currency has a healthy population of buyers and sellers all over the world.
Longevity:
- Gold: A 5,000-year history of stable purchasing power proves that gold cannot be replaced by another metal. No other element shares gold’s unique characteristics. Even other monetary metals, such as silver, platinum, and palladium, serve very different industrial and investment purposes.
- Bitcoin: Bitcoin has been around long enough to prove the system works. However, Bitcoin investors must bank on the fact that Bitcoin will remain the top crypto. Technology never stops improving. Bitcoin does have a first-mover advantage and a huge population of loyal holders, but a competitor could theoretically replace Bitcoin.
Volatility:
- Gold: Gold is revered for its low volatility. In fact, some economists argue that all prices should be measured against gold because gold is the most fundamental source of monetary value. The price can still rapidly rise and fall based on market demand, but over the long term, gold is a stable store of wealth.
- Bitcoin: High volatility is a hallmark of Bitcoin: high risk, high reward. Some investors love high-risk assets. Bitcoin probably has much greater upside potential than gold, which comes with much greater downside potential.
We could dive into other aspects of a healthy currency, such as fungibility, divisibility, portability, and supply limitations. Both assets qualify for all these characteristics.
Investors need to know that gold and Bitcoin serve very different strategic roles in a portfolio. Gold is a hedge. Investors turn to the safe haven when things look unstable. Bitcoin, on the other hand, behaves like a risk asset, generating massive returns when the economy is doing well and crashing when the economy struggles. For this reason, Bitcoin tends to be correlated with the stock market.
Strengthened by the past, prepared for the future
Perhaps the battle between Bitcoin and gold will help investors move past the conception of price as an objective measure of value. Too often, investors exclusively analyze asset prices, ignoring important measures of value such as exchange rate and ratios between assets.
Price is simply comparing an asset to the value of a fiat currency, which limits our ability to understand how a particular asset is performing in the grand scheme of things. Fiat currencies are a poor benchmark for measuring value, and the sooner we move past them toward a more democratized monetary future, the better.
Diversify your exposure against fiat currency. Gold and cryptocurrencies will both play a vital role in protecting the financial future of those daring enough to invest in a new monetary system – one strengthened by the past and prepared for the future.
