Could Bitcoin Replace Gold?

Could Bitcoin really become the next safe haven alternative to gold or is it just another risky asset for speculative investors to chase large profits?

As the world turns more digital and millennials increase their preference for crypto currency over gold, many people believe it will replace gold's store of value role for investors.

What is Bitcoin?

You have probably heard about Bitcoin and cryptocurrency in the news but may not fully understand what they are. A cryptocurrency is a digital or virtual currency, and like any other currency it acts as a medium of exchange.

Cryptocurrency uses cryptography (a method of protecting information and communications through the use of codes) in order to verify and secure transactions as well as to control the creation of new cryptocurrencies. Bitcoin is one of many cryptocurrencies but is by far the most popular and valuable. It was invented in 2008 and can be used instead of money today to buy and sell things.

Bitcoin saw its value rise from around £200 in 2015 to nearly £15,000 just two years later in 2017. Since then it has been fluctuating between £5,000 and £8,000, but after the pandemic lows in March it has increased by 200% and is currently around £12,000, at the time of writing. With the currency reaching its highest value since the heights of 2017, what is behind this recent growth and will it continue?

Reasons behind the recent rally

There are two main factors for Bitcoin’s recent growth. Firstly, the practical side of Bitcoin as an actual form of payment is becoming more and more prominent.

PayPal recently announced that from next year U.S. customers will be able to buy, sell and hold Bitcoin in their account and use it as a form of payment instead of having to go through other sites like Coinbase. This will make Bitcoin much more accessible to the average person.

The other reason for its recent growth is the current turmoil in the economy. Governments across the world have been pumping money into economies in order to stimulate growth during Covid-19.

In March, the US government injected $2.2 trillion into the US economy, this had great benefits for the economy, however this inevitably led to inflation and the devaluation of the U.S. dollar. Therefore, many American investors and companies turned to Bitcoin and gold in order to hedge their risk against the dollar.

Will this growth continue?

For the rest of 2020 I think it is highly likely that the value of Bitcoin will continue to rise. This is because many experts like Ed Cooper (head of cryptocurrencies at Revolut bank) believe that a lot of the interest in Bitcoin is driven by gamblers and speculators.

Ed Cooper stated that ‘as retail investors see the price rising, they tend to become more bullish and this further increases upward price pressure. This then leads to more news stories, more interest, and so the cycle repeats.' I can only see this cycle continuing for the rest of 2020.

Many experts also believe that the long-term prospects of Bitcoin are very promising. Bullish investors of Bitcoin believe it will reach $20,000 by the end of 2020 and could even go up to as much as $400,000 in the future. The current price of Bitcoin is seen as overvalued by many investors, but its long terms prospects give reason for great upside potential in the future.

Bitcoin’s volatility cannot be ignored compared to gold. With Bitcoin becoming more and more correlated with the market, particularly the S&P 500, its hard to title it a safe haven like gold but should instead be viewed more as a risky asset. That is not to say it cannot compete with gold as a great store of value for long term investors, but its short-term volatility is something that should make investors cautious.

What makes Bitcoin a good store of value?

Bitcoin, like gold, has a fixed supply, there is only so much gold in the world that can be mined, and this is the same for Bitcoin. There is, and always will be, only 21 million Bitcoins available to be mined, this is the same as gold where although some has not been mined yet, there is only a finite amount left.

As of 2020, 18.5 million of these Bitcoins have been successfully mined, with only 2.5 million left. Therefore, if demand keeps rising, but the supply stays the same, there is only one way the price can go, and for this reason many investors like it as a store of value similar to gold.

However unlike gold, cryptocurrencies have the risk of online security and as the value of Bitcoin continues to rise this will only make it a more and more attractive target for hackers. The security systems for cryptocurrencies like Bitcoin are very strong and virtually un-hackable, but millions of cryptocurrencies have been stolen before and so this is always a risk.

Will Bitcoin replace Gold?

As you can see gold and Bitcoin have more similarities than one may initially think, and it is for this reason that many people see Bitcoin overtaking gold as the standard store of value for investors.

JP Morgan’s Global quantitative derivatives strategy team see Bitcoin’s role as a gold competitor being amplified by millennial interest in cryptocurrency. Retail investors are split down the middle by generation over their preference for Bitcoin or gold.

A recent survey found that of millennials born between 1981 and 1996 and with £25,000 or more, 20% of them have invested in Bitcoin, with the national average being just 3%. As time goes on and millennials get older, the older generations who prefer gold will get squeezed out. As a result, Bitcoin's popularity will only increase, and we will continue to see more and more people choose Bitcoin over gold for long term hedges against inflation.

However, there are also many people who believe that gold will never be replaced by Bitcoin. A main reason for this is that gold has numerous applications, unlike Bitcoin which is simply another form of currency. Gold is used in jewellery, electronics, and dentistry to just name a few uses and because of this it will always be in demand.

Another factor is that gold does not need electricity to be traded. If, for whatever reason, there was no access to electricity, cryptocurrencies would be utterly worthless, whereas gold would hold its value, and continue to be used like it always has been.

Furthermore, the stability of gold compared to Bitcoin's volatility is very attractive to risk averse investors and will continue to be in the future.

Closing remarks

Gold is not going anywhere anytime soon, and I think the resurgence of Bitcoin will simply see it become a new store of value for investors alongside gold, but not replacing it.

The market capitalisation of gold is around $9 trillion, and Bitcoin’s is just $227 billion. If Bitcoin does compete with gold for its store of value role this comparison shows the room that Bitcoin has to grow. Some Bitcoin advocates believe that Bitcoin’s market capitalisation could even surpass gold’s, which really highlights the future potential of Bitcoin.

It will be interesting to see what new heights Bitcoin can get to, and also how practical its use will become in the future.