Cryptocurrency Vs Yellow Metal: Bitcoin no substitute for gold, it’s highly volatile, warns gold body

January 25, 2018

Mumbai-India (Jan 25)  Close on the heels of some Indian banks closing the accounts of some cryptocurrency exchanges and the Reserve Bank of India (RBI) asking banks to scrutinise the dealings of companies and exchanges involved in digital currencies, a global gold body has warned against the high volatility and big-return expectations in Bitcoins and said cryptocurrencies are no substitute for gold as the latter is a “tried and tested effective investment tool in portfolios”.

Bitcoin, the most widely recognised cryptocurrency, has had rapid price growth over the past few years — increasing 13-fold in 2017 alone. “Its price has also been extremely volatile — some 10 times that of the dollar denominated gold price. “Bitcoin’s high volatility was evidenced by the sharp price correction it has experienced since mid-December 2017, falling by more than 40 per cent in a month,” the World Gold Council (WGC) has said.

“Its price behaviour at this point, while still attractive to many investors, seems to be driven by high return expectations,” WGC said amid reports that gold prices and demand are suffering at the expense of cryptocurrencies. While gold’s performance was a solid 13 per cent, it was a fraction of the 13-fold increase of bitcoin by the end of the year. Some commentators went as far as to claim cryptocurrencies could replace gold and may become an established part of the financial system.

Bitcoin moves, on average, 5 per cent each day, a level that is nearly as high as the realised volatility of the VIX itself. While this is good for investors looking for extremely high investment returns, it is hardly a characteristic of a currency, let alone a store of value, potentially limiting bitcoin’s use as a transaction token, WGC said.

According to WGC, bitcoin and cryptocurrencies more generally are not a substitute for gold. “Gold is a tried and tested effective investment tool in portfolios. It has been a source of returns rivalling that of the stock market over various time horizons. It has performed well during periods of inflation. It has been a highly liquid, established market. And it has acted as an important portfolio diversifier, exemplifying negative correlation to the market during downturns,” WGC said.

Cautioning investors even as Bitcoins staged “remarkable” performance in 2017, WGC said, “but its purpose as an investment seems quite different from gold. Cryptocurrencies have yet to be tested in multiple markets. Since bitcoin’s inception, the stock market has been in an incredibly low volatility, trending, bull market, with very few pullbacks. The crypto-market is young, and liquidity is scarce. Its price behaviour at this point, while still attractive to many investors, seems to be driven by high return expectations.”

Defending cryptocurrencies, Ajeet Khurana, Head, Blockchain and Cryptocurrency Committee (BACC) said, “the recent knee-jerk actions by few banks in terms of closing bank accounts of some cryptocurrency exchanges has led to hardship to these citizens. It also created obstacles for exchanges in being able to carry out business. In the past, RBI has issued warnings and consumer education statements about cryptocurrencies. BACC welcomes RBI’s actions and regard them as measured and well-thought out.”

The move by banks and the RBI has come at a time when many Indian companies are reportedly planning initial coin offerings (ICO), an unregulated means by which funds are raised for a new cryptocurrency venture.

“It is our understanding that RBI has not asked banks to close accounts of any cryptocurrency exchanges. We invite banks to follow in the footsteps of the RBI, understand this emerging sector, recognise the harmful effects of their knee-jerk reactions, and only then decide their course of action. We will use advocacy, outreach, best practices and standards, and customer education to drive robust and healthy growth of this sector. Given our strength in the information technology and financial services, I have no doubt that India can take a leadership position in transforming money and financial institutions,” Khurana said.

Cryptocurrencies do not have a clear two-way market. “Their volume is driven by buy-and-hold investors, but, so far, they lack the characteristics common to most liquid markets with the ability to short large quantities. In addition, anecdotal evidence suggests there are high transaction costs for selling positions — both in monetary terms and in the time it takes for the transaction to settle. Despite the current size of the cryptocurrency market, which has been estimated to be valued at over $ 800 bn, volumes are very low compared to gold and other currencies,” WGC said.

Bitcoin trades $ 2 bn on average a day, which is roughly equivalent to the world daily trading volume of gold-backed exchange-traded funds (ETFs). This volume, however, is less than one per cent of the total gold market that trades approximately $ 250 bn a day.

The sources of demand for gold are very different from cryptocurrencies. “Gold has a 7,000-year history as an asset and a long-standing role as money. It is owned by central banks, as well as institutional and retail investors. Yet, it also has a large and diverse attraction as jewellery, which remains the largest source of demand — typically representing between 50 per cent and 60 per cent of annual demand over the past 20 years. Large parts of gold’s demand are deeply embedded within cultural and religious beliefs, especially in India and China,” WGC said.

Gold is a tangible good, with real technical applications. Gold is even used in the computer chips that ‘mine’ bitcoin. In contrast, bitcoin and other cryptocurrencies are designed to be used as tokens in electronic payment systems. These may have potentially useful characteristics. “For now, however, the opportunities to spend bitcoin are rather limited, and genuine transactions are quickly converted into fiat currencies due to bitcoin’s price volatility,” it said.

At a high level, there are some similarities between the supply profile of gold and cryptocurrencies. “The stock of bitcoins, for example, increases in number at a rate of approximately 4 per cent per annum, and is engineered to slowly decline to zero growth around the year 2140. While gold can be mined without a date limit, its production rate has been quite small and steady. Approximately 3,200 tonnes of gold have been mined on average, each year, adding about 1.7 per cent to the total stock of gold ever mined,” WGC said.

“The many cryptocurrency alternatives beg the question of whether a newer, better blockchain-based coin application may be equivalent to increasing supply, not unlike fiat currency,” WGC said.

Despite anecdotal comments from well-regarded financial commentators that gold prices and gold demand are suffering at the expense of cryptocurrencies, there isn’t any quantifiable evidence that gold holdings are directly suffering from competition from cryptocurrencies, WGC said. The weakness in physical demand in 2017 — for example, the paltry sales of US Eagles — is largely explained by the steady march higher of the S&P 500.


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