Is Bitcoin Digital Gold?

Overview

I read an article a few days ago by an investor I read quite frequently, Kyle Samani from Multicoin Capital. Kyle gave his interpretation as to why Bitcoin, dubbed “digital gold,” was actually far superior to its physical counterpart.

Bitcoin and Gold Similarities

• People will always value gold even if it’s not that functionally useful. Therefore people can value Bitcoin in the same way, even if it’s not that functionally useful.
• Bitcoin is not government sponsored or backed. There is no central bank dictating gold’s or Bitcoin’s money supply.
• Neither asset can be inflated by politicians. There is a fixed amount of gold in the world and a maximum of 21 million Bitcoins.
• Bitcoin and gold are both fungible.
• Bitcoin and gold act as a hedge against the risk of inflationary fiat currencies.

* Multicoin Capital

Proposed advantages over Gold

• No storage cost.
• Significantly reduced risk of physical theft because it is easier to store securely (plus options like multi-signature support).
• Not subject to capital controls. Try leaving China with $1M of gold.
• Bitcoin is divisible. You can divide Bitcoin into pieces and easily transact with it without ever converting to inflationary fiat.
• No counterparty risk. Your private key is your money. Your custody your money. No matter what happens, no matter how bad things get, you always have access to your money as long as you have access to your private key and access to the internet.

* Multicoin Capital

Although I do agree with Kyle’s assertions in many ways, there are a few parts that I find weak.

1. No storage cost

The majority of owners of Gold nowadays do not take physical delivery of their Gold. Gold investors are far more likely to own a financial product like a mutual fund or exchange traded fund (ETF) than take physical delivery.

Regular households would not incur demonstrable storage costs if they did take physical delivery. Only the extremely wealthy or nationstates would incur substantial storage expense for their Gold. For example, the median household income in the United States is ~ 60,000 per year, which equates to ~ 3 pounds in Gold at current prices.

2. Physical theft

The majority of Gold owners do not take physical delivery of their gold. I would argue digital theft of Bitcoin and physical theft of Gold are equally as likely. In many aspects, digital hacking or stealing someone’s phone or laptop for their private keys is easier than breaking into a safety deposit box at a bank.

In extreme circumstances or crises, preservation of personal safety and Bitcoin would not be equivalent. For example, the circumstantial benefit of Gold or Bitcoin is medium of exchange, i.e. purchasing a plane, bus, or train ticket away from danger. Unfortunately, neither Gold nor Bitcoin can do that readily at the current moment; only fiat.

3. Capital controls

These are very real risks in high inflation countries, but there are ways around capital controls beyond Bitcoin. The argument of “try leaving” China, Argentina, or Venezuela with $1M or ~ 50 pounds in Gold as impossible is not only naive, but also missing one of the key attractions of decentralized currencies for me, i.e. inclusion not just for the wealthy.

Chinese families manage to far exceed the capital control requirements of $50,000 by the Chinese Government, every year. In fairness, Bitcoin does make evading capital controls easier, but the overall premise for the argument is weak if one were to believe Bitcoin was the first way to avoid capital controls in history.

4. Divisibility

This is actually a great point in favor of Bitcoin and demonstrates a unique trait that aids the poor compared to the wealthy; especially in developing economies.

Gold ETFs offer the same benefit and formidable divisibility. As stated prior, the majority of Gold assets owned today are not taken physically. For example, an individual could buy one share of any Gold ETF (Example: GLD) with minimal capital outlay.

5. No counterparty risk

Pure Bitcoin does not possess counterparty risk, but possesses other risks like private key loss and wallet hacking. Private keys do get lost. Wallet hacks do occur, thus the cold storage industry (typically used by the wealthy) exists. Unfortunately, cold storage introduces storage costs and physical theft risk.

Counterparty risk does exist for mainstream Bitcoin. Coinbase, Kraken, and the alike represent counterparty risk to Bitcoin investors who maintain their assets on those platforms. In addition, as popularity and usage grows, unforeseen counterparty risks may arise as well.

Bitcoin replacing Gold

The current market cap of gold reserves in the world is ~ $7T while Bitcoin’s market cap is approaching $100B (at time of writing), which equates to ~ 1.4% of Gold’s. The article mentions an expectation for Bitcoin to largely replace Gold as a fiat hedge because Bitcoin has greater utility. The main assertion being that Bitcoin’s price is driven by supply and demand, thus the price will appreciate over time as investors sell their Gold and buy Bitcoin. I agree that Gold investors will speculate on Bitcoin, thus drive up its price in the short term. However, the long term may be a different story if Bitcoin’s volatility remains and its returns equate to Gold’s.

For example, the price of gold per ounce over the past 100 years, not adjusted for inflation, may provide a good proxy for the expected return of Bitcoin over the long-term given both assets are driven by inflation expectations and speculation.

onlygold.com

As you can see, there are periods of price appreciation and depreciation. Volatility and price appreciation begins after 1971 when Nixon closed the Gold window and the world officially entered the pure fiat age.

Over a 30 year and 100 year period, the non-inflation adjusted, price appreciation of Gold is impressive. However, when you calculate the internal rate of return (IRR) for said price appreciation, you get far less impressive results.

Gold’s 30 year IRR equals 3% and 100 year IRR equals 4%; which essentially equates to the annual inflation rate of fiat currency in the United States of 3% per annum. In fairness, if you purchased Gold before its major bull run beginning in 2000 and still held, your IRR would be 9%, which is far better. However, that would require either dumb luck of getting in at the right time or trading the market with accuracy; both of which are not something that retail investors should ever depend upon.

Summary

Humans are notoriously poor forecasters, but I do believe Bitcoin has the potential to chip away at Gold’s premier inflation hedge status, thus demonstrably appreciate in market value. However, this process will not be linear and may fail to generate attractive IRR returns over the long-term beyond the few pioneers who bought-in at the earliest stages.