Why bitcoin could be the new gold


Could bitcoin be the next gold?

The idea has a great deal of intuitive appeal. Gold bugs and bitcoin fetishists are inclined to share a profound distrust of fiat money and the nation-state, an impregnable bullishness about their favoured asset class and an obsessive attention to details of market moves along with a blithe disinterest in bigger-picture difficulties.

The idea has become especially popular as the value invested in bitcoin and other cryptocurrencies has marched up over the last year. Even following this week’s sell-off, motivated by China announcing initial coin offerings prohibited, the value of cryptocurrencies in flow is around $155-billion (U.S.), based on Coinmarketcap.com.

That may sound small in contrast to the {}7.8-trillion notional value of the planet’s 187,200 tonnes of gold. At exactly the exact same time, it is already about a tenth the value of the 40,000 tons of yellow metal used for investment as bullion bars and coins, and has resisted the amount stored in gold exchange-traded funds. At more than $78-billion, Bitcoin alone is not far from overtaking the $90-billion-odd spent in most gold ETFs.

There are two chief reasons to doubt bitcoin’s viability as an investment. One is an engineering issue: Its creaky infrastructure is very likely to be a turn-off for all but the hobbyist fringe. Another is more philosophical: Digital monies don’t have any fundamental value, so don’t have any place in a portfolio.

Both objections are poorer than you may think.

Take infrastructure. It is certainly true that bitcoin’s operations are surprisingly clunky. Just confirming one transaction typically takes over an hour or more — it briefly took over a day at one point a month, based on applications company Blockchain.info.

With that said, financial markets are usually constructed on similar Rube Goldberg foundations. It’s comically tricky for ordinary investors to purchase a genuine barrel of crude oil. The economist John Maynard Keynes, based on a possibly apocryphal story, after quantified up the storage capacity of the chapel of King’s College, Cambridge after coming dangerously close to needing to take delivery of a month’s worth of Britain’s wheat supply. Completing transactions in the real world is often so clunky that some banks are already researching using, um, blockchains instead.

What makes markets investable for the most part isn’t their physical foundations, but the superstructure of derivatives contracts, exchanges and clearing houses built on top.

Up to now, the area of bitcoin exchanges has been the Wild West. When Mt. Gox filed for bankruptcy in 2014, it stated it had dropped 850,000 coins worth more than $450-million. Another $70-million-odd was stolen in a hack of Bitfinex this past year. The likes of Deribit and Bitmex have been supplying bitcoin futures and options for a while, but important institutional investors are just likely to participate if they believe the clearing and settlement procedure is rock-solid and the trade itself faithfully solvent.

Change on this front is imminent. The Chicago Board Options Exchange is planning to begin offering cash-settled bitcoin futures next April, CNBC reported last week. Trading platform LedgerX LLC last month won regulatory approval from the U.S. Commodity Futures Trading Commission to act as a clearing house for derivatives settled in electronic currencies. The ability to brief or take leveraged positions in electronic currencies could open them to a much wider variety of investors.

What, however, is the worth of a digital money?

It is a fair question, but one which could equally be levelled at gold. Since Richard Nixon ended the fixed $35-an-ounce convertibility of gold in 1971, its value has risen at times (the 1970s, the 2000s) and dropped at others. The best argument to warrant investing in gold nowadays isn’t that it is an eternal “store of value” but its quite weirdness makes it special: According to modern portfolio theory, you should purchase the shiny stuff not because of its superior investment returns, but since it does not correlate much to other asset classes such as stocks, bonds and commodities.

But while gold did exhibit negative or weak correlations to yields on the Samp;P 500 for much of the 1980s and early 1990s, it has been positively correlated for prolonged periods since then. Throughout gold 2012 run-up, both proceeded more or less in tandem. If gold warrants investment dollars because its inconsistent correlation with stocks helps diversify portfolios, the identical argument can be made for bitcoin, also.

Digital currencies might be as vulgar as the first barbarous relic, but neither is going away any time soon. If this makes investors in both seem less like seers and more like problem gamblers gambling on where a fly will land — well, welcome to financial markets.

Courtesy: The Globe And Mail

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