Will Bitcoin Displace Gold?

August 17 2017

Will gold and silver be ousted by Bitcoin? These types of stories are to be expected, especially now the price of Bitcoin keeps rising even surpassing the $4000/BTC barrier. The supply of Bitcoin in circulation is limited to a maximum of 21 million units, and the annual growth in the supply of Bitcoin will diminish until that 21 million limit is reached. Apparently, the very same question keeps our dear readers up at night, because one reader recently remarked: “Since this technology (blockchain, ed.) is gaining ground fast and inflation is no longer an issue, to what extent is it still useful to protect yourself with gold. (…) The increasing popularity of, among other cryptocurrencies, Bitcoin causes, according to my opinion, also an ousting of gold and silver.” Let us today dive a bit deeper into the relationship between gold and Bitcoin.

Bitcoin Does Not Even Come Close to Gold

If we take the entire supply of gold (all the gold that has ever been mined) and multiply this with the current gold price in dollars, then we arrive at a grand total of $6,886 billion dollar. If we do the same for Bitcoin, then we arrive at a total of $57 billion. That means that the gold market is worth 120 times Bitcoin. And that is important.

What it also shows, is that Bitcoin still has a long way to go. We are only on the eve of the cryptocurrency revolution. Hundred twenty times the current price would imply a price of $400,000 per Bitcoin. And that jump, if it ever happens, will take a while. Until that time, Bitcoin will most certainly not “displace gold.”

It goes too far, therefore, to call Bitcoin a bubble. Some even go as far as to compare Bitcoin to the Tulipmania in the 17th century Netherlands, when the (option) prices of rare tulip bulbs went through the roof to, later, drop just as hard back to where it came from. Bitcoin, on the contrary, can become an enormous success or disappear completely, just as for instance happened once with the peer-to-peer application Napster (which allowed to share songs and videos). And that is something we can most definitely not say about gold.

Gold is not a “bet”, not an “all or nothing”, not a black or red at the roulette table, but a certainty.

Bitcoin Does Not Exist Without Blockchain and Blockchain Does Not Exist Without Miners

A Bitcoin is not something tangible, which should be clear to any of us. But we cannot even point to a virtual Bitcoin on a hard disk. A Bitcoin is nothing more than an entry in a blockchain, a type of public register, and without blockchain there exists no Bitcoin.

That this is the case, may become clear from the recent twist in the Bitcoin story. As I predicted earlier in a previous Bitcoin-related article, there has been a disagreement among “miners” about the efficiency of Bitcoin resulting in a “hard fork”. The problem is that the process which allows miners to earn Bitcoin and process payments is complex and does not allow for instant and cheap settlements. Moreover, the larger the transaction volume, the longer the delays and the more expensive a transaction. And that can be solved by allowing more transactions in one single block of transactions, but you sacrifice safety for the sake of efficiency.

And as Nick Szabo, who described the predecessor of Bitcoin (the famous Bit Gold, because, yes, Bitcoin is a digital copy of gold), once said for good reason: “Security is easy to measure only when it's too late.” In other words, you only discover how unsafe something is when it is already too late. And the fact that you sacrifice security for efficiency, could turn out to be a really bad decision when billions are lost and any trust in the currency is completely lost.

(On a side note: Nick Szabo already made a case for Bitcoin as a “more secure” option for larger transactions, for instance between financial intermediaries, whereas your daily cup of coffee would no longer be directly settled in Bitcoin, but with the use of a second layer of secondary blockchains and intermediaries dedicated to more every-day transactions, akin to a gold standard in which people use credit cards and bank transfers, but interbank clearing debts are settled in gold or promises to pay gold.)

All this led to a disagreement between miners, who can alter the Bitcoin protocol in a more or less democratic manner. As a result, suddenly two Bitcoin blockchains exist: the original (the “more secure” but less efficient) and Bitcoin Cash (the less “secure”). We now no longer have one Bitcoin, but two.

In what sense is gold different?

In the case of gold, the institutional context is given. A single miner, or a group of miners, cannot change anything to the natural and given characteristics of gold. The fact that one person or one group of persons controls all gold mining operations in the world, does not provide special privileges. This omnipotent owner responsible for the entire annual gold mining production, will never be able to bend the laws of nature to his or her benefit, for instance by making gold less scarce.

Gold exists without blockchain and could do without miners. Bitcoin cannot.

And that is the risk of Bitcoin. When someone owns a majority of the production capacity, then that someone is able to alter the protocol and software. As a result, for instance, the constraint on total Bitcoin supply (the earlier mentioned 21 million Bitcoin supply ceiling) could be eliminated and the supply of Bitcoin could suddenly expand, despite the fact that nowadays people invest in Bitcoin because its supply is constrained. But this constraint is of little value when it could be taken away at any given moment in time.

Benefits of Bitcoin in Comparison to Gold

Creating a digital replica of gold in the form of Bitcoin yields several important benefits compared to gold. No longer are expensive physical transports required and no insurance is necessary. As a consequence, billions of dollars in Bitcoin can be moved from one place to another for a fraction of the costs of moving billions of dollars in gold from one place to another.

Remember that the Dutch central bank (DNB) brought back home its gold from New York to store it in Amsterdam? Similar to the repatriation of the German gold from New York. Those were expensive operations. An expensive operation that would have cost only a fraction of the time and costs if it would involve Bitcoin instead of gold.

But well. There are some other scenarios in which Bitcoin become completely worthless for the pessimists among us. What to think of its dependence on the Internet? Or what about the number of miners (nodes) and the geographical distribution of miners? If all Bitcoin miners are concentrated in one or two regions, then authorities could simply track down these miners and shut them down. Gone blockchain. Gone Bitcoin. And that just happens to be the case.

There are about 8000 to 9000 miners who keep Bitcoin up and running. Here is a map that shows their geographical locations:

Source: Bitnodes

Shut down the miners in Europe and the US, and Bitcoin is suddenly much less secure. After all, these “nodes” verify each other continuously. And what is more secure? Ten “robots” who verify each other? Or ten thousand “robots”?

The idea that Bitcoin will displace gold in the short run as safe haven is therefore largely a myth. And the short run in the context of a centuries-long evolution of money and media of exchange easily means twenty years or more.

Worries about Bitcoin displacing gold anytime soon? Unfounded.


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