For centuries, gold has been a major driver of the global economy – kings fought, died, killed, plundered and pillaged for gold. The global financial landscape was firmly rooted in the stability that gold provided and central bankers held faith in their stock of gold reserves. Of course, investors don’t think twice before moving their wealth into gold at the first sign of geopolitical or economic uncertainty. However, it appears that there’s a new type of gold in town – cryptocurrency is shaping up as the digital gold of the digital age.
In the year-to-date period, the price of gold has managed to score gains of 6.09% to underperform the 9.85% gains in the general market that the S&P 500 represents. In contrast, the NYSE Bitcoin Index is up 138.2% in the year-to-date period, Bitcoin is up almost 200%, and Ethereum is up about 3000% in the same period.
One could argue that stocks are inherently more volatile than gold and that cryptocurrencies are exponentially more volatile than both stocks and gold. However, there’s no denying the fact that cryptocurrencies are becoming consistent in their ability to reward brave investors handsomely. In fact, many investors that missed the boat on Bitcoin and Ethereum are now jumping on board many of the initial coin offerings ICOs introducing new cryptocurrencies to the market. This piece looks at two main reasons cryptocurrencies have the potential to displace gold.
Simple Demand and Supply
Basic economics teaches us that the price of a commodity will increase if its demand is more than the available supply; conversely, the price of a commodity will fall, if the supply is higher than the demand. Cryptocurrencies are seeing a consistent increase in demand as their mass-market adoption continues to climb; interestingly the supply of each type of cryptocurrency is capped.
For instance, the total volume that will ever be mined cannot exceed 21 million Bitcoins. Ethereum and other coins also have similar caps on their supply. Interestingly, the mining of cryptocurrencies is designed to become progressively difficult. Business Insider reports that the rate at which new Bitcoin is being mined has dropped from 9.3% to 4.4% in the last one year. Going forward, Bitcoin won’t reach its 21 million cap until year 2045 based on the current mining rate.
Conversely, the supply of gold in the market has increased significantly in the last couple of years as technological advancements make it easier to mine previously inaccessible gold deposits. Available data suggests that gold production has climbed consistently since 2009 to the current record high of 3,100 metric tons.
Simple value proposition
The second reason I am convinced that cryptocurrencies have the latent potential to displace gold is the superiority of the value proposition of cryptocurrencies over gold in the current economy. Gold was replaced by fiat currencies as a means of payment because of the limitations on the divisibility of gold. Now, cryptocurrencies offer a better solution in terms of divisibility as a means of payment for micro transactions without incurring exorbitant transaction fees.
More so, cryptocurrencies are digital in nature; hence, they are most suitable for a digital economy without the need of a centralized clearing house that moves physical funds around to support how money flows in the economy. Gold on the other hand is physical in nature and its use in the digital economy is limited.
In addition, traditional bankers and central banks are starting to wake up to the reality that cryptocurrencies are the money of the future. Going forward, we can expect federal banks to start buying up cryptocurrencies are part of efforts to ensure that their economies are moving with the times.