The exponential growth and growing popularity of Bitcoin and other cryptocurrencies over the past year has sparked the interest of many investors. This has resulted in some social influencers questioning whether Bitcoin, in particular, is able to play a similar role to gold within an investment portfolio. However, despite some similarities between the two assets; predominantly their limited supply and their role as an alternative to fiat currencies, there are also some fundamental differences that investors - and potential investors - should carefully consider. Comprehensive analysis from the World Gold Council found the following:
- Sources of gold demand are more diverse compared to the supply and ownership of cryptocurrencies, which are more concentrated.
- Whilst cryptocurrencies have contributed to some extremely high returns, they have also added significant risk to portfolios.
- Gold is a highly liquid asset and portfolios with crypto could actually benefit from higher allocations to gold.
- Gold and cryptocurrencies play very different roles within an investment portfolio.
Fundamental Differences Between Gold and Cryptocurrencies
- The Dual Nature of Gold
Gold has been recognised as an important and tangible store of wealth and form of exchange for thousands of years. It is owned not only by individual investors, but also institutional investors and central banks all over the world. It has a growing use in technology and high-end electronics and is extremely popular in jewellery, particularly in China and India where it has strong cultural and religious connotations. This dual nature of gold, whereby it is valued as both an investment and a consumer good, sets it apart from other investment assets. It has also often resulted in a strong performance of the yellow metal both during times of economic hardship, and during times of economic growth.
Conversely, cryptocurrencies such as Bitcoin are, of course, digital (not tangible) and the source of their demand is more concentrated, predominantly for investment. According to the World Gold Council, the recent volatility in the price of Bitcoin may suggest that it mainly responds to speculative price momentum rather than a means of storing wealth over the long term.
- Gold is a Scarce Natural Element
Whilst both gold and Bitcoin are finite, gold’s above the ground stocks have been increasing by around 1.7% a year for the last 20 years. In contrast to this, Bitcoin stocks are currently increasing by around 3% per year*. Furthermore, the cryptocurrency space has grown immensely in recent years, and there are now thousands of different types of cryptocurrencies, along with Bitcoin, available to purchase via various online platforms.
- Bitcoin’s Value-at-Risk is Almost Five Times Higher Than That of Gold
The price of Bitcoin has risen substantially over the past two years and in 2020 it quadrupled. This rise in price captured the imaginations of many individual investors and even encouraged some institutional investment. However, with great rewards often comes great risk, and Bitcoin’s price rally has also come with significant volatility. Bitcoin has been three times more volatile than the S&P 500 in the past two years and more than four and a half times more volatile than the price of gold.**
Furthermore, Bitcoin’s Value-at-Risk (VaR) has been substantially higher. This means that during any given week over the past two years, investors had a 5% chance of losing $1,382 for every $10,000 invested in Bitcoin - this is almost five times more than the VaR for gold.*** For this reason, the World Gold Council suggests that a higher exposure to Bitcoin or cryptocurrencies - and therefore a higher exposure to risk - warrants a higher allocation to gold for a more balanced and diverse investment portfolio.
- Bitcoin has yet to Prove Itself as a Safe Haven
At certain times, Bitcoin has been seen to display ‘safe haven’ like behaviours, as it has appeared to move in a similar direction as some traditional hedges, including gold. However, there is no consistent trend to this behaviour. For example, in March 2020, the price of Bitcoin dropped by more than 40% and ended the month 25% down. In contrast, while the gold price initially fell by 8% in March, it quickly rebounded back to the level it started, and continued the upward trajectory as investors continued to add hedges to their portfolios.
Gold has been trusted as an effective store of wealth for millennia. According to the World Gold Council, gold has offered a source of returns rivalling the stock market over various time periods. Gold has also traditionally performed well during times of inflation and has a highly liquid and established market. Gold has played an important role as a portfolio diversifier, and has frequently demonstrated a negative correlation to the market during economic downturns.
The cryptocurrency market is still in development and its price behaviour appears to be driven by momentum around investor expectations for high returns. Bitcoin has been much more volatile than gold over the last two years, therefore adding additional risk to investment portfolios. The World Goldn Council suggests that portfolios with high allocations of Bitcoin - or cryptocurrencies - may benefit from higher allocations to gold due to its role as a hedge against risk.
Fundamentally, investors are regarding gold and cryptocurrencies as having very different roles within an investment portfolio. A 2019 survey by the World Gold Council revealed that investors view cryptocurrency as a more speculative investment and value it for its opportunity to achieve returns in the short term. Gold, on the other hand, was valued for its strategic role in preserving wealth over the long term, and for its position as a hedge against riskier investment options.
*The World Gold Council
**Source: Bloomberg, ICE Benchmark
***The World Gold Council