Since some commentators on Bitcoin specifically, and cryptocurrencies in general, have started labeling them as "digital gold," it has generated some comments from financial institutions and others, with the latest being from Goldman Sachs, which stated Bitcoin and other cryptocurrencies aren't the "new gold."
Part of the reason for that statement comes from the growing idea that cryptocurrencies have limited supply, which supports their value, and it has responded to geopolitical issues in the same manner gold has.
The question that needs to be answered is if comparing cryptocurrencies to gold is even relevant, in the sense of whether or not it's really comparing apples to apples, or it should be considered an entirely different asset class, even if there are some similarities with one another.
Why gold and cryptocurrencies have value
I've heard some that talk about gold in a way that undermines its historical value, by which I mean they call it nothing more than a rock that is taken from the ground. In one sense they're correct. It is in fact nothing more or less than that in and of itself.
But you could say the same thing about the U.S. dollar, or cryptocurrencies.
What makes them have value? The answer is this: we do. If you study economics at all, you know it's the imputation of value to something that provides its worth. That's true with gold. Even though by itself it is a nice-looking metal, it has value because we say it does.
Think of the U.S. dollar, which has lost about 97 percent of its purchasing power since 1913 when the Federal Reserve was instituted. People around the world still have faith in it as a medium of exchange, even though it doesn't buy near to what it did a little over 100 years ago.
That's the case with cryptocurrencies as well. Interestingly, people that have some trust in gold, also have a preference for cryptocurrencies. The reason why is they want to see a decentralization of the money supply, retain privacy and anonymity, and be able to buy goods and services across national borders without being penalized, among other reasons.
Some of those things will change with regulations, but they were a lot of the impetus behind the creation of Bitcoin.
We assign value to something we trust in, and in that regard, gold, the U.S. dollar, and cryptocurrencies are the more trusted stores of value, with gold continuing to lead the way.
One of the chief uses of gold in the U.S. years ago was it being a check and balance on the size of the government budget. It's of course why it was abandoned, with the final stage happening in 1973 under Nixon.
Governments, since the gold standard allowed for money to be converted to a specific amount of gold, couldn't just create money out of thin air if they wanted to increase spending. It had to be backed by gold reserves.
Cryptocurrencies and scarcity
Some cryptocurrencies like Bitcoin were designed from the beginning to include scarcity as part of their value. This, probably more than anything else, has some similarity to gold. Limitations on how many can be mined is another.
Bitcoin will never surpass 21 million in number. The software or code behind it won't allow it to exceed that number.
The protocol in place for Bitcoin is that there can never be more than 21 million mined. Once that total is reached, that is the end as far as how many will ever be available.
This built-in scarcity was designed for one of the purposes gold was originally used, which was to put restraint on the size of government spending and creation of fiat money, as mentioned above. There will never be another Bitcoin mined once the 21 million cap is reached.
Some have asked the question concerning what happens if the protocol is changed and more Bitcoin can be mined. The answer would be similar to that of the U.S. dollar: it would lose value. Its original purpose would be lost, and almost certainly would be replaced by a cryptocurrency that would retain its scarcity protocol.
There are other cryptocurrencies that have caps as well, and would without a doubt be used by those owning them if Bitcoin were to go that route. I don't believe it will.
What that suggests is the upside for Bitcoin remains extraordinary, and it's still in the early stages of its growth, even though it has soared to such high levels.
Recently, the amount of Bitcoin left was a little over 20 percent. Once that is acquired, demand should push the value up to very high levels. There have been some big estimates as to what the value of one Bitcoin will be in the years ahead, with some suggesting $1 million per coin.
If that were to be the case, buying one Bitcoin today would make an investor a millionaire. I'm not convinced it has that much upside, but it will move much higher than it stands today. Scarcity is a big part of the reason, as the market starts to embrace the value of Bitcoin and other cryptocurrencies.
Be careful of those that say it's too late to get into Bitcoin in particular, or cryptocurrencies in general.
While there has been some institutional investment in the sector over the last couple of years, it has been fairly modest. That is rapidly changing as hedge funds start to allocate a lot more capital to the cryptocurrency market.
Not only are hedge funds allocating more capital to the asset, but there are numerous hedge funds being developed for the purpose of investing in digital currencies.
As of the middle of September 2017, there were about 70 hedge funds designed to invest only in cryptocurrencies, having raised approximately $800 at the time. Citing Autonomous Research LLP, Bloomberg said the goal is to raise another $1.2 billion. I think that number is going to climb.
The rapid climb in the number of funds dedicated to cryptocurrencies came about primarily from day traders looking for profitable arbitrage plays. This is going to eventually calm down, and funds in it for the long term will generally dominate the sector.
For corporate investors, that market has been growing as well, with "42 equity investment deals by corporates, totaling $327 million."
For the small number of cryptocurrencies that have a lasting future, they will bring enormous returns for those that carefully research them, and invest in the right ones.
Scarcity will play a big role in the value of them going forward.
One thing to understand in regard to scarcity is there is a huge demand for money. If a lot of people want to use cryptocurrencies, it's easy to see how scarcity will drive up the price of those that are designed well.
What to consider when investing in cryptocurrencies or the blockchain
Investors can of course buy any available cryptocurrency and hold it. The most trustworthy right now are Bitcoin and Ethereum. I believe they still have a lot of room to grow, but the huge gains have, in general, already been made.
Whatever type of coin you want to take a position in, it has to be understood you have to have what are called a hot or cold wallet to store your key in, which is something like a password.
The difference between the two is a hot wallet has a connection to the Internet, and so is subject to potentially being hacked. A cold wallet is one that has no connection to the Internet. It could be as simple as having your key or code written down on a piece of paper, or preferably several, and placed in different locations. It's also advised by some to cut the code into different sections in order to protect it.
A hot wallet is easier to use, and the service is offered selling platforms such as Coinbase. The problem is they can still be hacked and you can lose all your investment.
That's why a cold wallet is the best way to go. The downside there is you have to be sure you don't lose your keys. If you do, there is no way to gain access to your coins; they're in a place of limbo with no way of recovering them. This is why you have to set up your cold wallet correctly.
In that regard, using paper and a digital storage device is probably the best way to keep it available to you. If one were to fail, you have a backup.
Most investors get intimidated by the process of being your own bank, which is essentially what I'm talking about here, so they either don't invest because of fear of losing their money, or don't take the proper precautions to protect themselves. One thing I would recommend never doing is giving up the protection of your keys or password to a 3rd party. Keep it in a cold wallet.
As I wrote recently, one of the easiest ways to take a meaningful and potentially very lucrative position in cryptocurrencies is with Overstock (OSTK). It's the third-largest investor in the sector as I write, and it has the potential to double, and probably even do better.
Another option if you want to have exposure to Bitcoin is Bitcoin Investment Trust (NYSEARCA:GBTC). It doesn't have as much liquidity with its volume of 57,323, but it performs close to the price movement of Bitcoin itself. That means it's a volatile holding that will experience wild price swings. It's not for the faint of heart, but if you believe Bitcoin has a lot of growth left in it, it's something to consider.
A relatively new offering is Canadian-based HIVE Blockchain Technologies Ltd. (PRELF). The company "operates as a cryptocurrency mining firm. The company focuses on building a bridge from the blockchain sector to traditional capital markets. It mines multiple cryptocurrencies, such as Ethereum, Monero, and ZCash."
The company recently announced it closed a "bought deal private placement" of 20,000,000 common share, which generated $30 million, minus 6 percent to the underwriters. It also completed a "non-brokered private placement of 4,666,667 common shares at C$1.50 per common share for gross proceeds of $7,000,000."
The latter will be used for general working capital, while the former was used to acquire "cryptocurrency mining equipment located in Reykjanes, Iceland." It's the second data center the company will have in operation, and will increase its cryptocurrency mining capacity my more than 70 percent.
Finally, one more company to seriously consider is Global Blockchain Technologies Corp. (OTC:BLKCF), which is listed on several other exchanges as well.
What's most impressive about this company is the team it's put together. It includes Steven Nerayoff, Rik Willard, Shidan Gouran, Jim Rogers, Jeff Pulver, among several others.
At this stage of the market, one of the most important factors to consider when investing in cryptocurrencies or the blockchain is the management team in place. This is one of the strongest, if not the strongest I've found.
Value of gold
One thing gold has that cryptocurrencies don't is it is used to make stuff too. It is used industrially, and also to make jewelry for brides in India, among other things.
In other words, while its value as a precious metal and store of value is imputed, it has other uses that relate to different markets. That said, the primary driver of gold prices over time is its imputed value, store of value, and protection against inflation. The rest, specifically in the case of Indian women, is seasonal.
This is only conjecture, but it would be fascinating to see how a gold-backed cryptocurrency would do. With the idea of scarcity, it would align with one of the most important reasons for Bitcoin emerging in the first place.
Goldman said one of the reasons why gold is preferable to Bitcoin is Bitcoin is very volatile. While that's obvious, gold has a lot of volatility inherent in it as well. It's also subject to decisions made by the Federal Reserve concerning interest rates and the effect on the strength or weakness of the U.S. dollar.
At this time, gold should still be considered the best store of value, even though that value is based upon imputation from people, just as the U.S. dollar and cryptocurrencies are.
What is changing in the cryptocurrency market is the new ones are first being built more like an app as their primary purpose, and a medium of exchange, as their secondary purpose.
SBI Ripple Asia to Test Blockchain Bank Transfers Between Japan and South Korea - CoinDesk
How Do Ethereum Smart Contracts Work? - CoinDesk
Now we're seeing smart contracts with Ethereum, and a move toward enhancing financial services with Ripple. Many more uses are here or coming.
This is why it's getting more difficult to compare gold against cryptocurrencies. It's easier with Bitcoin because its primary purpose is to be used to exchange goods and services. Newer tokens or coins are becoming specialized in services outside of currencies alone, making the comparison with gold, in many cases, impossible.
Conclusion
Many supporters of Bitcoin and other cryptocurrencies want it to be an alternative to gold. Some reasons are the mobility of the digital coins or tokens, and the anonymity included with it.
Some people unfamiliar with cryptocurrencies think they retain their privacy. The exact opposite is true. The nature of cryptocurrencies is they must be validated or confirmed; that means there is no privacy whatsoever.
Why this can get confusing is a lot of people consider anonymity and privacy as the same thing. How it works is the transaction will be seen by those that are required to validate it, without knowing who is involved with the transaction.
No one knows who the parties are that are engaging in the transaction, but the transaction itself is there for all involved in the process to see.
How it works is a peer-to-peer network records and then validate transactions across a network of computers. This is where the transactions can be seen, but those engaging in the transaction remain anonymous.
They're attractive because records of the transactions can be viewed and added to, but not altered.
One final thing. When considering the best store of value, what must be taken into account is the future increase in assets quality cryptocurrencies will bring.
Gold can protect against asset erosion when inflation climbs, but if a cryptocurrency soars in price and is sold for a huge profit, that's also a form of protection against erosion of assets; in that case by growing them far beyond the rate of inflation.
I think it's a good idea to hold physical gold while taking a position in cryptocurrencies to have the potential to grow your asset base in a big way.
It's far too early to think in terms of abandoning gold and replace it with cryptocurrencies, even if there are similarities in how they react to economic stimuli.
Gold has thousands of years of proof of being a consistent store of value. That isn't going to change.
Whether or not cryptocurrencies will have a competitive store of value has yet to be proven. At this stage, we don't even know which coins or tokens will be around even a year from now.
There is potential for cryptocurrencies to have a store of value superior to the U.S. dollar or other fiat currencies, but it's doubtful they'll be competitive with gold.
I think we'll have to wait for regulation to be enacted before we know the long-term picture with any clarity.
For now, I'm invested in gold and cryptocurrencies.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
Gary Bourgeault
I am a former investment advisor and owner of several businesses. These days I invest only for myself while continuing to write on a variety of financial and economic topics.
Analyst’s Disclosure: I am/we are long BLKCF, PRELF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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