Why bitcoin may be the new gold for savvy investors

Bitcoin’s price has doubled four times this year, from US$1,000 in early January to over US$16,000. An Atlantic magazine headline asks: “Is bitcoin the most obvious bubble ever?”

Rapid increases in price alone do not prove a bubble, especially when conventional valuation is virtually impossible. There is a reason, however, why bitcoin could continue its rise – and this offers a means for comparative valuation: bitcoin may be the new gold.

Economic convention says money has three properties: it is a medium of exchange, a unit of account and a store of value.

Despite original high hopes, bitcoin is not ideally suited as a medium of exchange, because the database that keeps track of bitcoin transactions – the blockchain – is very limited in the number of transactions it can hold.

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Nevertheless, new developments, such as Litecoin, provide features offering the equivalent of a current account to bitcoin’s savings account. Bitcoin is much quicker for international transactions.

Gold is much less useful still as a medium of exchange. Yet, many investors hold gold in their portfolios as a hedge against inflation. Many such investors have a libertarian streak, holding gold because they do not fully trust central banks, like the US Federal Reserve, to keep inflation in check.

Gold investors hope it will rise in price, but mainly hold it as a store of value. Private ownership has taken gold from US$1,220 per kilogram in the mid-1970s to more than US$40,000. The only specific reason for the price is because it’s what those who wish to own it are willing to pay.

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More and more investors now hold bitcoin. According to an article in Fortune last month, more people are searching online for how to buy bitcoin than gold. Many think the price will keep going up. But many are interested for the same reason people invest in gold; its price is seen as independent of other prices and of fiat currency inflation. Therefore, like gold, it can be a store of value for a portion of an investor’s assets.

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The World Gold Council says 40,000 tonnes of gold is held as private investment (about 21 per cent of all gold). At today’s prices, that’s worth about US$1.6 trillion. The total quantity of bitcoin that will ever exist is 21 million. If bitcoin replaced gold as a store of value, each bitcoin would be worth US$1.6 trillion divided by 21 million, or US$76,000 – several times bitcoin’s recent price.

Yet of all the world’s investments – somewhere between US$40 trillion and US$140 trillion depending on what is counted – gold comprises only a tiny percentage. Gold is an offbeat and awkward investment for most people. Bitcoin is much easier to buy and hold. If bitcoin attracts more investors who want some of their portfolio invested in a store of value that is immune to price fluctuations of other assets, including fiat currencies, bitcoin’s value could increase still further.

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Some note that there are hundreds of cryptocurrencies now, and this will dilute the value of bitcoin even if only 21 million bitcoin ever exist. But there are many precious metals and gems besides gold, such as silver, diamonds, rubies and so on – yet gold is the favoured store of value.

None of this guarantees bitcoin will continue its rise. But absent any other way to measure its potential value – it does not generate revenue or earnings like a stock, or interest payments like a bond – it is a plausible way to estimate it. If it unseats and surpasses gold, its ultimate price could be much higher than today.

Michael Edesess is chief investment strategist of Compendium Finance, adjunct associate professor at the Hong Kong University of Science and Technology and a research associate of the Edhec-Risk Institute