Many proponents and Hodls of bitcoin have made the argument that bitcoin is (or would be) a “digital gold”. Mike Novogratz, ex-Goldman Sachs partner and founder of the crypto merchant bank Galaxy Digital, has been quite vocal, reiterating his view on bitcoin, in past interviews – bitcoin would be “digital gold” and would function as “store of value”. It seems that the underlying assumption for “digital gold” is that “gold” functions as “store of value”. But is it? Is gold a “store of value”? is it indeed the way gold functions in the economy?
Novogratz in his interview to Bloomberg on February 13th, further added that bitcoin is going to be “sovereign money” – “there’s 118 elements of the periodic table and only one gold… Bitcoin is going to be digital gold, a place where you have sovereign money. It’s not US money. It’s not Chinese money. It’s sovereign. Sovereignty cost a lot. It should”.
Now we have three characterizations of Bitcoin – “digital gold”, “store of value” and “sovereign money”. Are these three interchangeable? Do they have the same meaning? Furthermore, could bitcoin truly encompass these characteristics?
To answer these questions, we should first understand the meaning of these characteristics.
What is Store of Value
A store of value is an asset that maintains its value without depreciating. What is considered store of value could differ among nations. Under certain circumstances or when demand exists, almost any physical asset[1] can be considered a store of value. In most developed economies, the local currency can be counted as a store of value. U.S. dollar[2] or British pound or the Swiss franc are deemed stable currencies, which enhance their economies. However, when hyperinflation occurs, fiat currencies may not be considered as a mode of store of value[3]. Others that could be considered as store of value are gold, silver, real estate, and fine art. Their relative value may fluctuate over time. But, they retain their store of value, especially if they are a scarce commodity with a finite supply.
The Role of Gold in the Economy
Gold is a worldwide commodity, such as oil or coffee. But unlike those commodities, it is not consumed. Almost all gold that was ever mined is still around. The industrial use of gold is very minimal, mainly jewelry or electronics. So why the price fluctuation? In a sense, gold is a reflection of the state of the health of the economy, especially in developed countries such as the US, UK and Western Europe. When a financial/economic crisis hits the economy, there is a “flight” to gold. Investors start moving their investments from stocks and bonds to gold. We have seen that during the financial crisis in 2008, the eurozone debt crisis in 2009-2011 and most recently when Great Britain voted to leave the European Union in June 2016. In each of these occasions, the gold price has surged. Particularly, during the ongoing Eurozone debt crisis, the gold price has almost doubled. Gold is a commodity used by speculators, such as George Soros, to bet on economic uncertainty and investors’ behavior. Hence, hedgers or speculators would use gold to bet on worsening economic conditions. The chart below demonstrates the inverse relationship between the S&P 500 prices and Gold prices for the past year.
Correlation between gold and S&P500 was -56%. During that time the correlation of bitcoin with both gold and S&P500 has been quite low – 21% and 26% respectively.
What is Sovereign Money?
The phrase “Sovereign Money” is now widely used to refer to a system where only the state, (i.e., government or central banks) can create or issue money, in contrast to the banking system in existence today where commercial banks issue most of the money in circulation. In today’s banking system, demand deposits are backed up with central bank money, but only a very small fraction of 1.5% in the UK, 2.5% in the Eurozone and less than 8.5% in the US. That’s the reason the system is called fractional reserve banking. Sovereign system, on the other hand, has full reserve banking or 100% reserve banking. In today’s fractional reserve system, the money in a bank account is not “real”, it’s not legal tender but rather a mere claim on money. Thus, in a banking crisis, the money in the bank account might disappear.
Most likely, when Mike Novogratz used the phrase “Sovereign Money”, he did not mean “money that is 100% issued by the government or central bank”. Because, that goes counter to the notion of bitcoin – a decentralized immutable system ungoverned by any entity. He probably was referring to the meaning of “sovereign” in the sense of “possessing supreme or ultimate power”. So, we ought to be careful when using the phrase “sovereign money”.
Are these three phrases or characteristics interchangeable?
From the above explanations of the three phrases, it seems that they are probably not. Gold does not necessarily function in the economy as a “store of value” nor it is falling under the definition of “sovereign money”. Therefore, using all three as if they mean the same, is quite misleading.
Could bitcoin fall into one of these characteristics?
Let’s examine each of these characteristics – “digital gold”, “store of value” and “sovereign money”.
“Digital Gold” – the idea is that bitcoin would function as gold functions today in the economy.
- In terms of a tool for speculators, then bitcoin has already been falling into this category. Since mid-2017 bitcoin trading has increasingly been controlled by speculators.
- In terms of a reflection of the health of the economy. Bitcoin is a decentralized currency, ungoverned by any entity, let alone an economy.
- When it comes to hyperinflation economies such as Venezuela, we have seen that people in this type of economies use bitcoin (and other cryptocurrencies) as a “flight to safety”. Yet, there isn’t much of a distinction or preference between bitcoin and other altcoins.
It’s a matter of accessibility and value. If other altcoins are easy to access (i.e., trade, economic use) and their value is stable, then whether it’s bitcoin or some other altcoin would depend on transaction costs, speed, and security.
“Store of Value” – the idea is that bitcoin would serve as a store of value.
- We mentioned that many local currencies in developed economies are considered a store of value, as they maintain their value. The high volatility of the crypto market has been the main reason for the recent proliferation of stablecoins pegged to fiat currencies, such as the US dollar. If the usage of stablecoins increases, as it’s very likely to happen, there might not be a need for bitcoin as a store of value. Stablecoins are in fact “store of value”.
- Because bitcoin has some historic value as being the first cryptocurrency, the first blockchain experiment, for that reason it might become a store of value. This is quite similar to the reason people collect art or old coins or old baseball cards – scarcity and historic value.
If bitcoin stops its mining and as long as people view it as valuable “art” or “memorabilia” then bitcoin might increase its value.
“Sovereign Money” – the idea is that bitcoin possesses “supreme or ultimate power”.
Superiority has nothing to do with being a “store of value” or “digital gold”. It could be superior regardless.
But, if bitcoin is superior to other cryptocurrencies or functions as “gold” rather than a currency, then maybe it should be removed from the cryptocurrencies’ basket all together. Very much like the reason we do not have “gold” or “fine art” in the S&P 500 index.
Let’s follow this thought even further:
Regardless of whether bitcoin is “digital gold” or whether it possesses any supreme powers, it should be set aside, de-touched from any other cryptocurrency for the following reasons:
- It was the first blockchain pilot. The first experiment and thus has been around more than any other altcoin or token. The other altcoins are either less known or have not had the opportunity yet to establish a following.
- Comparing (or pegging[4]) all altcoins to bitcoin is wrong. First, they provide completely different use cases to bitcoin – e.g., smart contracts (ETH), unbanked economies (XLM), transactions’ speed (EOS). They solve real-world problems that have nothing to do with bitcoin. Second, they have never stated that they are here to compete with bitcoin, but rather solve a real-world problem using the blockchain technology. Third, they are very different than bitcoin in terms of infrastructure, features, protocols, use cases, etc. Therefore, any comparison is not only wrong but does not make any economic or logical sense.
- Because Bitcoin has been around longer than any other cryptocurrency, it’s the most familiar one and gets the most attention in the media. The focus on bitcoin makes it seem as if the other cryptocurrencies do not count. Thus, bitcoin wrongly becomes the pulse of the crypto market.
- Bitcoin problems of scalability, speed, and costs have been addressed with other blockchain projects and altcoins. If other altcoins are able to resolve these problems, then it is very likely that they would end up the most adapted and used by the mainstream.
- If bitcoin is not going to be the most adopted coin then either it would go bust or becomes a memorabilia item, a part of history in the evolution of blockchain technology. In the former case its value would go to zero, and in the latter case, it becomes a store of value or a collection item.
Therefore, bitcoin should be separated and removed from any cryptocurrency basket. It should stand on its own, whether as “memorabilia” or “art” or any other separate category. By removing bitcoin from the “rest of the pack”, we might observe more realistic valuation in the crypto market and less volatility. It’s time each altcoin and token stand on its own and reflect its own potential value.
Endnotes
[1] That excludes any physical asset that depreciates in value over time. Such as machinery, automobiles, electronics and in some cases real estate. It should be noted that when it comes to real estate, it’s the land that appreciates (or maintain) its value, not the assets built on top of the land.
[2] Many crypto stablecoins, such as True USD, Circle, Gemini dollar and Paxos are pegged to the US dollar, for that exact reason – the US dollar maintains its value and serves as a store of value.
[3] Most developed economies have not experienced hyperinflation since world war II. Germany’s hyperinflation in the 1920s led by high unemployment was the main cause for the rise of Nazism in the early 1930s.
[4] Coindesk valuation metrics are doing exactly that – (i.e., pegging each and every altcoin and token to bitcoin), putting bitcoin in the center and creating a relative value metric where everything is compared to bitcoin. There are no fundamental foundations to support such an approach.
About the Author
Dr. Merav Ozair is a data scientist, a quant strategist and a Crypto/Blockchain expert. She has more than 12 years of business and consulting experience. She earned her PhD in Quant Finance from Stern Business School at NYU and has over 15 years’ teaching experience. Currently she has been teaching at NYU.
Dr. Ozair is the founder of CryptoNerve – Providing the Crypto Market Pulse through in-depth research and analysis, proprietary metrics and proprietary valuation framework for crypto assets and crypto market. For more information about cyrptocurrency and blockcchcain research, valuation and trading signals you can reach her at mr649@nyu.edu.
