Commodity Trade Mantra

Think AGAIN! – Is Bitcoin a Better Store of Value than Gold?

Think AGAIN! - Is Bitcoin a Better Store of Value than Gold?

Bitcoin Plummets Big-Time

Bitcoin plummeted, extending its drop to 29 percent from a record high, on speculation some traders were buying its offshoot amid a struggle over the digital currency’s future.

Bitcoin dropped to as low as $5,605 on Monday, from a record high $7,882 reached on Wednesday, data compiled by Bloomberg show. Bitcoin cash rose to $2,426 on Sunday, before plunging to $1,379 as of 9:32 a.m. in Hong Kong, according to Coinmarketcap.com.

Bitcoin has slumped since the cancellation of a technology upgrade to increase its block size, amid speculation supporters of the proposal bid up bitcoin cash to undermine the original bitcoin.

At the heart of the debate is how bitcoin’s underlying technology can accommodate rising transactions as its popularity booms. While increasing its block size would help, opponents argue it would only concentrate mining power, undermining the decentralized nature of bitcoin.

Bitcoin Plunge Exposes a Fundamental Flaw

Virtual currency’s threat to the human environment has been hitting the headlines recently. The race to mine new Bitcoins, exacerbated by rules that make the process use more computer power as time goes on, threatens one day to consume as much power as the whole of Japan, according to Citi. Already, Bitcoin mines stacked high with customized machines whir away in Inner Mongolia, hinting at the crypto-currency’s “Mad Max” problem, as ING’s Teunis Brosens puts it.

But this is a problem only as long as people are desperate for new Bitcoin, and only as long as its rules remain fixed. The dramatic events over the past three days have shown us that neither is guaranteed. The tumble in value of the granddaddy of crypto-currencies, from about $7,300 to just more than $5,600, is testament to its biggest sustainability problem: An inability to evolve as a piece of code without tearing itself apart.

The root cause of the recent price drop is a long-running conflict over Bitcoin’s failure to fix its most obvious flaws.

Although Bitcoin was designed to be a functional payments network, it has failed to live up to those expectations. A boom in transaction activity, worsened by the crypto-currency’s speculative price bubble, has led to intense network congestion.

Each entry in the Bitcoin payments ledger—or, in crypto-parlance, each block in the blockchain—is capped in size, and transactions are slow to process. Transaction fees have blown past $10. Given the obstacles to spending Bitcoin like a currency, the incentive has been to hoard it like a commodity.

If this were Microsoft Corp. or Apple Inc., it would only take a nod from the CEO to deliver a system upgrade or patch to improve the network. But this is crypto-land. An issue as trivial as increasing capacity ended up kicking off a civil war among developers, miners and evangelists that has raged for several years. Those who want to keep transaction batch sizes small are accused of being nostalgic cyber-idealists, while those who want to ramp them up are accused of wanting to centralize power among wealthy vested interests.

In protest, a new crypto-currency with bigger block sizes, Bitcoin Cash, was launched in August. As for Bitcoin, a compromise solution intended to launch last week failed to get off the ground. Bitcoin remains Bitcoin.

These events have triggered a step-change in how markets view Bitcoin—just as Wall Street was starting to get comfortable with trading it. Bitcoin’s price is falling while that of Bitcoin Cash is gaining. The computing power of the miners is switching away from Bitcoin to its would-be successor in search of more dependable profits. If this continues, Bitcoin’s already clunky network will suffer as transactions are delayed and fees rise. Assuming this isn’t just a temporary power grab, optimists reckon Bitcoin Cash has a shot at becoming the new Bitcoin—one that’s actually a bit better at the whole payments thing.

Regardless of which side has more merit, investors will no doubt be scratching their heads at a far more fundamental question. If every developmental fork in the road for Bitcoin leads to a new currency branching off, how sustainable can its price boom be?

True believers who think it to be as rare and precious as a digital version of gold may soon face the grim reality that it’s just one flawed crypto-currency among many. A commoditized technology, in other words, rather than a technological commodity. – Lionel Laurent

Is Bitcoin a Better Store of Value than Gold?

As gold continues to wallow below the $1,300 per ounce mark, bitcoin made a fresh record high this week. Considering bitcoin and gold share some similar attributes, why is gold’s performance so lacklustre as bitcoin continues to march higher?

The question now is, is Bitcoin a better store of value than gold? To answer this we need to know what is driving the lacklustre performance in gold and if the factors weighing on the yellow metal will last.

  • Interest rates: expectations that the Fed will hike rates in December and continue with its rate-hiking cycle in 2018. Since gold yields nothing, and US assets are starting to yield more, this erodes gold’s attractiveness.
  • The Fed’s balance sheet: the Fed’s decision to shrink its balance sheet is also contributing to gold’s under-performance.
  • Stocks: this earnings season has seen a surge in firms who have said that they will increase their dividend. This also makes stocks more attractive than gold from a yield potential.
  • Demand: the World Gold Council reported that demand for gold slid to an 8-year low. Demand for gold fell to 9 tonnes in Q3, down 9% from Q3 2016.
  • Demand cont.: Sluggish demand is coming from significantly lower inflows into gold ETFs and a softer jewellery market in India, according to the World Gold Council.

But this doesn’t explain why Bitcoin, which shares some attributes with gold, continues to embark on its ferocious march higher. Here are some of the attributes shared by gold and bitcoin:

  • Both are decentralised, and are not under the control of a central bank or other authority.
  • Both are mined: one physically, one digitally.
  • Both yield nothing.
  • They are considered a store of value.

But, the crucial differences between gold and bitcoin include:

  • While demand for gold has slumped, demand for bitcoin is soaring, which is why its price has increased by a whopping 900% so far this year. This compared with a more moderate 14% gain for gold in the last 12 months.
  • Demand for gold ETFs has also slowed, one reason may be the prospect of more bitcoin-linked products that are about to come onto the market including bitcoin futures listed by the CME and bitcoin options listed on the CBOE. Some investors may be taking money out of gold-backed funds in anticipation of investing in bitcoin when these new products go live.
  • Gold has been around for millennia, bitcoin is the new kid on the block, which is inevitably adding to its lustre.

Overall, you could argue that the story behind bitcoin is stronger than it is for gold right now and that is the chief reason why gold is lagging behind Bitcoin. The potential for Bitcoin and crypto in general to overtake the fiat currency system in the coming years is also a powerful driver of demand, and is something that gold cannot compete with.

The case for gold:

We would caution against writing gold off completely for a few reasons:

  • Gold positioning, as measured by the CFTC, is still relatively strong even if it has backed off the highs of the year. There are currently 1.9mn long gold futures positions, which is above the 5-year average of 1.2mn contracts.
  • The technical picture also suggests that any further decline in gold could be capped by some key support levels including the 38.2% retracement of the Dec 2016 low to the September high. This level comes in at $1,268 and acted as solid support in early October and early November.
  • Gold is a tried and tested safe haven. During the financial crisis the price of gold surged 181%. Bitcoin is yet to be tested during a period of intense financial stress. Can the cryto currency only rally in a low volatility environment? If that is the case, then old-fashioned gold could see its fortunes rise once again, but we may have to wait for the elusive market sell-off before we can get excited about a potential resurgence for gold.

To conclude, although gold and bitcoin share many attributes, the bitcoin story has grabbed the trading and investing world’s attention like nothing else, hence the huge rise in its price this year. Gold cannot keep up with this and it is natural that we see some drift away from gold and into bitcoin in the coming months. In the short-term this may continue to weigh on the gold price, however, if we get a period of market stress then it could be time for the gold bugs to step up a gear as no one knows how bitcoin will react to a market panic. – Kathleen Brooks

Chart 1:

Source: City Index and Bloomberg

Chart 2:

How Will Bitcoin React in a Financial Crisis Like 2008?

If the ownership of bitcoin is as concentrated as some estimate, then the liquidity issue distills down to the actions of the top tier of owners.

Whenever I raise the topic of bitcoin and cryptocurrencies, I feel like an agnostic in the 30 Years War between Catholics and Protestants. There is precious little neutral ground in the crypto-is-a-bubble battle; one side is absolutely confident that bitcoin and the other cryptocurrencies are in a tulip-bulb type bubble, while the other camp is equally confident that we ain’t seen nuthin’ yet in terms of bitcoin’s future valuation.

I’ve stated here more than once that in my view the real value of bitcoin will only be revealed in a financial/market crisis/crash like 2008-09. Longtime correspondent Mark G. recently proposed three tests that illuminate some of the dynamics that might come into play in the next financial/market crash/crisis.

(CHS NOTE: gold fell from a peak around $1,100 per ounce in March 2008 to $830 in October 2008. It then bounced back to $1,100 in February 2008. The standard explanation for the sharp decline was that gold was sold off to meet margin calls and other obligations arising from the Global Financial Meltdown of late 2008. That gold was perceived as a reliable store of value may have increased its attractiveness as an asset to sell in the mad scramble to raise cash.)

Here is Mark’s commentary:

I propose that the performance of gold in 2008-2009 offers an indicator into how bitcoin is likely to behave.

I propose three practical tests for bitcoin.

Test 1. Is it possible to meet any sort of ‘margin call’ using bitcoin directly? Is it possible to do so on a large enough scale to affect market liquidity in any particular market? i.e. are any margin loans or the functional equivalent thereof denominated in bitcoin? In 2008 as “margin calls” flowed in from everywhere, all speculative assets experienced the same selling pressure to raise cash to meet obligations denominated in “money”.

Test 2. Can the physical necessities of daily life be commonly paid for directly and locally using bitcoin? I mean things like food, fuel, medicine, clothing and local debts for utilities, taxes, rents and mortgages. Or is it necessary to first exchange one’s bitcoin for ‘legal tender’ to conduct these transactions?

Test 3. Can bitcoin even be used to financially sustain bitcoin’s minimum physical infrastructure of servers, brokers and trading desks? Can it pay leases, electric bills and purchase the servers required for this?

Are there any lenders of “last resort” ready, willing and able to sustain bitcoin banks, traders and speculators? If not, and precisely because there is a limited supply of bitcoin, it seems a certainty that the financial failures previously seen in the decades prior to the Federal Reserve Act are likely to recur in the bitcoin infrastructure for precisely the same reason: liquidity crunches appearing.

These are precisely the tests that gold and silver failed in 2008/2009. And until bitcoin is ready to pass these tests I think it too will collapse in any future Global Financial Crisis.

Thank you, Mark. Liquidity is an issue in any financial crisis, as sellers may be unable to find buyers at any price. Bitcoin has two liquidity issues:

1. Will sellers of bitcoin find a bid from buyers if a flood of bitcoins hit the market as speculators sell assets to raise cash to meet margin calls (or simply book profits in volatile markets)?

2. Since bitcoin must generally be converted to local currencies to buy the supplies and pay the bills Mark listed above, liquidity must also include the convertibility of bitcoin to USD, euros, yen and yuan, that is, the willingness of traders to exchange USD, euros, yen and yuan for bitcoin.

A liquidity crunch has the potential to unleash a positive feedback loop (i.e. self-reinforcing feedback loop) in which the absence of liquidity triggers panic that then sparks more selling which then worsens the liquidity crunch which then increases panic selling, and so on.

Another potential factor is the ownership of bitcoin. The topic is complicated because one individual can own a number of exchange accounts, wallets and coins in cold storage. On the other hand, one address might represent more than one owner.

To further complicate matters, an unknown number of bitcoins have been lost, i.e. the keys have been lost in hard drive crashes and the like. There is no way to know the number of zombie bitcoins with any precision.

For this reason, charts of bitcoin distribution refer to addresses, not individuals.

The acronym HODL pops up a lot in the crypto space: hold on for dear life, meaning hold on to your bitcoin, Ether, etc. through thick and thin rather than trade or sell it.

If the ownership of bitcoin is as concentrated as some estimate, then the liquidity issue distills down to the actions of the top tier of owners: if some substantial percentage of major owners are forced to liquidate their bitcoin to cover massive margin calls elsewhere in their financial holdings, the sale of big blocks could overwhelm buyers, creating a liquidity crunch.

If most of the major owners have eschewed debt and margin in favor of cash, bitcoin, gold, etc., then they might be in a position to provide liquidity as speculators dump bitcoin to raise cash or lock in gains.

Given the limited number of bitcoin available to trade, liquidity could dry up very quickly if major blocks are dumped on the market.

Given the strong views bitcoin arouses, it may come down to how many major owners will HODL in a panic-soaked financial crisis, how many will avoid being forced to liquidate their bitcoin holdings to meet margin calls or other obligations, and how many will have the wherewithal and the courage of their convictions to be buyers when volatility soars.

Put another way, beliefs and confidence can generate behaviors and decisions that may well appear irrational to speculators.

I don’t know how the market for bitcoin will react in a 2008-type crisis, but the small float of available coins practically guarantees high volatility. How it all shakes out a year after the crisis is another question that’s unanswerable.

One thing we can anticipate with some certainty is that one camp will be right and the other camp will be wrong. – Charles Hugh Smith

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