Thursday 18 June 2020 2:45 pm

The digital asset inflation hedge beyond gold

The extent of money supply increases needed to facilitate stimulus packages by sovereign central banks to counter the negative effects of the current crisis will dictate the inflationary pressures that ensue. Current world currencies are driven in a large part by expectation value and when confidence wanes there is a flight to alternative stores of value. 

Bitcoin and gold advocates claim that the increase in money supply to keep economies going as a result of the current crisis will cause increasing inflation, therefore reducing the value of money in real terms given that interest rates are near zero. They cite that bitcoin, with its limited supply, and gold are the hedge against this risk. Are they right or wrong and what about other digital assets? 

Bitcoin v Gold

Gold has always been an inflation hedge and an asset which is used to store value in times of uncertainty. Signs are showing that this is also the case during this crisis. Data from Bullion Vault shows that gold is trading around the $1730 per ounce mark, up from $1550 in early January, whilst some analysts have even predicted it reaching $2000 over the next few quarters. Generations of savers in numerous countries have turned to gold as an effective hedge against inflation and currency weakness, notwithstanding the same being true with professional investors.

Gold will be a favoured safe haven in these economically troubled times. Empirical evidence shows that gold has acted as a stable store of value for thousands of years while the value of world currencies has steadily declined. Investors and savvy individuals understand the need to own tangible and liquid assets, even more so in an environment of ever-expanding fiat money and government debt, which will now be exacerbated by the crisis.

What bitcoin is and gold have in common is that those investing into such assets are partially opting out of the current financial system by directly owning tangible wealth. That way they can ride out the economic contraction until things settle and then see how they come back into the market when other assets are underpriced and the economy has stabilised. Investing into gold and bitcoin whilst reducing short term exposure to financial assets will also shield investors from a system that is fraught with counterparty risk given that both governments and institutions are going to be increasingly leveraged.

The concept of a flight to bitcoin is a relatively new one given that bitcoin came into being in 2009 just after the 2008 financial crisis. Since then we have not had another big financial crisis, until now. The volatility of bitcoin is cited by some as making it less stable as a hedge compared to gold. We saw a recent flight away from it, with a decrease in its price, which was correlated to the fall of financial assets in March this year as the crisis deepened. However, it then rebounded in April and May suggesting that the bears were being counteracted by some bulls. That said there was also a downward adjustment in the gold price during March before a rebound.

As inflation increases drastically, as has been seen in countries like Venezuela, bitcoin is not only being used as a store of value to hedge against rising prices and currency devaluation, but also as a means to get money out of the country. Bitcoin can transcend borders and then be converted into fiat money or other assets at the appropriate time if so required. This is where bitcoin has a major advantage over gold, because the fact that it is a digital asset means it is portable. Gold in its physical form is not. Even fully asset backed tokenised gold has to have the underlying gold in storage somewhere. Given that gold is physical, supply chains and physical delivery are being massively impacted. This will of course have a near term impact and is already creating a discord between gold futures and physical gold.

Beyond Bitcoin

Aside from its volatility, opponents of bitcoin cite that it has other drawbacks as it is play based on programmed scarcity, where consensus control can be concentrated and it is energy intensive because of its mining foundation. Last month the Goldman Sachs wealth management division in a presentation to its clients said that bitcoin is not a “suitable investment for our clients.” A number of reasons were given for this, including that it provides no cash flow or earnings through the exposure to global growth, nor does it provide diversification, nor dampen volatility and has shown no evidence of being an effective hedge against inflation. Yet the bank has made investments into the space in ventures such as Circle and BitGo, suggesting that different divisions within the bank have alternative views. Bitcoin is an asset and as long as there are buyers and sellers, it will continue to be sought after as will the ventures that facilitate its use. 

Whether you are pro bitcoin or against it, one thing is clear, in that it has paved the way for the digital assets revolution we see emerging before us today. Whilst the 2008 financial crisis led to the birth of bitcoin and subsequent wider use of blockchain, this crisis could really be the one that defines digital assets as a whole.  New forms of digital assets will continue to emerge having learnt lessons from their predecessors so that substantial innovation is seen in this space. This will encompass wider adoption of decentralised currencies, stablecoins, central bank digital currencies, asset-backed tokens such as gold and security tokens.

History dictates that the crisis with abate and with it will come new opportunities. When the next crisis ensues, there will likely be more alternatives to gold and bitcoin as a store of value. Digital assets will enable real change to the financial system and democratise economies and markets so that it results in a more optimised financial system, which is hybrid (both centralised and decentralised) with the best facets of both. 

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