With the recent meteoric rises in bitcoin and its alternative cryptocurrencies, coupled with predicted market contractions as an inevitable result of the pandemic, there has been a lot of talk about the best way to safeguard money and keep investment portfolios from decreasing in value. One way to do that is to diversify portfolios and invest in assets that hedge against economic downturns or inflation.
A traditional hedge against stock market volatility is gold. But in the last few years, many have argued that digital currencies can fulfil the same role, even going so far as to label bitcoin “digital gold.” Both seem to be largely detached from the ups and downs of the stock market, are readily available, and are unaffected by movements in fiat currency. So, which is better to include as an investment for a diversified portfolio?
History and Legitimacy
The history of the two assets is a stark contrast. Gold has been a store of value for at least five millennia. The first digital currency, bitcoin, only came into existence in 2009 and has only been taken seriously by most investors for a couple of years.
One of the main hurdles for cryptocurrencies, as opposed to gold, is legitimacy due to a lack of intrinsic value. Gold is a rare metal traded and valued for centuries and is also of practical use in various industries as well as in jewelry. Digital currencies have no inherent value as they are computer-made. The surge in popularity of alt-currencies and the increasing number of places they can be used, such as PayPal or buying a Tesla car, have given them some legitimacy. However, many financial experts remain cautious.
Cryptocurrency Might be a Better Alternative Currency but is it a Hedge Against Inflation?
The usability of cryptocurrencies does give it an advantage as an alternative currency. While both assets are incredibly liquid and easy to trade, it is easier to buy something or transfer wealth using a digital currency than with gold. This is a good argument for owning some cryptocurrency but doesn’t necessarily mean it deserves a permanent place in an investment portfolio.
The fees often associated with cryptocurrency purchases limit its use as a currency for now. However, if it does become more user-friendly, it remains unclear if it would be immune from inflation.
As Joseph Sherman, Founder and CEO of Gold Alliance, points out, “Gold has been used as a store for wealth for thousands of years and has a proven history as a hedge against inflation. Whereas alt-currencies, such as bitcoin, are a recent invention and have no such history. Digital currencies have only existed in times of low inflation.”
They Aren’t Equally Finite
Another issue is that value comes from rarity, and, again, there is another big difference between the assets. The most popular alt-currency, bitcoin, will be limited to 21 million coins, and only a certain amount of gold exists on the Earth. Both are relatively rare, but there is a problem.
“Like gold, bitcoin is finite,” Sherman explains. “But bitcoin is just the best-known cryptocurrency, and it isn’t necessarily the best one of them or may not be the best one down the road. The number of potential alt-currencies is technically infinite. There’s likely to be serious competition ahead, possibly diluting the value of the currently established cryptocurrencies. That just doesn’t happen with gold.”
The Bigger Issues – Volatility and Acceptance
Two of the most significant concerns currently faced by digital currencies are volatility and acceptability by governments. “Volatility is what scares a lot of investors when it comes to things like bitcoin,” Sherman says. “Conversely, it is also what attracts so many to cryptocurrencies.
“Bitcoin has gone from $3,500 to $50,000 in just a couple of years, and for those with high-risk tolerance wishing to speculate, there is a considerable appeal. But it could easily drop back again or go even lower, as bitcoin has done in the past. Volatility is not advised for a retirement portfolio as you don’t want to speculate your retirement away.”
Sherman cautions that government intervention is another factor for consideration. “Both gold and cryptocurrencies are technically competing with fiat currencies and could be banned or made inaccessible by governments. This is unlikely with gold due to the simple fact that central banks hold huge gold reserves, and it is in their interest to have a lively market for gold. However, numerous governments around the world including Denmark, India, Thailand, and others have already strongly advised against bitcoin and altcoins.”
Due to their digital nature, cryptocurrencies have the potential to be an alternative currency. This competition with fiat currencies is clearly worrying governments, which is further proven by numerous governments starting to develop their own digital fiat currencies. There is likely to be strict regulation ahead.
So, Which is Better?
The fact there is a debate about gold versus “digital gold” shows how far cryptocurrencies have come in terms of acceptance and as a potential hedge against market changes. Digital currencies began as an alternative to fiat currency, but due to their volatility and trading fees they have, for now, become an investment for those who have a high-risk tolerance. Future government regulation may make them mainstream or completely unviable. It is still too early to tell.
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