As I concluded in my previous post Bitcoin – The Emergence of an Asset, the intent now is to compare gold, bitcoin and fiat under the main properties that characterize sound money:
- Be durable;
- Be portable;
- Be divisible;
- Be rare and hard to produce; and
- Be difficult to control.
My objective is to show that Bitcoin mimics the strengths of gold and circumvent gold’s weaknesses. I will briefly discuss about the credentials of Bitcoin, gold and fiat against each of the above properties. Ultimately, a scoring matrix will be derived to assess the strengths of each of the three assets under study against the main properties mentioned above.
Gold: Gold is one of the less reactive elements on earth. This is the main reason why gold has been used heavily throughout humanity to display wealth and as adornment to gods, as it survived time without tarnishing. This is also why gold has been widely used, through time, as a trading medium between nations. However, gold being malleable, wear and tear through exchanges has historically been associated with a lowering content of gold in coins over time. Gold’s malleability also gave rise to an endemic problem called clipping, a process whereby counterfeiters would file the sharp edges of circulating coins after the minting process.
Fiat: Fiat money has taken many shapes through history. Fiat money was first issued as paper, such as bank notes or certificates, which typically was meant to be fully convertible in specie. Paper money changed hands frequently, and paper has a poor resistance to time. Many nations have, up to recently, invested important financial resources in developing new technologies to reduce the intrinsic wearable nature of paper money. However, a significant portion of fiat money has now moved from paper to electronic format, following the important breakthrough in communication protocols and technologies over the years, thus increasing its durability.
Bitcoin: Bitcoin is a computer code and is not physical. Therefore, its theoretical durability is infinite since it can’t be altered with.
Gold: Gold is 19.32 times denser than water. Imagine trying to fill up your office’s water dispensing machine using a 4 gallons tank weighing 292 kg. Although gold is dense, which is great for storage, it is not easily portable, which explains why gold holdings of nations were usually stored in the same facility, most notably in London or New York, and bars rolled between vaults on small carts for trade balance settlement. Although gold used to be portable in coins, it is difficult to transport bulk quantities, requiring expensive transportation means, security, insurance, etc.
Fiat: There are quite a few horror stories related to the portability of fiat money. The most notable is during the hyperinflationary period of Weimar Germany starting in 1918, after WW1, with its peak in 1924 after a stabilization plan was set forth. Notes of 50 trillion marks were issued, with a total quantity of Papermark in circulation reaching 400 quintillion (400 x 1018). Paper money was so worthless that it became less expensive to use it as a combustible than wood or coal:
Regular purchases, such as doing the groceries, sometimes required the use of a wheelbarrow:
Although many other occurrences as the one described above occurred throughout history, most notably in Somalia, Zimbabwe and recently Venezuela, some of us thankfully never had and hopefully never will have to experience such dire situation. Today, with electronic funds transfer and electronic money, requiring a wheelbarrow to carry currency for purchases is no more needed, although history proves that when the monetary system is politicized and centralized, anything can happen. Similar to gold, transporting bulk quantities of fiat currency is cumbersome, requiring expensive arrangements. However, since most of the transactions today take the form of electronic funds transfer, it has become much easier to move large quantities of money.
Bitcoin: Bitcoin is highly portable. In fact, it is so portable that it is borderless. It resides on the internet as a communication protocol and suffers from no physical restrictions to its flow. At a minimum you need a smart phone and access to a data plan. This is highly convenient!
Gold: Gold can be divisible in various fractions. Its high thermal conductivity and consequential low specific heat capacity makes the process of melting gold into different quantity relatively easy. However, specialized tools and equipment are required to melt gold, which is not accessible to all. Finally, gold needs to be refined to quality standards which require capable third parties to assess its purity.
Fiat: Fiat money can be broken down to two decimal points in most of all monetary systems around the world. Dividing fiat is now mostly seamless for the users using electronic funds transfers of all sort, not having to carry the various aspects of fiat’s divisible lower fractions in our pockets!
Bitcoin: Bitcoin is also highly divisible. Bitcoin can be divisible up to 8 decimals, to what is called a Satoshi, representing 10-8 Bitcoin, or 0.00000001 Bitcoin. Like electronic funds, the divisibility is seamless.
Rarity and Difficulty to produce
Gold: One of gold’s most important characteristic in the eye of the proponents of the gold standard is its rarity and inherent difficulty to produce, making monetary debasement harder for a central authority having the rights of minting. Gold has an occurrence of 0.003 ppm in the earth crust, and is one of the rarest elements on earth as displayed in the figure below (Wikipedia):
Gold is not easy to produce. When you are very, very lucky, you may get gold grades above 5 grams per tons, but sometimes mines operate at grades lower than 1 gram per ton! Extracting a gram of gold is not a straightforward process: it is energy intensive, it is capital intensive and most often involves important chemical processes to extract it from the ore (mostly cyanide). To add to the difficulty, because of its high density, during the first years of the existence of the earth, gold sank deep within the molten earth crust. The deepest mines in the world, mostly in South Africa, are operated at a depth of 4km into the earth’s crust, while other deposits operating with open pits take advantage of geological hydrothermal processes which brought gold closer to the earth surface at very low grades.
Most of the easy deposits, such as placer gold deposits that characterized the Californian gold rush that started in 1849, have been depleted, requiring miners to increase efforts and resources to extract the precious metal in deposits with low gold grades and deeper within the earth’s crust.
The following graph represents the yearly percentage change in gold production, data from the USGS:
As one can observe, there is a current clear asymptotic trend of gold production growth around 2.5% and falling. A low supply means that over time, an asset gains in value relative to other assets whose production growth are higher, such as for copper, iron ore, and paper money.
Something very interesting to investigate is the relationship between the change in gold price versus the change in supply. See below graph:
Unlike commodities like iron, copper and paper money, large swings in gold prices do not result in a large increase in production, which additionally supports gold’s rarity and difficulty to produce.
Fiat: There is nothing difficult involved in printing paper money, and therefore, in its rarity. In the current fractional reserve banking system, there is no theoretical upper bound on the amount of money which can be printed, as we have seen for the case for Weimar Germany at the end of WW1. The only limitation comes from efficient markets, which discount the value of paper money when they start losing faith in it. To understand the loose dynamics of paper money, consider the recent intervention of the Federal Reserve Bank of the US in late 2008 through QE1 and then QE2 in 2010, which contributed to an increase in monetary base from approximately 900 billion USD to nearly 2,800 billion USD in 2011 (source: FRED):
Even Alchemists can’t dream of a better outcome! Fiat money does not espouse the concept of rarity and difficulty to produce. It is driven by the independent willingness of the central bank to increase or decrease the monetary base.
Bitcoin: Bitcoin was programmed with a cap on supply of 21 million Bitcoins, which resemble the fundamentals of gold production in time, thereby making it rare and hard to produce. See below (source: Blockchain.com):
The supply growth of Bitcoin was initially very high, which we could compare with the easy production of gold from high grade deposits when they were first mined. With time, the growth supply of Bitcoin asymptotically approaches zero, such as gold. Unlike fiat money, the supply of Bitcoins can’t be increased seamlessly and effortlessly. See below the graph illustrating the supply growth of gold, Bitcoins and fiat money (source: FRED & Blockchain.com):
Only the supply of Bitcoin is predictable in time since the issuance of Bitcoin is a computer code already defined and accepted. A closer look at the Bitcoin growth supply provides a better understanding on its future stability:
Mining bitcoin will get harder and harder, and the reduction in supply towards a static supply cap enhances Bitcoin’s rarity. Bitcoin mining is capital intensive and energy intensive, like gold mining.
Gold: Gold has, through history, mainly been owned by individuals through private ownership of jewellery and investments as a store of value (bars, coins, ETFs, etc.). According to the World Gold Council, jewellery and investment represented over 80% of the demand for gold from 2010-2017. That is, gold is mostly owned by individuals through direct ownership or institutional investments in gold funds and other financial securities.
Although private ownership is great for an asset to be qualified as a store of wealth, gold has a black eye as a result of one of the most indecent act of private property confiscation in US history: FDR’s populist Executive Order 6102, banning private holding of gold. One may point that this event occurred during the harsh economical environment of the Great Depression, which polarized politics. Whether or not this event has a negligible probability of happening again is irrelevant; the fact being that, under the force of law, the government coercively outlawed gold private ownership, which led gold to be easily centralized and seized under the hegemony of the US Federal government. Populism being on the rise in the world, the potential controllability of assets becomes a very important property to consider in defining an asset as a store of wealth.
Fiat: The monetary system that we know today is constructed out of many different centralized institutions, such as the central bank, the banking institutions, the communication protocols (e.g.: SWIFT), etc. Why is that? Because that architecture makes it easier for a government to control the system. Has this happened before? Many times. Think about capital control and money draft restrictions in countries like China, Venezuela, Zimbabwe, Argentina, and yes, even the USA. Any powerful central figure can easily mobilize resources to impose restrictions on the centralized financial institutions, at the expense of private citizens. This decision comes at the risk of a loss in credibility, but populism is a mean to an end.
Bitcoin: The beauty of Bitcoin is that it is a decentralized system which does not require trusted third parties, typically centralized institutions, and is thus laying out of the control of hegemons. Instead of having to control a few dozens of institutions as in the case of fiat, anybody wishing to control Bitcoin would have to control several thousands of nodes worldwide operating and securing the network, requiring the mobilization of massive amount of resources, with a limited probability of success. Unlike gold, Bitcoin is “everywhere”; in the era of digitalization, having an asset that is virtual and not physical, that is borderless and whose ownership and utilization is decentralized since it resides on a telecommunication network makes it safer to keep wealth out of the reach of the long tentacles of governments.
The table below summarizes the score I have attributed to each asset class with respect to the properties corresponding to sound money. I have also associated, with each sound money property, a weight in the overall score as per the importance each property has in my opinion. The lowest score is 0 and the highest score is 5.
I have always been keener to see gold as a superior medium of storing value than fiat, as the scoring matrix indicates. This is also reflected in the overall increasing purchasing power of gold versus major currencies over time:
In my opinion, Bitcoin possesses features that are superior to gold because not only does it mimic the fundamentals of gold which have been sought for 6,000 years, but Bitcoin circumvents gold’s weaknesses in terms of portability, divisibility and controllability.
In my next post, I will investigate the relationship that gold and Bitcoin share so that we can conclude whether or not Bitcoin exhibits any of the characteristics that gold has with respect to the US dollar, and thus, as a store of wealth.