In the previous post Bitcoin, Gold and Fiat, we have demonstrated the superiority of Bitcoin regarding gold in terms of portability, divisibility and controllability, and the superiority of Bitcoin and gold over fiat.
If Bitcoin is indeed a serious challenger to gold as the ultimate store of wealth, then it should also be negatively correlated with the US dollar, or conversely, that Bitcoin should be positively correlated to gold. Is this the case? In this post, I will perform a high-level analysis on the relationship between the prices of gold and Bitcoin in order to validate furthermore the store of wealth characteristics of Bitcoin.
The period under investigation is January 2nd, 2013 to January 31st, 2018, for a total of 1528 trading days. The reason I have selected this period is that prior to 2012, only a few thousand transactions were taking place on the Bitcoin network:
From mid 2012 to early 2013, there was a net increase in network participation, stabilizing around 50,000 transaction per day. Since this is 500 times higher than in early 2012, I felt the analysis would be more meaningful over that period.
I have broken down my analysis as follows:
- Period 1: January 2nd, 2013 to December 31st, 2014, representing 496 trading days
- Period 2: January 2nd, 2015 to December 30th, 2016, representing 496 trading days
- Period 3: January 3rd, 2016 to January 31st, 2019, representing 536 trading days
Clearly, Period 1 demonstrates a negative correlation between gold and Bitcoin. The following figure illustrates the regression of Bitcoin price onto gold price:
During Period 1, the overall relationship between the two assets was clear, with a negative correlation of -0.6 over 496 trading days. The negative correlation in this case can be attributed to the low liquidity of Bitcoin in its early days, even at an average of 50,000 transactions per day.
The period spanning the years 2015 and 2016 saw a change in the trend of transactions over the Bitcoin network, with daily transactions breaking the 300,000 mark in 2016, which is 6 times greater than the amount of transactions at the end of the previous period. What was the impact of this increased participation over the Bitcoin network on the correlation between Bitcoin and gold?
What is represented in the above graph is an indication of a positive correlation between Bitcoin and gold, as a result of an increase in the participation over the Bitcoin network. For the complete Period 2, the correlation was 0.46 over 496 trading days.
The last period under study is quite interesting. Period 3 saw a drastic rise in the price of Bitcoin culminating in December 2017, before falling to approximately 6,500 USD/BTC in July 2018 and maintaining that price level (more or less) until mid-November when Bitcoin dipped to 3,500 BTC/USD. During that same period, the activity on the Bitcoin network increased in supporting the high Bitcoin price and re-settled to the level seen at the end of 2016.
The relationship between Bitcoin and gold during Period 3 is illustrated as follows:
The starting hypothesis of this post was that Bitcoin shared the inverse relationship that gold has with the US dollar and other USD denominated assets, and thus, that Bitcoin and gold shared a positive correlation. What have we found? First, we saw Bitcoin being negatively correlated with gold in Period 1, from 2013 to the end of 2014. During that Period, Bitcoin was relatively unknown, and the amount of transactions over the Bitcoin network was consequently low.
Then, Period 2 and Period 3 demonstrated that Bitcoin started exhibiting a positive relationship with gold as the Bitcoin network grew and gained in maturity, and thus, as its liquidity started increasing. If we combine Period 2 and 3 together, spanning 1032 trading days between January 2nd, 2015 and January 31st, 2019, we get a total correlation of 0.44 and the following relationship:
Can gold be fully substituted for Bitcoin? Not at the moment. There are still milestones needed to be attained for Bitcoin to increasingly become liquid and a better store of wealth. However, the analysis of this post suggests that as time advances, Bitcoin’s correlation with gold becomes ever more positive.
Let’s remember one thing: Bitcoin is barely 10 years old. It is normal that at this point, its potential as a true store of wealth has not fully reached its potential. Nonetheless, we can certainly appreciate that Bitcoin possesses better credentials than gold regarding portability, durability and controllability, and that its correlation with gold is positive and increasing.
Bitcoin’s potential as a store of wealth will grow with time as the network develops and will become a much more potent asset to challenge gold and the likes.
In my next post, I will cover the false claim that Bitcoin represents an opportunistic vehicle for criminal activities and compare it with the current system.