Will Bitcoin replace Gold as a “Safe-haven"?
A long long time ago before humanity developed, mankind used to live in a Subsistence economy, whereby they had to self-produce just enough food and other resources to get by life. Many economies and even small family set-ups must have had a farm to produce all the food they needed to survive. In fact, farming was the major activity in everyday life for almost everyone as one had to rely on own produce to survive.
Due to geographical advantages and the level of skills in farming, certain groups of different societies around the world were able to farm more than enough produce for themselves. This surplus of farming led to those farmers starting to trade their extra harvesting with other farmers who had surplus of different goods. For instance, one farmer specialising in farming cattle who had produced enough for a specific period would exchange with another different farmer, let’s say, a sheep farmer or maize farmer. This was called Barter trade, a situation where one person exchanged one good for different good. So the farmer would exchange a cattle for a sheep or a bag of maize meal.
As barter trade kicked off, more and more goods were exchanged for other goods. This even led to a new smaller transport economy blossoming as the goods being exchanged had to be transported to different places. You can imagine one farmer about to trade 10 cows, paying a Shephard one cow to deliver those 10 cows to another farmer for 10 or more bags of maize meal. To maximize the barter trade and keep the costs of doing so as low as possible, the farmer had to pay his shepherd a lower wage, say a small handful of salt or even just a meal in order to trade those other cows for different other goods. This obviously led to many farmers enslaving some groups of society as they wanted to reach maximum production capacity.
As more exchanges picked up, it resulted in new activities and jobs in societies. However, more and more farmers realised that barter trader was not a fair or the best exchange system. How would you determine the fair value of your well-fed cow/sheep, and how much were you willing to exchange it for, a bag of maize meal or two? Another major problem with barter trade was the mismatch between trades. Let’s say a cattle farmer wanted to exchange two cows for a bag of maize meal and one bag of spice, but the Maize meal farmer instead wanted to exchange his bag of mealie for a sheep instead of a cow. The solution to this problem was the broad adoption and acceptance of some kind of medium of exchange in the form of metals, including gold.
Metals as Medium of Exchange
Metals such as copper, silver and gold started gaining popularity as a way of paying for goods and services. Because these metals were rare to find and “mine”, which led them to being scarce in society, they became accepted as medium of exchange. This meant that the farmer who wanted to exchange his cow for a bag of maize meal and spice could simply exchange his cow for some handful of gold pieces and then use some of those gold pieces to pay another farmer or trade with the farmer for the bag of maize meal and spice, instead of exchanging the cow directly for a bag of maize meal.
Gold gained more popularity than other metals due to the Network effect, which simply meant it gained more value as more and more people used it as a medium of exchange. This also meant that it could be stored as wealth because the more gold you had, the more goods you could buy with it.
This new form of exchange, whereby one would “buy” goods with gold instead of exchanging goods for other goods resulted in the creation of banks as we know them today. The people that produced more goods and sold them for gold needed a safe place to store all their gold and banks offered that surety where one could leave their gold and come back to get it when they needed it.
The Gold Standard and Fiat Currency
When an individual left his gold with a bank, he needed to go back to the bank to get the physical gold in order to use it to exchange it for other goods he wanted to buy. However, banks realised that this was not an effective way of managing the gold they stored because once this individual takes the gold from the bank and gives it to the next person in an exchange, that next person would return the very same gold to the bank, if they both banked with the same bank at that time, which was often the case as back in those days, people who exchanged goods more often lived in close proximity and there was one bank within that proximity.
The most efficient way for banks to deal with this problem was to create and issue a cheque book to all the holders of gold with the bank or clients to the bank. This worked in very much the same way that cheques as we know them today work but back then when they started, they made life easier when it came to exchanging goods. This was because instead of one individual going to the bank to get the physical gold before exchanging, he could simply issue a cheque to the person they are exchanging with and that person would go to the bank to redeem the specified gold in the cheque. Essentially, this meant that instead of using gold, one could use “paper” to buy goods and this was how the money we know today go to be created.
The gold standard was adapted in the 19th century, which implicated that banks needed to issue an equal amount of cheques or “paper” to how much gold they held. So if one bank had 10 tons of gold, they could only issue cheques or paper worth 10 tons of gold and not more than that. This meant that anyone who held any cheque of the bank at that time could simply go to that bank to get the actual physical gold at any time. This is how gold became a “safe haven”, which essentially meant to investors in particular, that when other investable assets lose value, gold is seen as the best and one of the few assets to buy and hold as its value will increase or remain relatively the same as it was physically redeemable.
Fiat currency was adopted after the gold standard and how it was different was that instead of banks only issuing out cheques or paper money that was equal to the gold they held, they could issue out ten or twenty times more money than the gold held. Although the situation is a bit more complex than I have explained when you factor in inflation and loan creation, what it meant was that not all individuals holding a cheque could go to the bank and redeem all the gold the cheque was worth. Today, I don’t know of any bank that you could redeem all your cash for gold with and this is because we have adopted fiat currency so much that it would be very inconvenient for you to try use gold, unless you want to use it as jewellery, which you can find especially made for this purpose elsewhere other than at a bank.
Cryptocurrencies and Digital Currencies
After boring you with the details of how gold was used as a medium of exchange back in the 90s and how it got to be a “safe haven” for investors, I will spare you the details of what cryptocurrencies are as there is wide range of articles and papers on them and how they function. However, it is worthwhile to draw your attention on the key difference between Cryptocurrencies and Digital currencies.
Cryptocurrencies such as Bitcoin, Ethereum, Litecoin, etc, are currencies that are not issued by an authorized central authority.
Digital currencies such as the newly established Digital Chinese Yuan are issued by an authorized central authority. While Cryptocurrencies are virtually only digital and technically fall under digital currencies, these terms and classification are evolving as the space of crypto market is still developing.
Another key difference between Cryptocurrencies and Digital currencies is their value and how it is derived. Cryptocurrencies’ value depends on the number of its users and how much the users are willing to exchange it for while the Chinese Yuan’s value, the only digital currency launched so far today, depends on the central bank as it is issued and controlled by the government.
While an argument can be made that the world we live in today is somewhat in a digital space and we use digital currency already when we pay for online shopping or when when we pay using our bank cards since we don’t use the actual cash, the difference between the current set up and a Digital currency is that with the current fiat system, you can go to the bank and withdraw all the money that is in your bank account, that is, if your bank card holds 20 US dollars or even 20 million US dollars, the bank is obliged to give you all that money if you went to redeem it with your card. However, a digital currency such as the Chinese yuan and presumably all the other digital currencies that will follow is that they are technically designed in a way that they are not redeemable in cash but only to exist and circulate virtually.
The two conditions under which Bitcoin will replace Gold
- Broad adaption of Bitcoin and other Cryptocurrencies
There has been some key developments in the cryptocurrency market in recent months that seem to suggest that they (cryptocurrencies) are becoming broadly accepted globally. Among such developments is Tesla’s $1.5 Billion investment in Bitcoin, the leading cryptocurrency, and the suggestion that it will start accepting it as payment in the future. Other key developments are mostly in the financial sector and include Blackrock’s introduction of Bitcoin Futures in January with the aim of adding those futures to two of its funds. (Blackrock is the largest asset manager with over $8 trillion assets under management as of end of last year). Mastercard has also announced that it will start offering some “support” to some cryptocurrencies, and whatever support it does bring to the party should not be underestimated as this could help streamline cryptocurrencies as payment options.
2. Legislations and Regulation of Cryptocurrencies
As more and more heavily regulated financial institutions get involved in cryptocurrencies and start asking questions of what they can do and what is off the table, and generally the public start taking interest in cryptocurrencies, regulation becomes inevitable. While cryptocurrencies are designed to be more in open-resource markets which are not regulated by any government around the world, regulators are more likely to limit the different institutions and in particular, financial institutions on their radar, on what they can do with cryptocurrencies and their involvement in these markets. It is therefore more important now to understand how legislations are enacted in different regions in order to be able to predict how cryptocurrencies and different stakeholders are more likely to be regulated as most countries are still developing their legislation around this space.
In the United States, where democracy or “The First Amendment” as is known, is more valuable, legislations works in a very peculiar manner that it will make you question what is meant by this “Democracy”, but this is not the focus of this article. The important thing to understand with legislation in this region is that it is often biased to benefit the donors of the current ruling legislators. To give a purely hypothetical example, if Mark Zuckerberg and his associates made significant donations to the Republican campaigns and they won the election, then legislation that will be enacted will very much likely favour Libra, the cryptocurrency proposed and initiated by Facebook. Another thing worth noting with regard to legislation in the United States is the time it takes for any proposed legislation to be enacted. It takes a bit longer compared to other developed regions as the proposed legislation must first be debated and then approved at different stages.
In Europe, legislation works a bit different in the sense that it is often not directly linked to any particular donor of any ruling party. The laws enacted are often aimed at benefiting the country at large and majority of its citizens. Evidence to support this argument include the Digital Services Tax first proposed by France, the “heavy fines” given to the biggest tech companies by the European Commission in recent years and even Brexit is a good sign of how legislation works in this region.
Substantively, when it comes to cryptocurrencies, Christine Lagarde, now president of the European Central Bank, has publicly called for their regulation. While it is not clear what form this regulation will be, one can have a great gauge of the direction it might take based on the laws enacted previously by the European region in general.
In China, the law works very different to the other regions. The government often takes the pledge of protecting its citizens very seriously and has zero tolerance on any developments that are deemed to be detrimental to society and China’s advancement. A much more recent apt demonstration of this kind of approach when it comes to legislation in China is the halting of Ant Group’s listing as a public company. Ant was viewed as an encroachment to the financial system that would have eventually and unintentionally weakened the prudence of the financial system if it continued to grow without being heavily regulated like other financial institutions. When it comes to cryptocurrencies, there is not much evidence of how they are regulated in China, however, the central bank has already launched its own central digital currency that aims to rival the use of cryptocurrencies.
One other key take-away from here is the pace at which legislation is enacted in China compared to any other regions. Laws can be enacted and be effective in a very short period of time (less than 24 hours, yes, that short) compared to the United States, where it can take more than a couple of months.
Other regions, while not yet financially significantly important, might take vastly different approaches when it comes to regulating cryptocurrencies. From Saudi Arabia and Dubai to India and Africa, legislation and how it is enacted vary significantly, however, the approach to regulating cryptocurrencies might not vary as significantly to how the other three large regions will regulate them.
To conclude and answer the question of whether Bitcoin will replace Gold as a safe haven? One should ask themselves if they will be willing to go to the bank and get a few bars of gold instead of cash notes and use those gold bars to purchase anything they might need or want, or, if they will be willing to make use of cryptocurrencies or even central bank issued digital currencies to purchase goods online. The latter is likely to be the case to most people that are rational in the era we live in.
Therefore, gold should be replaced as a safe haven, whether it will be by Bitcoin or another cryptocurrency or a digital currency that will be issued by a central bank, that would remain to be seen.
Disclaimer
This article should not be regarded as investment advice and anyone seeking such advise should do so with a person or entity registered with the relevant authorities to give such advice.
The views expressed in this article are that of my own and do not represent the same views of any entities I am associated with.
Disclosure
I am actively short and long different cryptocurrencies, including Bitcoin at different prices.
