Goldman Sachs Analyst: Is Bitcoin More Valuable Than Gold?

Abstract: With the recent rise in the price of Bitcoin, many voices in the industry have pointed out that Bitcoin has become a digital currency comparable to gold. Stefan Wieler, CFA, an analyst at Goldman Sachs Group, recently published a report article pointing out that the price of Bitcoin seems to have exceeded the price of gold for the first time; however, this comparison is too arbitrary. Because gold is calculated by weight, Bitcoin, like currency, is just an abstract form of currency and can only be measured in its own unit. The value of one Bitcoin far exceeds the value of 1 gram of gold, but it cannot be compared with 1 ton of gold.

“Despite Bitcoin’s stellar 2016, the size and depth of the cryptocurrency market pales in comparison to the $7 trillion gold market. Gold remains the only truly global currency that is comparable in size and volatility to fiat currencies. Bitcoin (or cryptocurrencies themselves) is the most exciting monetary experiment in modern society.”

Unlike fiat currencies, Bitcoin is not paper money in the traditional sense. It emulates the scarcity of gold, because it takes a lot of resources and computing power to create one Bitcoin. Energy value links gold to the primary industry and allows gold to maintain people's purchasing power for a long time. Otherwise, over time, any form of currency will inevitably be destroyed and lose its meaning. Bitcoin has some similar value scales to gold, and it is these values ​​that make gold far superior to fiat currencies, so this is also the key factor in Bitcoin gaining recognition from some people and becoming a global currency accepted by the public. Even the US dollar does not dare to be so confident.

Leifeng.com previously reported that Bitcoin has characteristics that no other form of currency has, especially the anonymity in electronic transactions; however, some people believe that this characteristic may hinder people's acceptance of Bitcoin. Now, the total global market value of Bitcoin is only $20 billion (although its price has rebounded), and its trading volume is negligible even compared with more altcoins. That is, as Bitcoin's adoption rate increases, governments may no longer be satisfied with its ability to support anonymous transactions, but may consider it a threat and may no longer allow legitimate businesses to continue using it as a currency. At the same time, for savers, Bitcoin remains the only alternative to gold and other precious metals because it does not depreciate like other currencies.

Bitcoin has become the focus right now, as its price has surpassed gold in some transactions (although at the time of writing this article, Bloomberg said that the average price of Bitcoin has not yet surpassed the price of gold, but it seems that it is only a matter of time). According to previous media reports, Bitcoin's volatility is significantly less than that of gold, so Bitcoin has become more valuable than gold. However, we refute this statement because we are sure that Bitcoin's volatility will return to 100% in the near future.

Bitcoin has gained nearly $500 in the last year, and at the time of writing, 1 Bitcoin is trading at $1,135, while 1 ounce of gold is trading at the equivalent of $1,164. To some, it may seem like Bitcoin is more valuable than gold, but this is conceptually incorrect.

Gold and other precious metals can be measured by weight (ounces, grams, kilograms, tons, etc.), whereas fiat currencies, or any other abstract commodity or currency (including Bitcoin), cannot be measured in this way. Because they are abstract, they can only be measured in their own units. Therefore, gold and silver are the only forms of currency that are currently traded by weight. In addition, fiat currencies cannot be measured in terms of any currency other than other fiat currencies, at least since Nixon ended the free convertibility of gold in 1971. In this respect, Bitcoin falls into the same category.

Therefore, when comparing units of gold to units of Bitcoin, one must first define the units in which they are measured.

Will it be the gram ($37/gram currently), the kilogram ($37,000/kg) or the ton ($37 million/ton)? Or will it be measured in the cruder measure of the troy ounce ($1,157/ounce), which is used for anything other than exchange-traded metals?

Therefore, comparing the price of 1 Bitcoin to 1 troy ounce of gold is a bit like comparing shares of Seaboard ($4,179/share) to shares of Apple ($116/share) and concluding that Seaboard is 35 times more valuable than Apple. Obviously, if calculated by market value, Apple is the largest and most valuable company in the world, with a market value 126 times that of Seaboard.

The same basic principle applies to money. Existing gold reserves are currently around $7 trillion, which, as we pointed out last year, is more than all paper money in circulation combined (published on February 22, 2016: Abolishing paper money means no more checks, and no more balance between banking policies and practices), and is larger than Bitcoin’s market cap of around $18 billion. In fact, the market cap of all cryptocurrencies (which we count as 710) is only $21 billion (see Figure 2).

There is another factor to consider when comparing Bitcoin and gold: volatility.

It is generally believed that high volatility is not conducive to gold as a medium of value exchange. We found that the volatility of gold (measured by standard deviation) is roughly the same as that of currency. It turns out that even if interest is taken into account, gold is more valuable than any currency. Bitcoin's volatility is significantly higher than that of gold and currency. According to Leifeng.com, although Bitcoin's volatility is sometimes stable for a short period of time, or even close to that of gold and currency, it often changes rapidly again soon after.

However, standard deviation should not be confused with a measure of risk. Standard deviation quantifies the benefits of diversification: it does not matter whether that diversification is due to upside or downside.

For example, an asset with a 1% return every other day and a 0% return every other day would show an annualized standard deviation of 8%. An asset with a -1% return every other day and a 0% return every other day would show the same standard deviation. In the context of asset management, these two assets may have the same risk coefficient. In fact, if negatively correlated with other assets, the asset with negative performance may actually reduce the risk in the portfolio. But for savers, the first asset is obviously less risky.

So, instead of measuring volatility as standard deviation, we can just measure the downside. This provides a much better way to understand currency risk. So how do we think about Bitcoin? Bitcoin's downside is still orders of magnitude higher than gold or currencies. In the past two years, Bitcoin has experienced a downside greater than 45%. Since 2010, data shows that it has also experienced a downside greater than 100%.

Volatility, or more precisely, the risk of downside, makes it difficult for Bitcoin to be used more widely as a currency.

For Bitcoin, it has performed very well in the short term, but this outstanding performance comes with a huge downside risk. Merchants who accept Bitcoin payments are exposed to this downside risk unless they immediately convert Bitcoin into regular currency in subsequent transactions. Even though the entire process theoretically takes about 6 minutes, in practice it takes about two hours to convert Bitcoin into regular currency, one hour to confirm the transaction and another hour to confirm the price, during which time the merchant may be affected by downward fluctuations. Holding Bitcoin forever may have huge upside potential, but merchants must also be willing to accept downside risk. After all, merchants should spend their time and energy doing what they do best - selling goods, not trading currencies and Bitcoin.

Another claim we disagree with is that Bitcoin has no counterparty risk like gold.

This is not an easy task, the source code of cryptocurrencies may change, and there is no guarantee that the Bitcoin blockchain will not change in the future. In this regard, we disagree that Bitcoin has no regulator or counterparty risk; the blockchain itself has a fat tail effect - the probability of extreme market conditions increases, and some unusual events may cause major market shocks. It can be said that it is impossible to change in a way that is contrary to the interests of those who own and hold Bitcoin. This is in stark contrast to fiat currencies, which are clearly aligned with the interests of those who control their circulation to promote their depreciation.

This means that, for now, gold remains the only global currency that individuals and businesses can trade at any time without time delays. It also has no counterparty risk in terms of price volatility compared to major currencies, and has proven to retain its value even if stored for thousands of years.

Note: In a previous version of this article, we described Bitcoin's counterparty risk in overly simplified language related to the fact that the source code of any cryptocurrency can be changed. We are not suggesting that entities should have the power to change the blockchain at will, so we have revised our wording accordingly. This is not part of our core analysis, so it should not be taken as an argument against Bitcoin or cryptocurrencies.