The argument that Bitcoin is the new gold mainly stems from perceived similarities in their limited supply and their role as alternatives to fiat currencies. However, this comparison overlooks key differences between gold and Bitcoin – not only in terms of their market dynamics but also in terms of their performance and the role they play in portfolios.
Gold’s demand is driven by investment and consumption
While nearly 60% of gold’s average annual net demand¹ is linked to pure investment purposes, jewellery is an integral part of the gold market making up 34% of demand. Gold is also widely used in technology – including components that are needed to ‘mine’ cryptocurrencies. This dual nature sets gold apart from many assets – allowing it to perform well in both times of economic stress as well as times of long- term economic expansion – enabling gold to have a role in portfolios as a source of returns as well as an effective risk diversifier.
In contrast, Bitcoin’s main source of demand (at this point) is primarily for investment.
Gold production and ownership is well diversified
Gold mining is truly global with major mines in China, Russia, Australia, the US, and Canada, as well as various Latin American and African. Average annual production is evenly distributed across regions, with no one continent capturing more than 25%.
When it comes to actual ownership, the breadth of distribution is even greater. The US Treasury is the largest known single holder of gold but only owns 4% of all above-ground stocks.
In contrast, according to Bloomberg, “five mining entities – all of them based in China – control 49.9% of all computing power on the network, the highest concentration of mining power ever”. And ownership is extremely concentrated with 2% of Bitcoin holders owning 95% of all available Bitcoins.
Bitcoin’s contribution to an investment portfolio has brought high rewards but has also added significant risk
Since the beginning of 2020, Bitcoin has grown by more than 700%. These gains are headline grabbing and makes it hard for institutional investors to ignore. However, as with any financial asset, reward does not come without risk. The last 15 months of Bitcoin’s ascent has come with significant volatility and risk – over the last 2 years, Bitcoin has been 4.5x more volatile than gold; investors have a 5% chance (95% VaR) of losing at least US$1,382 for every US$10,000 invested in Bitcoin which is nearly 5x more than risk with an equivalent investment in gold.
So what does mean for us as investors?
If we want to invest in Bitcoin given its recent performance, we will want to have an asset like gold in our portfolio to manage the additional risk that such spectacular returns bring. Remember, there is no such thing as high return and low risk. Investments are either high return and high risk or low return and low risk.
1. Source: World Gold Council.