Bitcoin as Digital Gold

by Archer Financial Services | Jan 05, 2018
By Matt Krupski
To learn more about Matt, click here

Bitcoin dominated the headlines in late 2017.  Traders, seeking volatility anywhere they could find it, poured into the new trading instrument and the bitcoin price exploded.  As bitcoin dominated the news, analysts struggled to define it and identify its place in one’s portfolio; is it a currency, a commodity, or something else entirely?  Judging by its performance over the last few weeks, it seems to have found some use as an alternative to gold.

Traditionally, gold has been used as a store of value and inflation hedge.  Throughout history investors have bought gold to hedge against rising inflation.   Inflation, by definition is the relative declining value of a currency: your dollar bill will buy less tomorrow than it can today.  As a rare physical asset, gold has a well-defined limited supply.  While new gold can be mined, the costs and difficulty to mine new gold must make economic sense.  To guard against the declining value of a currency, investors have bought gold, essentially storing the value of today’s dollar in a rare asset.

Like gold, bitcoin has a well-defined limited supply.  More bitcoins can be mined but the costs and difficulty to mine new bitcoins are known and cost prohibitive, like gold.  Unlike the physical nature of gold, bitcoin is purely digital.  However, the general public has grown more comfortable with online transactions, as evidenced by the growth of online banking and e-retailing. The digital nature of bitcoin does not scare people like it may have five years ago.   Many of the same demand drivers for gold could also drive demand for bitcoins. 

The chart below shows the recent performance of bitcoins (in black) and gold (in green).  In October 2017, CME Group announced that it would list bitcoin futures, bringing more legitimacy to the product, helping bitcoin break above $5000, and adding new fuel to the rally. As the rally grew, the headlines helped fuel more speculation and the price really took off in late November. In studying the chart, we can see a highly defined negative correlation between gold and bitcoins starting around late November.  The spike lower in gold corresponding with the spike higher in bitcoins suggests that investors were selling gold holdings to buy bitcoins. The negative correlation has continued to hold as bitcoin prices have moderated, and gold has recovered in late December through early 2018.  

Chart from Barchart.com

It should be noted that this is simply one correlation among many that can be used to infer prices.  Other factors are also undoubtedly at play, but it does appear to me that the markets have partially defined bitcoins as a substitution for gold.  As bitcoin is a relatively new instrument to the investment community, this definition may rapidly change, but this correlation is worth monitoring.  

For more information about this article, please contact me at 312.242.7978  or via email at matthew.krupski@archerfinancials.com.  I look forward to hearing from you. Thank you.

Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. The risk of loss in trading futures and options can be substantial. The views and opinions expressed in this letter are those of the author and do not reflect the views of ADM Investor Services, Inc. or its staff.  Research analyst does not currently maintain positions in the commodities specified within this report. The information provided is designed to assist in your analysis and evaluation of the futures and options markets.  However, any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to ADMIS. Copyright © ADM Investor Services, Inc.