Bitcoin and Gold – a match made in the unknown

Moving fully into the digital era requires courage to walk the unknown path.

2024-06-03 | Lars Verhoef | Insights

We live in a world in which the great powers are quietly clipping the value of our coins, and most of us notice only in a rueful glance at a receipt. Our money is being inflated away, yet one or two money like alternatives resist this dilution, namely gold and silver. The appeal of a fixed gold supply, for many, lies in its capacity to preserve purchasing power over time. In our own age, a concept known as Bitcoin has been created to replicate this digitally. How does it preserve purchasing power, and might it have a place in your portfolio?

ERA OF CONCEPTS

Bitcoin is a mathematically fixed supply of encrypted digital units, expressed as coins or, in smaller denominations, Satoshis. Every movement between digital wallets is recorded on a shared ledger. Transactions are grouped into blocks, which the network (the miners) must solve mathematically before each block can be validated and added to the chain (hence “blockchain”). Owners hold their coins in a digital wallet, online or offline. Whoever created Bitcoin fixed its supply at 21 million coins, a limit not yet reached and unlikely to be reached for another 120 years or so.

At its core, this is an ideology that fuses a physical premise, a bright, malleable yellow metal, with a man-made construct: money. Money is a concept refined over centuries of testing and cycles, driven by an almost primal urge to acquire more of it. It manifests physically as a stamped token, or now as digits on a screen, circulating as a collectively agreed measure of “value”. That value is deeply embedded in our minds, even though history shows repeated and often severe dilution of the tool itself. After many such cycles of dilution, inflation, as we now call it, an alternative has emerged. A concept with a fixed supply, held with the ease of a digital asset rather than the burden of a physical one, and designed to preserve purchasing power. It resists dilution because no government or institution can create more of it. And yet, in recent years, its quoted price, in whatever currency you favour, has fallen sharply, as some holders have sought to exit. That decline interrupted what had been a sustained uptrend. So does the premise still hold?

If such an asset can lose value so quickly, what sense does it make to hold it while that value evaporates? The real question is whether such a bit (Bitcoin) has value at all. Value is typically derived either from the velocity of an asset’s flow through a system over a given period, or from the equilibrium struck between supply and demand. How, then, might we determine the value of a digital commodity like Bitcoin?

Combining these two components, gold and money, offers a way to grasp Bitcoin’s potential value. Gold’s price is governed by supply and demand: it has some industrial and aesthetic value, but is priced primarily on investment demand (setting aside, for now, the possibility of a cornered market). The metal dilutes by around 2% a year, as mining steadily adds to supply. Money was once backed by gold. Today’s dollars and euros are fiat currencies, backed by nothing but the trust of those who use them (For a fuller account, it is worth reading further on “Where money actually comes from”). It has value only because we collectively agree it does, an agreement reinforced by the fact that commodities such as oil are priced and traded in it. The central bank (a private institution with something close to godlike power) can expand or contract this supply at will, and with it, alter the value of the money itself.

“The Bank of the United States is one of the most deadly hostilities existing, against the principles and form of our Constitution.”

– Thomas Jefferson

THE IDEA OF VALUE

Understood this way, Bitcoin is simply another such concept. One with no production or aesthetic value of its own, but with value derived from how the collective prices it through supply, demand and velocity. The market sets that price by buying and selling. The essential difference is that no institution validates, backs or guarantees Bitcoin. Our present world was built by institutionalising social contracts; Bitcoin proposes a new one, based on decentralisation, in which the collective holds power rather than institutions. That, at least, is the idea. In practice, several large organisations already hold significant Bitcoin, while miners (some private, some publicly listed) validate transactions and secure the network. Success may already be drawing Bitcoin back into the old institutionalised system. Uncomfortable as that may sound to early holders, it could also stabilise the price. If a genuinely collective understanding of the coin’s value takes hold, we may be entering a period of trust and sustained purchasing power. If it does not, a sharp decline in its quoted price is entirely plausible, and the coin could yet be dismissed as worthless speculation. Like money, it has value only because we collectively agree it does. Bitcoin may simply need more time to settle in the collective mind. The US government’s proposed Strategic Bitcoin Reserve, which would add Bitcoin to national reserves and would lend the concept further validation. A move that could a frame for digital gold.

Looking at the gold market (roughly $30 trillion) and the silver market (roughly $2.5 trillion), a great deal of capital sits in these largely unproductive assets. Our monetary system is built on debt and interest , a total money supply of some $130 trillion set against global debt exceeding $320 trillion, excluding an estimated $1 quadrillion in derivatives, and this has produced a flywheel that must, at some point, come apart. A case can be made that when it does, capital will flee towards alternative liquid assets, and Bitcoin may be among them. That said, the thesis remains fairly weak until Bitcoin ownership reaches a critical mass of trustworthy holders. Large holders (governments and corporations) could help stabilise the price much as vaulted gold does, particularly given the comparatively small tradable float. A meaningful catalyst would be the use of held Bitcoin as collateral, at a conservative loan-to-value, to acquire other assets. These, however, remain possible conditions and is not the current state of affairs.

OUR VIEW

We do not, strictly speaking, “invest” in these assets — we hold them as part of a broader strategy. Physical metal function as insurance against the monetary system in our portfolio rather than as an investment in its own right. Bitcoin carries a larger allocation, owing largely to capital gains, and is held as a cash alternative alongside short-term government bonds. We will reduce, or borrow against, our Bitcoin holding as opportunities arise. Pinning down an exact value or price for these assets, now or in future, we are unable to do. That said, we are confident we acquired them at deeply discounted valuations relative to the expanding supply of fiat currency.

Disclaimer: This publication is intended for informational and educational purposes only. It does not constitute personalised investment advice, nor an offer or solicitation to buy or sell any security. It reflects the author’s opinions, estimates and analysis as of the date of publication, based on information believed to be reliable but not guaranteed for accuracy or completeness. Investing involves risk, including the loss of capital. The author may hold positions in the securities discussed; any material positions, compensation or other conflicts of interest will be disclosed in the relevant publication. Readers should conduct their own research and reach their own investment decisions.

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“The only true wisdom is in knowing you know nothing. The unexamined life is not worth living. There is only one good, knowledge, and one evil, ignorance. Be kind, for everyone you meet is fighting a hard battle.“

-SOCRATES