Dec 10, 2017

The Futility of Bitcoin's 'Digital Gold' Vision

A few days back, Bitcoin crossed the $15,000 mark. In just two months it has more than tripled its price, proving that sceptics were naive all the way long. There has also been a decided shift in the perception of Bitcoin: from a revolutionising currency to a store of value. People might still be optimistic about its practical utility, but it’s difficult to treat a currency with such wild movements as…well…a currency. There’s little sense in using Bitcoin to buy things when you can expect it to buy thrice as much in a few weeks more, much less in accepting it when it’s prone to crash, fees are ridiculously high, and verifying transactions takes forever.

Then, calling it a store of value, like Gold, makes more sense. Similar to Gold, Bitcoin is valued by consensus, although they both are not very useful in themselves. Gold has few industrial uses, but they aren’t compelling enough to make it valuable. Nonetheless, from the ancient age, people have coveted gold. Human labour and capital have been spent on mining and refining it. Bitcoin has a similar story. Millions of dollars are being spent to solve computationally expensive puzzles whose solutions are impossible to use in any meaningful way.

Would it be fair to call Bitcoin a digital incarnation of Gold? Not useful in itself but valued nonetheless. Mining Bitcoins is hard (and expensive), just like mining Gold. Bitcoin has a few added advantages, too: it can be stored without physical space and transferred across anywhere in the world without regulatory oversight (at least for now).

That would be a fair comparison. However, equating Bitcoin with Gold trivialises the value it has provided for millennia. The critical purpose of a currency is to establish trust. If a ₹10 note means the same thing to you as it does to me, then markets will function. But trust needs to be backed by something too, which, in a turbulent world, was a lost cause. How would you trust an ordinary coin when invaders can topple the kingdom and invalidate all the currency overnight? Why would the rulers adhere to sound economic principles (in a time when they were yet to be discovered)? More problems arise in the case of international trade. The Chinese rulers would’ve no reason to trust an ordinary coin of Roman merchants. Why believe that they are Roman in the first place?

In comes gold. Rare enough to be highly valuable, relatively abundant compared to other precious metals and highly stable to retain its preciousness for years. Essentially, a durable store of value. Stability and rarity are the chief reasons why it came to globally accepted. Accepting a gold coin was relatively safe because there’s little chance it’ll lose purchasing power in a moment. Between 1715 and 1800, the Gold price remained pretty stable between 4.25 and 4.35€ per ounce.

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Gold was valued because it was a necessity of the times. Gold isn’t a pre-requisite for a stable economy which is why we haven’t seen anything change since when Richard Nixon severed the last-standing tie between US Dollar and Gold. Many things made this possible: the world had gotten more stable, global trade had grown exponentially, and for a major economy, the fallout of issuing money irresponsibly had become massive.

Gold still trades around. In fact, it itself has risen exponentially in the last decade. From 1999 to 2011, Gold rose from $256 per ounce to $1780 per ounce, driven predominantly by lack of confidence in the economy as a result of periods of financial crisis.

Gold served a critical purpose once, but today, it doesn’t seem physical limit of a precious metal is necessary for a stable economic system to work.

Even if we were to disregard the violent movements of Bitcoin, it’s hard to be excited about the use of Bitcoin as a store-of-value. There is an evident futility of this goal. If an economic doomsday does arrive, and the US dollars becomes untrustworthy, there would be far more problems than what an alternative currency could solve. The economy doesn’t need an alternative form of Gold and possibly, won’t need in the future.

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