No one can deny there has been a lot of crazy news lately. These kinds of developments often shock the markets.
In particular, the ongoing pandemic has forced the government to increase spending at an alarming rate, a trend which typically adversely affects the U.S. dollar. Whenever the dollar takes a hit, people often look for hedges, ways to defend against lost purchasing power from inflation.
Traditionally, that has meant buying gold or silver. Yet a new kid on the block emerged after the 2008 financial crisis: Cryptocurrencies have become real alternatives to metals as a dollar hedge.
Cryptocurrency advocates believe that crypto is a better alternative for hedging. For one, they argue, decentralization of cryptocurrency infrastructure via blockchain technology gives no entity control over its management.
Gold often is held in governments vaults. Transparency about inventories is nonexistent. Many governments are no strangers to controversy when it comes to potentially corrupt use of stored precious metals.
Crypto, meanwhile, shows promise as an incorruptible alternative. Companies are spending billions of dollars on the development of the core infrastructure of cryptocurrency, known as the blockchain.
Blockchains can be used for more than creating and managing cryptos. They are created with specific functions in mind, such as transferring money or paying contracts. But the cryptocurrencies associated with them often serve as the reward for participating in the infrastructure process.
Currently, Bitcoin is seen as the main crypto coin. Bitcoin proved to the world that digital currencies could not only be used as a hedge but could theoretically replace fiat currencies.
It’s not without its problems, though. Bitcoin was developed as a prototype. As it gains popularity the coin is experiencing growing pains. Transactions are slow. Bitcoin also is not scalable, and there have been no solutions to date to address this issue.
As the de facto standard in the crypto space, Bitcoin has enjoyed a hack-free existence. Yet there have been issues with hacking around coin exchanges, such as the massive Mt. Gox hack among others.
Companies in time will increase budgets for blockchain technologies, which means they will likely find a secure solution for wider cryptocurrency use.
For now, however, the risks raise doubts that Bitcoin, or any other crypto, will soon become a widely used hedge against fiat currencies, let alone a replacement for them.
Comparing gold and cryptos
Both gold and cryptos suffer from high mining costs. One does not have an advantage over the other in this department. There may be a temporary victor, but technology helps to lower costs. This factor is likely to flip frequently.
Scarcity is required to keep the value of a hedging instrument, such as gold or crypto, from falling overnight.
Both hedges are about even on the scarcity factor. Humans have been mining gold for centuries. There does not seem to be evidence that new supplies suddenly will appear, though a rising gold price can goose up investment in prospecting and mine development.
Most cryptos, meanwhile, have a production limit built into their algorithms. For Bitcoin, that number is approximately 21 million coins. There are about 18.3 million in existence now.
Even with its problems, gold has a history as a store of value. Crypto, which is far more volatile, does not — yet. Not many ordinary people have signed up for a digital wallet to hold crypto for them. It’s not clear they even understand the meaning of this concept. Few banks will store Bitcoin, though this is changing.
Digital currencies require all its participants to have the appropriate technology. While companies are taking steps to help people obtain technology, it is far from being solved.
There is little doubt that cryptocurrencies will overcome their obstacles in the future. However, there is a sense of urgency in the world today that is giving the advantage to gold as the hedge of choice. The devil you know is better than the devil you don’t.