Is Bitcoin Digital Gold? A Look At The Data

Posted: Apr 03, 2018 10:21 AM
Is Bitcoin Digital Gold? A Look At The Data

It seems pretty clear that Bitcoin was designed to act something like a digital form of gold. After all, new Bitcoins are 'mined', not created. The original white paper which laid out the algorithmic basis of the cyber-currency focused on supply limitations, which is the traditional argument for gold backing for currency and against fiat money.

So does Bitcoin actually act like gold? The answer is a bit more complicated than you might think.

It sometimes acts like gold and sometimes does not.

For example, the following scatter chart shows the correlation between Bitcoin prices and gold prices in a November.

The fit is good, which means that the data points like close along the line. The slope is upward, which means a positive correlation. A positive correlation means that the prices of Bitcoin and Gold moved in the same direction by and large. A negative correlation would indicate that they moved in opposite directions.

Unfortunately, December of 2017 and January of 2018 provide good examples of negative correlations.

This means that as of last December the price dynamics shifted dramatically from a pattern of Bitcoin tracking with gold to one with Bitcoin tracking against it.

What does this mean?

It means that investors are still deciding what Bitcoin is. The more recent data show that they are moving away from the original vision of the Bitcoin founder, to some different vision. Why might they do that?

I would suggest that there are significant ways in which Bitcoin is not gold, which investors eventually figured out. One of the most important features of gold is that almost every ounce of it ever mined is still available to us. Sure, once in a while people lose gold, and in addition, small amounts of gold jewelry are buried with loved ones (though over the aeons, more of that than we'd like to think, have gotten reclaimed and reinserted into the economy by grave robbers - yuck).

But the ratio of new gold production to gold base is very, very low. My friend, the economist and gold and silver trader, Keith Weiner taught me that. That is not remotely true for Bitcoin. All the Bitcoin base is newly produced. Annual production of Bitcoin is high relative to base. This makes Bitcoin far more volatile that gold because it makes the total world reserve of Bitcoin much, much more variable than the world reserves of gold. It's not even close. We'll have more specific analysis of this particular point in a separately published piece here - it deserves its own treatment.

What a short course on Bitcoin vs. gold price dynamics. This one is free and less than 7 minutes long. It deals with advanced topics but in ways which beginners will readily understand. And it doesn't stop with gold, it also explains the relationship between Bitcoin and the dollar.