The GoldSilver Team
Could any two investments seem more different than precious metals like gold and silver versus digital currencies like Bitcoin, Ethereum, Ripple, Litecoin and their numerous brethren?
One is dug from the ground, forged in flames and hurts like heck when you drop it on your foot. The other is purely digital, created by computers crunching complex equations, existing only in bits and bytes.
Yet they actually share a great deal in common. The original cryptocurrency, Bitcoin, was even purposefully designed to mimic some of gold’s unique natural properties. You even “mine” for new Bitcoin digitally like people mine physically for gold, and the supply is purposely limited. Because they have a lot of similarities, they appeal to many of the same investors.
Still, for all they share, precious metals and cryptocurrencies are very different assets that serve vastly different purposes in an investor’s portfolio. It’s useful for investment purposes to understand these differences. For the sake of simplicity, we’ll stick mostly to the Model T’s of both metals and cryptos: gold and Bitcoin. We’ll also touch on fiat currencies (“cash” to keep things simple), silver and alternative cryptocurrencies (i.e. “alt-coins”) when fundamental differences also apply.
In the end, gold and other precious metals have long served a role in portfolios. Bitcoin and alt-coins are emerging as a powerful innovation, both as a possible complement to — and, in thus far rare circumstances, a replacement for — cash or precious metals in many applications. As the market comes to grips with cryptos, however, it’s increasingly clear there is a place for each in the world, and none of them — not cash nor gold nor cryptocurrencies — are going away anytime soon.
But how to invest in them remains a question that many people need answered. We’ve put together this guide so everyone who’s considering buying gold or wondering how to buy Bitcoin can understand the advantages of each and what role they play in your wealth. Some of the topics we’ll cover include:
So, let’s start with what makes each unique. Then we’ll compare those features side by side for an easy illustration of where both fit in a portfolio.
The appeal of gold as the oldest continuously used form of money on the planet — in use for millennia — is not just a function of tradition, but of gold’s unique properties. Many a treatise has covered the case for gold in depth. But, to sum it up, gold has stood the test of time for a few key reasons:
Gold’s unique physical properties have long made it an ideal form of coinage. Since the times of ancient Egypt and ancient Rome, and even well before, it has been accepted as a reliable store of wealth. This history alone has turned gold into a modern economic asset with trillions of dollars’ worth in circulation, trading hundreds of billions of dollars every day around the globe.
Gold is, simply put, where the wealthy — from nation-states down to savvy individuals — store the portion of their wealth they want to keep safe from political turmoil. It’s been passed down from generation to generation. It performs as a safe haven asset when other markets crash or local currencies collapse. It is, in financial terms, the ultimate hedge — the preeminent insurance policy against black swans.
Bitcoin was designed to share many of gold’s unique properties, and even one-up it in some interesting ways.
Cryptocurrencies like Bitcoin allow people to transact with each other, using the internet, anywhere on earth and trust the results as fraud-free.
In the original 2008 whitepaper, its pen-named author, Satoshi Nakamoto, described:
“A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. Digital signatures provide part of the solution, but the main benefits are lost if a trusted third party is still required to prevent double-spending. We propose a solution to the double-spending problem using a peer-to-peer network. The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work, forming a record that cannot be changed without redoing the proof-of-work.”
In other words, Bitcoin uses cryptography — the same branch of computer science and mathematics used to protect electronic communications from the military to your bank’s online password — to ensure coins cannot be copied or counterfeited. Unlike with cash, or even a bar of gold, in theory, you can be sure the bitcoin you received is real in a matter of seconds. (In practice, Bitcoin can take hours to verify this, and there are some underappreciated risks of its peer-to-peer design. Still, it’s an amazing innovation.)
Bitcoin’s use of cryptography to achieve these goals allows for some interesting side effects. For example, the use of “public key” and “private key” digital signatures (the same basic technology behind a secure connection from your browser to a website) is like having two account numbers: one for deposits, and another for withdrawals. The only thing other people can do with your public key is send funds to you. It’s your private key that gives you access to send funds, and you need not ever share it with anyone. You could put your public key on a billboard if you wanted to and your funds would still be secure — without your private key, money cannot be withdrawn.
However, this also means that, just like gold and cash, whoever last took possession of a coin is the official, sanctioned owner of that coin — even if by hook or crook.
“Mr. Takagi, I'm not really interested in your computer. But I need the code key, because I am interested in the $640 million in negotiable bearer bonds that you have locked in your vault. And the computer controls the vault.” – Fictional villain Hans Gruber, Die Hard, 1988
Just like cash in your wallet, or gold in a home safe, Bitcoin makes a tasty target for would-be thieves. You must keep your Bitcoin private key exactly that, private, to prevent your coins from being stolen. Its security is entirely your responsibility. And once it is lost, there is little hope to recover it, as the recipient can spend/sell it just as easily as you could.
That’s because Bitcoin is another “bearer” instrument. Whoever possesses Bitcoin — or gold or cash — owns it and can claim its value, short of an intervention to physically repossess it.
Long before the age of computers, when companies issued bonds or stocks, they were bearer instruments. You showed up at the right place with your bond in hand, the issuer checked to ensure it wasn’t counterfeit, stamped the certificate as paid, checked off the same on their own book and paid you the interest. This is why Hans Gruber wanted those bonds bad enough to hold those people hostage for hours at gunpoint: He could show up and collect the cash with no questions asked.
Bearer bonds went the way of the dodo with the electronic age. Instead, big Wall Street firms and their ilk started to keep those types of documents centrally, with firms like the Depository Trust & Clearing Corporation (DTCC) in the U.S. and local equivalents around the world.
The clearinghouses could record when items changed hands, when interest was paid, etc., all without the certificate ever leaving the safety of the ultra-secure vault. Then computers came along and the DTCC morphed with them into an almost purely digital firm with the same purpose of updating ownership and debt records without the need to physically transfer bearer instruments.
In a way, Bitcoin takes us back to those times. As a pure bearer instrument, if a thief gets hold of your coins, you’ll likely never get them back. For this same reason, most people keep their money in a bank, or their gold in vault storage. It’s safely held by professionals and easy to transfer electronically.
Similarly, many Bitcoin users choose to keep their private keys in online services. But, like the early days of deposit banking, these upstart institutions have found themselves the targets of unscrupulous robbers who will go to great lengths for that bounty. And, with their digital nature, there’s no need to lug around heavy bars or keep a getaway car running — often only seconds of vulnerability is enough for a robber to get away scot-free from halfway around the globe.
For example, thousands of users have seen their holdings stolen when those online services were hacked. To name just a few of many examples:
A portion of the funds from these hacks have been repaid, but most has not. It’s all come down to whether the companies trusted with the money had the resources to cover the hack out of their own profits. Unlike a bank for cash or a vault for precious metals, none of these crypto companies are required to, or even able to, carry insurance on their “deposits”. And for many customers, legal action is not feasible as they were often dealing with companies based in questionable, foreign jurisdictions like Slovenia. Who, exactly, are you going complain to?
When storing digital currency with a third party you should take the same level of precaution you would in, say, choosing a vault provider for gold. Among other factors:
One advantage some users seek from cash and gold is privacy. While there is no such thing as a truly private transaction, no electronic record necessarily needs to be created that records who paid whom and where/when. For some people, that is important.
Bitcoin, on the other hand, requires that very information — who and where and when — to function. Which means it’s not particularly private without its users going to great lengths to obfuscate themselves. This surprises some crypto investors, as they assume they’re anonymous, just like they can be in a web discussion group. But with Bitcoin, each and every transaction ever completed is recorded on its public ledger, including both the sender’s and receiver’s wallet addresses and digital signatures, authenticated by their public keys to prove it was actually them. While wallet addresses are just random numbers, once someone knows your public key, they can find every transaction you’ve ever completed on the network — your wallet is just a pseudonym like the pen-name of an author.
If a government comes knocking at your favorite crypto-exchange or online wallet looking for your public key, it won’t be long before they can backtrack all of your activity. Similar techniques have already been used to jail a few notorious “darknet” criminals.
Many popular services try to engineer around these limits by generating multiple wallets for every Bitcoin user, even a new one for every transaction. But access to the service and its records would quickly pierce through that — providing some public privacy, but no protection from something like a subpoena.
Some alt-coins have attempted to provide complete privacy through the added use of cryptography. However, few are particularly popular as of this writing, and while they have convincing math which claims to prove their anonymity, none have been tested on a widespread scale by the ever-devious and creative hacker.
More on Bitcoin & Cryptocurrency
If you’re looking to learn more about how Bitcoin and other cryptocurrencies work, check out the eighth episode of Mike Maloney’s smash hit docu-series, Hidden Secrets of Money: The Cryptocurrency Revolution. In it, you can follow Mike’s own personal quest to understand the fascinating new technologies.
Gold’s primary purpose in most portfolios is as insurance — something that’s value is generally stable most of the time and is on standby to serve a specific purpose when needed.
In other words, gold is boring. And that’s how you want it. Between more speculative assets, whose value changes with the whims of traders, like stocks, bonds and even currencies, gold is meant to be a stalwart. You buy it, pop it in a safe and hold it.
Bitcoin, on the other hand, has been nothing but excitement for quite a few years:
As you can see below, compared to gold, Bitcoin is a highly volatile asset, the kind that speculators and gamblers alike are really drawn to. Until it finds wider commercial uses and more buy-and-hold-minded investors, it’s likely to remain that way.
The takeaway is simple: Gold, with its stable of long-term-minded investors — from the world’s largest governments to the generational wealth of family offices — has a history of retaining its purchasing power with relatively low volatility over many decades. Most of the time.
But don’t mistake gold’s normally low volatility for a non-performing asset. When economic or monetary conditions deteriorate, gold’s role as a hedge moves to the fore and shields investors from losses.
This was a wakeup call for many investors come the market crash of 2008, for example. You’ll recall how hard many investments were hit at the time during the extreme, pervasive uncertainty around the globe. While the gold price initially fell in tandem with stock and bond markets — due largely to liquidity needs at the time drawing money out of all assets — it ended 2008 up 5.5 percent. And over the next three years, it nearly tripled, eventually gaining four times the amount the markets lost.
The same thing happened in the late 1970s — during a period of two recessions, an energy crisis, sky-high interest rates, runaway inflation and a flat stock market, gold rose over 700 percent from its 1976 low to its 1980 peak.
There are many examples from history like this, where gold buoys and sustains a portfolio precisely when most other investments are failing or at least underperforming.
Wall Street types call this inverse correlation, or low beta, which means it tends to move in the opposite direction from the stock market. And it’s why you’ll find a bit of gold on every heavy hitter’s balance sheet, from the U.S. Federal Reserve to Goldman Sachs.
What you may not know is that Bitcoin was born in part as a reaction to that market panic and volatility of 2008. Investors who saw fiat currencies pumped into the banking system to save it, when those very banks appeared to have caused the crisis, grew frustrated. They sought out ways to insulate their savings from the political class in many ways, from returning to gold in large numbers to the invention of cryptocurrencies.
The valiant goal of Bitcoin was to make a digital asset that mimicked the best attributes of gold without its notable downsides (like the inability to make a piece of pure gold worth a penny or two that’s any larger than dust — a piece of gold the size of a penny fetches a few hundred dollars U.S. these days).
Unfortunately, Bitcoin hasn’t been around quite long enough to know how well it will fulfill its self-anointed role. For instance, we’ve yet to see how it will act during a market crash like 2008. Despite its roots, Bitcoin’s initial rise occurred in tandem with almost all other assets in the world, from the U.S. dollar to global stocks and bonds, rising to historic proportions in one of the longest bull markets of the modern era. Meanwhile, gold prices have dropped by one-third during that time.
If that massive growth in asset values reverses, and liquidity dries up, what will become of Bitcoin’s price?
Art Imitating Life Imitating Art
Bitcoin partly inspired sci-fi/fantasy author extraordinaire Neal Stephenson’s action thriller novel, REAMDE. In the novel, a video game’s digital currency, based on those favorite physical properties of gold among independent money advocates — limited in amount, and progressively more difficult to mine — becomes the most stable currency in the world as governments all fall victim to their own greed.
People trade into and out of the digital currency from their local ones, through the online game’s marketplaces, creating an ad hoc global ‘forex’ market. One that international criminals then depend on for their ransomware demands… sound familiar?
Yet some have suggested Bitcoin itself was inspired by another, earlier book also by Neal Stephenson, Cryptonomicon, about the founding of an independent digital currency that is purely digital… but backed by gold once stolen and ferreted away by the Japanese during WWII and unearthed decades later by intrepid ‘white hat’ hackers. Of course, we cannot interview the Bitcoin whitepaper’s author(s) to validate, but what an ironic twist that would be.