Cryptocurrencies and Bullion: How they compare

By Larissa Fernand |  24-04-19 | 
 
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Larissa Fernand is Website Editor for Morningstar.in. She would like to hear from you and welcomes your feedback.

The cryptocurrency revolution has been referenced many times. While critics and skeptics abound, and no one really has a clearly articulated vision of the future of cryptocurrencies, we can safely assume that its here to stay.

Just for perspective, did you know that four Iranian financial institutions – Bank Mellat, Bank Melli Iran, Bank Pasargad and Parsian Bank, have plans to issue a cryptocurrency token backed by Gold? This is a development over the news last year that Iran might develop a national crypto as a means to bypass new economic sanctions enacted by the U.S.

If that does not interest you, Apple accepts legitimate cryptocurrency.

I guess the point is made, the relevance of cryptocurrency is on the rise.

If you have been living under a rock, here’s what you need to know. Simply put, cryptocurrency is a form of payment that can be exchanged online. Instead of a tangible piece of currency in your wallet, a cryptocurrency is a digital asset. Being a medium of exchange, it serves the same purpose as tangible currency. The "crypto" aspect implies that it uses cryptography for security and verification during transactions.

In this space, Morningstar’s vice president of research, JOHN REKENTHALER, tackles just one angle: the similarity between cryptocurrency and bullion. Both would behave differently from both stocks and bonds, thereby delivering diversification, and are far easier to trade that most tangible assets such as antiques or collectibles.

1) Neither distribute cash

The first question of an investment is what cash it distributes.

  • bank accounts and debt issued by creditworthy organizations
  • assets such as dividend-paying stocks, junk bonds, and rental property that also carry yields but are less certain to meet their obligations
  • securities that pay no cash today but may do so in the future
  • issues that will never disburse cash.

Warren Buffett is delighted to own categories 1 and 2, is leery of 3, and won't touch 4. In a similar vein, investment analysis traditionally applies only to income-generating securities. No payments, no calculations. (That approach is loosened for the stocks of firms that do not pay dividends, by using their free cash flows.)

Cryptocurrency finds itself in group 4. As with copper ingots, seashells, peacock feathers, and gold, cryptocurrency is a medium of exchange, rather than something that creates wealth on its own. It can be used to purchase cash--but it does not earn it.

Assessing cryptocurrencies by calculating the value of their future payments is therefore a dead end. If cyber coins can be appraised, even tentatively, another approach must be found.

2) Both have value

Throughout history and across societies, gold (and gem stones) have been reliably been prized. Besides, there are practical applications. For example, about 10% of annual demand for gold is directed toward industrial and medical needs. However, these uses have only a small effect on the commodity price. The value comes predominantly from pleasing people visually, or from serving as a form of currency.

While cryptocurrencies boast no beauty, they have significant value. They provide security and confidentiality in financial affairs. Some prefer not to use conventional currencies on personal grounds, because they mistrust federal governments.

The motivations are unimportant; the point is that if cryptocurrencies did not exist, somebody would surely invent them. They meet a demand, which puts a floor on their prices. If cryptocurrencies continue to function properly, so that neither technological changes nor government regulations invade their privacy, they in aggregate will be worth far more than zero.

3) Supply of both are affected by the development of new mines

Cryptocurrency vendors can control their own supply, but they cannot prevent competitors from entering the business. There is no theoretical limit to how much cryptocurrency may be mined, and seemingly not much of a practical limit, either. CoinMarketCap, a crypto tracker, lists 2,103 currencies on its website. Anybody can enter this industry.

That makes calculating cryptocurrency prices based on usage extremely difficult, if not impossible. Even if somebody could accurately measure aggregate customer demand, which has not been done and which will not be happening anytime soon, the supply of cryptocurrency is highly fluid. And the danger is real.

From 1500 through 1800, the price of gold in British pounds declined by 80%, largely because of increased supply from the New World.

4) Both have investment advantages

Gold and cryptocurrencies have major investment advantages over competing tangible assets--collectibles such as art or vintage wine. Gold (through exchange-traded funds) and cryptocurrencies can easily be traded, with very low commissions. Their rivals, of course, boast neither attribute. They can be disposed of only with difficulty, and at a high cost.

In many respects, cryptocurrency resembles gold bullion. It doesn't throw off cash; it carries properties that many find valuable; and its supply is affected by the development of new mines. Gold has the edge of being tangible. In addition, its supply is relatively fixed. However, cryptocurrencies have compensation, in that people wish to use them. They fill a commercial role.

When it comes to beauty, gold scores. No matter how attractive you find cryptocurrency as part of your financial portfolio, cryptocurrency earrings will not be surfacing in jewellery stores any time soon.

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