Blockchain and Gold: Compliments or Substitutes?

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Many early adopters of Bitcoin and other cryptocurrencies were people who oppose a system of government fiat money, and therefore also have a longstanding interest in gold. These overlapping interests have inspired many interesting conversations about cryptocurrencies’ potential as either complements to or substitutes for gold. We’ve previously discussed the complementary role that the blockchain technology powering cryptocurrencies can play with gold, by enabling easy and secure transfers without physically moving the asset. But others have argued that by enabling currencies without governments, blockchain technology provides the same benefits as gold-backed money. However, this view misses several key factors that make Bitcoin and other digital currencies at best imperfect substitutes for gold. In what follows, I’ll directly compare gold and Bitcoin, but the ideas mostly apply to other cryptocurrencies as well.

Those who think of Bitcoin as a substitute for gold-backed money cite the limitations on new coins and the economic incentives programmed into its algorithm. Bitcoin’s code limits the number of coins that can exist to 21 million in an effort to prevent the inflation endemic to fiat money. Until that limit is reached, miners can create new coins at an ever-increasing cost, mirroring the naturally increasing marginal cost of mining gold. The argument, therefore, is that bitcoins are scarce resources that lead to a world of sound money.

However, one topic not discussed enough is that the limit of 21 million bitcoins could absolutely be exceeded if miners reached a consensus to change the underlying computer code. While the current debate around scaling Bitcoin shows that gaining consensus is difficult, once the 21 million limit is reached the incentives for miners to raise the cap and reap seigniorage revenue will be immense. This highlights a significant difference between Bitcoin and gold: the supply of gold is constrained by nature while the supply of bitcoins ultimately rests with decisions made by people. Bitcoin is harder to inflate than fiat money, but far easier to inflate than gold.

Another desirable aspect of gold is people’s trust and expectations that it is a valid currency. This comes from its long history as both a currency and an object of intrinsic value. For the vast majority of the population, Bitcoin lacks such attributes. While attitudes about technology always evolve with time and new generations of people, it is hard to imagine Bitcoin fully catching up in this regard.

Advocates of Bitcoin over gold tout its “decentralization,” which some believe compares favorably to the need to keep gold in banks or secure warehouses. However, the current debate among Bitcoin stakeholders about how to facilitate more transactions on the network is teaching some the hard lesson that more centralization is unavoidable if Bitcoin is to be widely used around the world.

None of this means that supporters of gold-backed money should avoid cryptocurrencies or that cryptocurrencies are a bad idea. Quite the opposite: as mentioned above, the technology can help bring gold into the modern era and, as Newscape Group CIO Charles Morris notes in the June issue of Gold Investor, increase its liquidity. As with many new and unfamiliar technologies, it is wise to maintain an interest in cryptocurrencies while still questioning some of the hype.

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Max Gulker

Max Gulker is an economist and writer who joined AIER in 2015. His research often focuses on free markets and technology, including blockchain and cryptocurrencies, the sharing economy, and internet commerce. He is a frequent speaker at industry conferences, especially on blockchain technology. Max’s research and writing also touch on other economic topics, including governance, competition, and small businesses.
 
Max holds a PhD in economics from Stanford University and a BA in economics from the University of Michigan. Prior to AIER, Max spent time in the private sector, consulting with large technology and financial firms on antitrust and other litigation. Follow @maxgAIER.