Bitcoin and Gold: Valuation of hard-cap currencies in times of financial crisis

How would a bitcoin economy react to coronavirus? At the moment we don’t know. However, we can turn to a proxy for some insight: gold.

Bitcoin’s “digital gold” narrative (BTC) has held up well due to the cryptocurrency’s low delivery schedule and a hard cap of 21 million bitcoins. The theory of how a gold-based economy would react to an external shock such as the current global pandemic lends itself, in turn, to a look at a future Bitcoin economy.

As CoinDesk reported on Monday, both Bitcoin and gold rose on news from the Federal Reserve, which provided an indefinite amount of aid to the private market. From a supply perspective, both assets stand still as the Fed feverishly seeks to outperform COVID-19.

“The Federal Reserve will continue to purchase treasury and mortgage-backed securities from agencies in the amounts necessary for the proper functioning of the market and an effective translation of monetary policy to broader financial conditions,” the central bank said on Monday.

Given the inflation concerns of such a policy, what would an alternate world look like – where infinite supply depresses the value of the US dollar? What would the macroeconomic history be in a world where bitcoin or gold dominated as a medium of exchange?

Gold during downtime

For one thing, the value of gold-based money would not artificially increase, Mark Thornton, Austrian economist at the Ludwig von Mises Institute, told CoinDesk. (However, mainstream economists fear that in times of financial collapse, central bankers would have far less leverage to operate them.)

As in any market, the value of gold is determined jointly by supply and demand, but has natural limits on the amount delivered in any given year. On average, the amount of gold mined each year is around 2 percent of the total known gold supply.

In fact, the price of gold has risen in recent years largely because the price of gold is expressed in dollars, Thornton said. As the amount of dollars in the market increases, so does the price of gold.

In addition, gold – a safe haven – serves as a hedge against inflation in financial crisis environments like now. In the long run, Bitcoin proponents like Messari co-founder Dan McArdle believe that the conservative properties of BTC will bring long-term value similar to that of gold.

For Austrian economists like Thornton, the value of gold is based on the economic theory that the Austrian school founder Carl Menger first put forward in “Principles of Economics” (1871). To sum it up briefly, Menger said that everyone subjectively determines value, while society creates a price that can be bought or sold in the open market.

The value of gold can easily be demonstrated by its continued use as a store of value, especially during recessions or financial crises.

“The delivery schedule for gold is relatively stable. The amount of gold shipped is a response to the demand for gold and its price, ”Thornton said.

A gold based economy

But how would a gold-based economy differ from our current economy? A stable medium of exchange would force people to be more responsible with the money they have, Roy Sebag, co-founder of precious metals manager Goldmoney, told CoinDesk in an email.

This responsibility would have two outcomes: A stable money supply would make it difficult to pile up large corporate debt, which limits the dangers of a 2008-style financial crisis. But it would also help distribute wealth more efficiently in the economy than current systems, Sebag said.

First, Sebag said that a fiat-based system known to inflate currency to protect against business failure is causing companies to take on too much debt. (Think of commercial airlines who buy back stocks during troubled times instead of investing in their services, which some might consider a moral hazard.) Sebag says his position is easy to see today on Capitol Hill – where Congress has a billion dollar bill Incentive weighs package with protection for companies like Boeing.

“Under a gold standard, leveraging a balance sheet is a risky undertaking under all circumstances,” said Sebag.

Instead, mistakes could happen – but they wouldn’t get so colossal at all. “Failure is common and resilience is becoming an integral part of defining wealth,” said Sebag of what a gold-based system would look like.

See also: Bitcoin, Gold Spike as Fed Reveals Unlimited Coronavirus Stimulus Package

Second, if people were able to plan financially over long time horizons, retirees would not be left in a precarious position every time the economy blows. Sebag goes so far as to suggest that the elderly would stimulate the economy during a recession rather than be knocked down by it.

In fact, the Dow Jones Industrial Average has lost over 30 percent since its peak in February 2019. Many people’s retirement provision is under water.

A gold economy, Sebag said, would allow people to plan for the future using a key metric: the interest rate.

Historically, Sebag said, the natural rate of interest – which means the cost of future money if it wasn’t set by a government – has been around 5 percent. Compare that to the Federal Reserve’s decree and periodic percentage declines: It’s difficult to plan for the future if you don’t know what value your wealth will be in six months’ time.

Two extremes

A Bitcoin economy is ridiculously distant from the mainstream perspective – even more so than a gold-based economy. Bitcoin’s market cap is under $ 200 billion, while the Dow hit as much as $ 8 trillion in December 2019. The current market capitalization of gold is $ 9 trillion.

However, savings-based money like gold or bitcoin becomes more attractive when Fed and Washington lawmakers push for fiscal extremes.

“In a gold-based economy with no interest rate manipulation, taxes, etc., people would have a lot more savings and far less debt. But now, with Fed inflation and paper money, we have very little savings and huge debts, ”Thornton said.

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