Bitcoin Surpasses Gold: What It Means And What It Doesn't

in #bitcoin4 years ago

by James Corbett
March 5, 2017

Cast your mind back to February 2013. It was a chaotic month for metals traders.

Indeed, as I noted at the time, the silent gold rush was continuing apace and those in the know were keeping a close eye on the precious metals markets.

But there was another story that was taking place at that very moment. A story that, in retrospect, may prove to be more important than any of those just mentioned. Bitcoin reached parity with silver.

Specifically, the price of one bitcoin equaled that of an ounce of silver for the first time on February 19, 2013.

And just this week, the price of one bitcoin equaled (and quickly surpassed) that of an ounce 0f gold for the first time. (Well, OK, the second time, but in retrospect Mt. Gox's valuation didn't count, did it?)

So what does this milestone mean?

To start on an answer to that question, it might be helpful to look at an even simpler question: How is the spot price of gold and bitcoin determined, anyway? In fact, these are two separate questions with two very different answers, and that in and of itself is very telling.

Although remarkably few know it, until 2015 the gold spot price that set the benchmark for traders around the world was not a number arrived at through some automatic algorithm averaging bids and asks on an exchange somewhere. No, it was set in a bizarre ritual conducted by a company literally known as "The London Gold Market Fixing Ltd." The Gold Fix, as it was called, was a twice-daily meeting that took place between participating members of the London Bullion Market Association, including (of course) Nathan Mayer Rothschild & Sons. When the fix formed in 1919, and until Rothschild pulled out in 2004, the meeting took place in a wood-paneled room at Rothschild's office on St. Swithin’s Lane in London’s financial district. After that point it became a teleconference, still held at 10:30 AM and 3:00 PM London time each day.

The meeting itself followed a bizarre and arcane ritual:
"The gold fix usually begins with the chairman declaring a gold price which is very near the ongoing spot market gold price. Then, the participants will decide to erect flag or not based on their customers' supply and demand. Until all of the members' flag is put down, the gold price is fixed. Otherwise, the chairman must change the proposed price."
[caption id="attachment_22025" align="alignleft" width="319"] What...don't you trust them?[/caption]

But (gosh darn, wouldn't you know it?!) it was discovered to be a huge scam when, nearly one century after it began, the whiz kids in the financial world finally realized that the traders in the meeting could use their advanced knowledge of the yet-to-be-announced new gold price to their advantage. The financial fake news media finally woke up and took notice after the U.K. Financial Conduct Authority launched an official investigation into the scam and everything unwound shortly thereafter. (ZeroHedge's piece on who, exactly, was participating in the fix, was a particularly interesting tidbit to emerge from the scandal.)

Now the Gold Fix has been replaced by the LBMA Gold Price operated by the not-at-all-shady ICE Benchmark Administration and everything is hunky dory in gold price fixing world. Now, instead of a closed-door conference of a few powerful banking interests, the process is "independently administrated, tradeable, electronic and physically settled, conducted in dollars, with aggregated and anonymous bids and offers as well as being published on-screen and in real-time."


The price of bitcoin, on the other hand, is at once a more transparent and less tangible figure.

Like everything else with bitcoin, there is no central coordinating body or authority, meaning there is no single price of bitcoin. There are many different exchanges where people are buying and selling bitcoin, and each exchange has its own price based on the bids and asks taking place in their own internal marketplace at any given time.

Organizations like Coindesk have taken it upon themselves to create the Bitcoin Price Index (XBP) which calculates the midpoint of the bid/ask spread on a number of leading exchanges. But while this is automatic, electronic, transparent and instantaneous, it is by no means definitive. As the XBP FAQ explains, its use of a midpoint average instead of a volume-weighted average is an essentially arbitrary decision, taken because "the bitcoin market currently lacks sufficient depth and regional liquidity." And what exchanges does one choose to include in such an index? Again, although few would dispute that the exchanges included in the XBP are the "leading" exchanges in a volume sense, exactly where that cutoff lies and what criteria might go into deciding which exchanges to include or reject from the average is, again, arbitrary.

This may seem trivial, but it reveals an important truth, one that is often forgotten when traders are looking for the spot price of any commodity, be it bitcoin or gold or oil or anything else. There is no inherent price for any of these goods. There is only what someone is willing to pay for it.

Which brings us back to the question: What does the recent bitcoin/gold price crossover actually mean?

On its simplest level it means that at this moment traders are willing to pay more of one type of currency (USD) for one bitcoin than they are for an ounce of gold.

But that doesn't tell us very much, does it?

So, more to the point: Why are people willing to pay more Federal Reserve notes for a bitcoin than an ounce of gold? What has changed recently to make this crossover in the price chart occur?

[caption id="attachment_22026" align="aligncenter" width="499"] Just a regular day in bitcoin trading[/caption]

The movement has been largely on the bitcoin side. Bitcoin was stuck in the $400 price range for the first half of 2016 before suddenly breaking out in June. With characteristic large intra-day swings and rapid movements, the price has been trending up ever since, with only two large pullbacks. As I write this, bitcoin is looking set to challenge the $1300 mark for the first time.

What accounts for this upswing? Two main factors have been pointed to ad nauseam in the press:

  • Continuing strong interest from China, where bitcoin has, until recently, provided a convenient way for Chinese investors get around stringent capital controls.
  • A surge in interest from countries rocked by monetary uncertainty, like inflationary Venezuela and post-demonetization India.

But anyone who purports to be able to tell you exactly what accounts for these wild movements is either lying to you or lying to themselves. In 2014 a poll was taken of 50 bitcoin "experts" asking them what they thought the price of bitcoin would be by the end of the year. The results were not only uniformly wrong, but laughably wrong.

Part of the problem is that bitcoin is still a tiny currency by any measure. As The Financial Times points out:

"For context, the Central Intelligence Agency put the planet’s stock of broad money—notes, coins, and various forms of bank account—at $82tn as of the end of 2014. On the CIA figures, the value of bitcoins hashed into existence is similar to the broad money total for Uzbekistani soms. With apologies to Tashkent, the value of soms and bitcoins, and the number of people for whom they are relevant pieces of information in the world of modern finance, both round to zero."

Just as a tiny leaf can be blown around in a light breeze, so too can a tiny currency suffer wild price swings from relatively minor disturbances. Bitcoin is certainly prey to that. And, more ominously, a smaller market is more easily dominated by a few big players, and there are certainly large bitcoin holders capable of making large transactions that can have a large impact on the market.

For these reasons, betting on bitcoin to continue its remarkable ascent in an unbroken manner would be foolish to say the least. The biggest lesson from the cryptocurrency's previous smashing of the $1000 barrier in 2013 is that, once the hysteria died down and the price fell, the market eventually returned to the near-$200 mark that it had been at right before the price took off. From there, it began a more-or-less steady climb toward $400 before the latest craziness set in. If we were just using the previous era of bitcoin mania as a guide, investors would be looking for a return to the $400 mark after the bottom falls out.

But there are some very large warnings that things may never return to any semblance of normality for bitcoin. Not only is there The Coming Bitcoin Clampdown that we discussed last week, but there is an even more fundamental question about the future of the cryptocurrency: the block size. I will spare you all the technical details, although those who are serious about delving into the real question of bitcoin's utility and future potential are invited to explore the subject at length. Unfortunately, that may take a great deal of time because the subject is becoming more complex by the day.

Suffice it to say: For technical reasons the bitcoin network can currently only handle about 7 transactions per second. Visa, by comparison, routinely handles thousands of transactions per second and, in a pinch, can accommodate up to 56,000 per second. If bitcoin's true purpose is to be an electronic payment system, it is about to spectacularly fail at that mission. In fact, it already is; transactions that used to be nearly instantaneous and nearly cost-less are becoming slower (taking hours or even days to be confirmed) and more expensive.

For gold, the known commodity with a track record of thousands of years, these types of considerations do not apply. As we've discussed before, gold certainly has its own problems, specifically in the manipulation of the spot price. But for precisely that reason, seeing the price collapse to zero or shoot into the tens of thousands of dollars in the blink of an eye seems exceedingly unlikely.

So once again, it comes back to the basic philosophy behind the question of "value." Are you interested in the value of gold and bitcoin as measured in US Federal Reserve notes? Are they just another commodity to be used to turnaround a quick buck? If so, then by all means, study the charts, look for the patterns, find your opportunities and enjoy the game.

But what if the "value" of gold or bitcoin is not measured in government fiat, but in their own potential as monetary instruments? After all, the US dollar will not outlast the US government (in its current form, at any rate), but gold will and bitcoin might. And if these instruments are not investments but hedges, that changes the meaning of their "value," doesn't it?

Again, a monumental post containing great information that concerns us all! Simply said, WOW!!!

Thanks for sharing all of it with us and giving it exposure through this platform, it is highly appreciated. I'm going to go to bed less of an idiot today again, joy!

All for one and one for all! Namaste :)

Thanks for a great post. Your last paragraph certainly sheds light on the topic for sure.

Interesting thoughts, good post, resteemed.

Very well written. More of the philosophy of value!

Nice post. Still trying to understand the Bitcoin craze and this gives some good insight.

After only just discovering Steemit, one of the first searches I placed on the site was "James Corbett", whom I am very familiar with. This article was returned amongst others, and I am glad to have found it! Very well written, full of source links and informative to everyone. As always, with James, we come away knowing we are better off, for having read it.