Could Cryptocurrency Ever Challenge the Gold Standard?

Bitcoin is often defined as digital gold because it is finite in number (21 million), and the fact that it has to be “mined” like gold. Recently, bitcoin prices surpassed the $66,000 mark, and bitcoin’s market capitalization became $1.3 trillion. Crypto advocates and enthusiasts like the billionaire investor Paul Tudor have compared crypto with gold again. He remarked that cryptocurrency is a better hedge against inflation than gold. Not backed by any government authority or central banks, cryptocurrencies are truly decentralized in nature. Their value does not depend on inflation and government control. This makes them autonomous to an extent. Given this bullish signal, more and more investors are looking to invest in cryptocurrencies to diversify their portfolios.

On the other hand, gold has been the standard for other currencies, i.e., different countries fixed their currency to a specific amount of gold. Gold was a valued asset and a store of wealth. This system was later changed during World War 2, after which the US dollar became the standard currency. However, an ounce of gold had a fixed price of $35 even at that time. In 1971, President Nixon ended the system entirely and abandoned the gold standard. He announced that the US would no longer exchange dollars for gold held by foreign governments. Thus began the decline of gold. Nonetheless, it is still a valuable asset, and central banks still hold large reserves of gold, making it the bedrock of the financial system.

So, could cryptocurrencies ever become the new gold standard of the world? In other words, could cryptocurrencies ever become the reserve financial system of the world, the way that gold presently is? Some financial experts believe that cryptocurrencies could one day become a de facto “digital gold” standard upon which the world’s economic systems depend for financial guidance and future direction. Will governments, corporations, and heads of state look towards the digital gold-like comforts of cryptocurrencies as a way to reliably store them in havens as caches of value? And unlike gold, cryptocurrencies are incredibly accessible to anyone who wants to buy them. Cryptocurrencies are easier to buy, trade, sell, or invest for the average investor under preferable market conditions, unlike gold. Anyone with a computer can buy cryptocurrencies. You need a lot of money to buy a significant investment of gold.

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The accessibility of cryptocurrencies is a significant factor to consider when contemplating whether or not they could challenge or become the new gold standard. And “accessibility” is a keyword. What usually keeps the average person or investor from participating in the traditional financial market. Most Americans are not familiar with how domestic and international financial markets work. And the average non-investor is not familiar with the various ways that money moves around the world. It is expensive to move caches of gold stored in banks, vaults, and international financial havens. However, many financial deals can be struck based on the amount of gold in the world, the contractual shifting of ownership based on such, and the projected value of gold in the future.

The point is that even though there is no gold standard tethering of the precious metal against physical currencies anymore, the world still values gold. Unfortunately, by eradicating the gold standard by President Roosevelt and President Nixon in the 20th century, gold ownership as a financial concept became harder for the average person. Gold became less accessible to people, and the dawn of fiat currencies as we knew them took off in 1971 with President Nixon’s decree. For centuries the gold standard ruled the financial world. And the shift towards fiat currencies, and all the market turbulence that came with that, may have paved the way for the dawn of cryptocurrencies

After all, the first Bitcoin block was mined in January 2009, just a few months removed from the global financial crisis of 2008. The global fiat currency system, the gold standard reserve system, and the global credit system were mismanaged to such a point by unscrupulous brokers and financial systems to such a point that they all almost failed. And only people with money, large reserves of gold caches, and an innate understanding of the traditional fiat currency market system would have been OK if worst came to worst. Of course, that didn’t happen. What did happen is that everyday Americans, and citizens of the world, saw their faith in the world’s financial system shaken.

After the 2008 financial crisis, there were repercussions for the world and the economic system. For example, let’s take how the total abolition of the gold standard in 1971 gave way to the rise of new currencies, like the Euro. After 1971, the international Bretton Woods system, which tethered various international currencies to the dollar, and ostensibly the gold that gave transaction power to the dollar at the time, was obsolete. After 2008, the cryptocurrency system rose in prominence. The peer-to-peer lending system exploded and helped bypass everyday Americans’ need to deal with traditional credit and lending systems.

And the gold standard, a system where gold is still an investment commodity even if it is not tethered to the American dollar, becomes less relevant to people who don’t have access to it. And that is the point to remember. Cryptocurrencies are readily available to anyone with a computer and internet connection. And for investment novices who don’t understand the traditional financial system or how the blockchain works, it’s still undeniable that the blockchain is more accessible. And while cryptocurrencies may not replace physical money, its adjacent blockchain technology may replace the traditional fiat currency system we have today in the same way that the fiat currency system was empowered by the abolition of the gold standard in 1971.

Cryptocurrencies, or more specifically, cryptocurrencies and their accompanying technology, could indeed one day become the new gold standard. However, it is still a theoretical potential. And if it were possible, it won’t happen for a long time from now.

But before we get into all of that, what exactly was the gold standard? Why did it fall out of favor? And could cryptocurrencies become the new gold standard that buttresses a global financial system?

WHAT IS A GOLD STANDARD?

A gold standard is a system by which the inherent value of a currency is tied to its proportional value of gold. So, in a gold standard system, the currency’s value is just a stand-in for the proportionate value of gold tethered to it. Let’s put it this way – as of this writing, one ounce of gold is about $1,800 per ounce. For simplicity’s sake, let’s say that an ounce of gold is $500 per ounce. So, one dollar would have a value of about 1/500th per ounce of gold. And not only that, in a gold standard financial system, you could go to a bank and exchange your dollars for its equivalent value in gold and vice versa. From 1788 to 1862, and then from 1879 to 1929, the United States had a gold standard system tethered to official currency value.

And this system worked very well if you were rich. However, everyday and poor Americans saw the value of their savings wildly fluctuate if throughout wars, economic volatility, and inflation surges. This meant that the definition of a gold standard system had to evolve since there is a finite amount of gold, and more people are investing and buying into the system. So, by 1913, paper and coin currency was only backed by about 40% of the gold in the American financial system. And then the 1929 stock market crash happened, an event so apocalyptic in consequence that it infected the whole world.

Everyone who had money in the bank ran to the bank to withdraw their savings or exchange their dollars for gold. The financial system was rapidly deteriorating, and if everyone exchanged their dollars for gold, the United States would have no gold, be in debt, and be financially ruined. So, President Franklin D. Roosevelt abolished the gold standard in 1934, preventing Americans from trading dollars for gold and vice versa. Then, only foreign governments could transact in gold with the United States government. And later, FDR entered into the Bretton Woods Initiative, which used the dollar and an international-only gold standard system to enable the U.S. dollar as a reserve currency tether to gold. President Nixon’s decree in 1971 abolished the gold system completely.

 

The Demise of Gold 

It has been over 50 years that gold has been abandoned as the official standard for global currencies. Before that, gold had been used for thousands of years for exchange and store of wealth. In 1971, after the Vietnam War, gold was abandoned due to rising inflation. Even then, it remained a powerful vehicle of investment, especially against inflation or political and economic uncertainties. In light of the global pandemic, the prices of gold have been going down since August 2020. The demand for gold is going down, and not many investors are interested in buying it as an investment. The prices of gold fell by 6% in just 2021, i.e., even below $1800 per ounce. Gold purchases by central banks were down by 60% in 2020 as the health crisis persisted. Besides that, the jewelry market has also been quite disappointing during this time. The biggest jewelry markets like India and China registered a drop in gold jewelry sales. There is an inverse relationship between gold and the US dollar. As the strength of the dollar increases against other global currencies, the prices of gold fell, increasing its worth in other currencies, thereby decreasing demand. In August, an increase in US payrolls led to an increased demand for the US dollar in the Asian markets, which started selling gold for dollars. This, in turn decreased the prices of gold. The chief investment officer at UBS Global Wealth Management, Dominic Schnider, predicted that gold prices could go lower as the value of real yields would go up. In such a scenario, fewer people want to hold a non-yielding asset like gold. They would instead invest in yielding assets like bonds. 

Cryptocurrency: A Challenge To Gold 

Like gold, bitcoin is also a rare finite asset; however, it does not exist physically like gold. It does not have a direct use and is mainly used as a means of exchange. Unlike fiat currencies, cryptocurrencies are decentralized, and the government cannot control their value. Cryptocurrencies are based on blockchain technology, which is increasingly used in healthcare, voting, remittance transfer, and other financial services. They have become more than a store of wealth and found many practical uses in several industries. Even the cryptocurrencies like Dogecoin, which started as a meme on the internet, became famous overnight. They have witnessed a considerable surge lately. Countries like El Salvador have already accepted bitcoin as a legal tender, which legitimizes cryptocurrencies. Bitcoin had almost the reverse trend when compared with gold. Its value plummeted initially when the pandemic set in, and then there were increases in prices when the COVID-19 vaccines rolled in. Even the price of gold is based on a collective notion determined by what people are willing to pay for it rather than a predetermined value, as we assume. This is also the case for cryptocurrency, but unlike gold, they are far more volatile because they are pretty young, unlike gold which has been there for centuries. The wide array of uses and applications provided by cryptocurrencies far exceeds precious assets like gold, whose prices are continuously declining. This has further encouraged investors to hold long-term crypto assets as a part of their investment strategy. With 401(k) providers like ForUsAll allowing people to allocate 5% of their retirement funds to cryptocurrency, the legitimization of crypto is increasing day by day. 

The Bottom Line 

It is to be remembered that cryptocurrencies are quite volatile, and therefore, you should limit your crypto investment to 5% of your portfolio. Perhaps they might replace the gold standard and become the ultimate source of wealth, but that depends on mass legitimization and use. The current scenario hints towards greater mainstream adoption of cryptocurrencies as many notable businesses like Tesla are pumping investment into cryptocurrencies. However, for cryptocurrencies to truly become mainstream, greater governmental regulation is required. The US government’s announcement of the digital dollar earlier this year depicts their commitment to a global digital currency. It also depends on the willingness of the government to share power as the sole printer and controller of money. 

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At Unbanked, we believe in the power of cryptocurrencies to revolutionize the world. With time, cryptocurrencies have become one of the significant investment vehicles and provided better returns than gold. To know more about cryptocurrency investment, read our blog.

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