You might have heard that Bitcoin is “a digital form of gold”. Here’s why Bitcoin is as good as gold – or even better.
Today I was asked by a friend why Bitcoin isn’t “backed by anything”? How can it have value if it is not backed by a precious metal like gold or silver, as it was the case with government currencies for centuries?
This is a valid question. I had the same doubt when I first discovered Bitcoin. Before my Bitcoin journey started, I devoured books about Austrian Economics. Many Austrians such as Ludwig von Mises favour a gold backed currency, so I discarded Bitcoin as “just another form of Fiat money”. I liked the idea of electronic peer-to-peer cash, but I thought that it needed to be backed by a precious metal.
It took me a while to understand that this is not necessary and would even lower the value of Bitcoin. The reason why Bitcoin has risen from 7.50 US dollars, when I first discovered it, to an All-Time-High of nearly 70,000 dollars: Bitcoin has the qualities that are needed for good money. It’s the same qualities that you can find in gold – and even a few more.
These qualities are well defined in economic text books. In order to serve as money, a good has to have the following qualities:
First and foremost, a good needs to be scarce to be used as money. Things like sand or grass do not work for this purpose – there is just too much of them. In human history only scarce goods such as special shells, arrowheads or cattle were used as money. Precious metals such as gold, silver and copper became popular already a few thousand years ago. Their quality as a medium of exchange has been discovered independently in different cultures.
Bitcoin is even scarcer than gold or silver. While new gold mines can be found, even on other planets or asteroids, there can never be more than 21 Million Bitcoins. This is hard coded into its protocol and cannot be changed – at least not realistically. A vast majority of Bitcoin users would need to approve such a change, which will never happen, as it would devalue their savings.
Scarcity alone is not enough for a good to work as money, it needs some more qualities to make it useful. An important one is durability. Truffles would not qualify as money, although they are hard to find and therefore rare. However, they would rot quickly, so they cannot be used in the long run. The same is true for metals that corrode. One important reason why gold works so well to store value is its durability. A gold coin found today after thousands of years would not have lost its purchasing power.
Bitcoins are durable, too. As long as there is electricity and the Internet, Bitcoins will survive. Even if the Internet is shut down for a while, as soon as it recovers and the Bitcoin blockchain has been stored on only one computer, the Bitcoin protocol will keep on running. Some people are worried that without electricity and the Internet, Bitcoin cannot exist. This is true, however, these two achievements of civilisation are not likely to disappear. Without electricity and the Internet, we would have much bigger problems, think of malfunctioning supply chains or grocery storage. I think it is safe to assume that there will always be enough engineering skills to provide electric energy and a well running global computer network, because humanity cannot live without it anymore.
To be useful in day-to-day transactions, money needs to be divisible in smaller pieces. Cattle were one of the earliest forms of money – even the Latin word for money, pecunia, derives from pecus (cattle). But what to do when you want to buy a good that has less value than the cow you want to trade it for? Cutting the cow in half is obviously not a viable solution. That’s why precious metals have replaced cattle as the most commonly used form of money.
Diamonds are also scarce and durable, but if you smash them into smaller pieces, they have less value than a big diamond. Gold is much better in this regard: a gram of gold will roughly have the value of 1/1000th of a kilogram. Of course, there are practical limitations in cutting a physical substance like gold into ever smaller pieces. Bitcoin is digital, so it can easily be divided into 100 million parts, the so called Satoshis. This makes it the most divisible asset ever.
This is a rather unusual word, which basically means “interchangeable”. An important quality of good money is that it doesn’t matter with which coin or note you pay, as long as they have the correct value. If I lend 100 USD to a friend, I would not insist on receiving the same bank note that I gave him. I would be totally OK with receiving a 100 dollar note with a different serial number, two notes of 50 USD or 5 notes of 20. This is where money differs from most other goods. If you lend your car to a friend, you would probably not be happy to get a Nissan back instead of your Mercedes. Most goods are “non-fungible”. For trading them digitally, Non-Fungible Tokens (NFTs) become relevant – but that’s another story.
Gold bars are often falsified by hiding the much cheaper material tungsten, which has a similar specific weight, under a thin layer of real gold. You need the expertise and the right equipment to find out whether you have real gold in front of you or not. Bitcoins cannot be falsified. It is simply impossible to make a Bitcoin transaction that does not follow the rules of the Bitcoin protocol. It is therefore very easy to recognise real Bitcoins, much easier than recognising real gold.
Another important quality of good money: it needs to store a reasonable amount of value in a relatively small space. Gold has a very high specific weight, so a few gold coins worth a couple of hundred dollars easily fit into your pocket. If a light metal like Aluminium was chosen as money, one would have to carry large amounts of it for the same value, which is not very practical. Bitcoins are even better when it comes to portability. Millions of dollars worth of Bitcoin can be carried on a hardware wallet the size of a USB stick, or even on a piece of paper. This becomes especially important if you want to travel with your money and cross borders. Gold and cash can be detected easily, Bitcoins not.
Bitcoin is better than gold
You see: Bitcoin has the same qualities that have made gold the money of choice for mankind for more than 5000 years, and even some more. Unlike gold, you can move Bitcoins around the planet at the speed of an email. Bitcoin transactions can’t be stopped by anyone and Bitcoins can’t be confiscated by governments – unless they force you to deliver your private key at gunpoint. Because of all these qualities, Bitcoin doesn’t need to be “backed”, just like gold is not backed by anything.
On the contrary, gold used to back government money, which otherwise would not have any value at all. The same is happening for Bitcoin: it is already being used to back stablecoins that are pegged to the dollar, like the Dollar-on-Chain. In the future, we will see Central Banks holding Bitcoin as reserve currency, as they hold gold and US dollars today. The Central Bank of El Salvador is already doing it, many more will follow.
There are cryptocoins that are indeed backed by gold, such as the PAX token or the Digital Dirham. However, they are losing one crucial advantage of Bitcoin: its trustlessness. For a gold backed coin, you need to trust the company that issues it. You need to trust them that it is really backed by the correct amount of gold and that you can redeem your gold at any time. With Bitcoin, you have to trust no one, except the cold hard laws of mathematics. It is this trustless, decentralised character that makes Bitcoin so special and so valuable – much more valuable than gold.
The one big advantage that gold has over Bitcoin: people are familiar with it. Compared to the more than 5000 years gold has been used as money, Bitcoin is still in an embryonic stage – it only exists for a bit more than 13 years. That’s why it is important to inform people about its qualities.
By Aaron Koenig