The value of crashing differently

Among a field of early contenders, gold emerged as the universally recognized store of value thanks to its superior physical properties — more malleable than cowrie shells, less perishable than grain, more divisible than livestock.

Those same properties are why gold is found in a surprisingly long list of useful things: dental fillings and wedding rings, of course, but also the corrosion-proof circuitry in your smartphone, the nanoparticles in rapid pregnancy tests, and even the ultra-thin radiation shields on astronaut helmets.

But its primary use remains as a store of value, so gold is categorized by investors as a non-productive asset.

More precisely, it’s a store of value because it’s non-productive.

A recent study by the quants at D.E. Shaw concludes that “gold’s lack of productive capacity can be seen as a feature, not a drawback, since it leads to lower correlation with growth-oriented, pro-cyclical assets.”

In other words, gold is valuable not for what it does, but for what it doesn’t do: Participate in the economy.

If gold derived most of its value from being useful, an economic downturn would cause a downturn in the demand for gold, too — at the same moment investors were hoping it would hedge their pro-cyclical portfolio of assets.

Making gold more useful in industry would therefore make it less useful to investors.

By that logic, bitcoin should be even more valuable than gold — it has no use in the real economy at all, so it shouldn’t, in theory, be affected by an economic downturn.

And yet, bitcoin has been falling even further behind in the race to become the world’s most valuable asset that doesn’t do anything.

On the year, bitcoin is up just 23% vs. gold up 38%.

This is disappointing in a time when Bitcoiners’ doomsday scenario is finally playing out: Threats to the Fed’s independence, questions around the dollar’s global reserve status and runaway government spending have all become mainstream concerns.

Being the smaller and newer store of value, you might expect bitcoin to do better than gold in that kind of scenario — especially as it improves on gold in so many ways: It’s weightless, instantly divisible, doesn’t have to be dug out of the ground and has a finite supply.

But all those winning attributes are achieved with technology — which is presumably what makes bitcoin positively correlated to Nasdaq. 

That is not what traditional investors want in a store of value. Just the opposite: If they are going to park money in a non-productive asset, they need it to go up when Nasdaq goes down.

This is not just a matter of perception, either, because Bitcoin is technology; it has a different set of risks than gold.

Last week, for example, Ledger’s CTO warned of a new “NPM” attack that risked becoming a mass crypto hacking event: “If your funds sit in a software wallet or on an exchange, you’re one code execution away from losing everything.”

Most people hold their bitcoin in a software wallet or on an exchange, so that is quite a statement.

Ledger makes hardware wallets, so its CTO admittedly has a vested interest in sounding the alarm about other means of holding bitcoin.

But investors seeking a risk-off asset don’t want to learn what NPM even means, let alone take the time to assess it as a risk to their portfolio.

(Note: NPM stands for “Node Package Manager,” the blandness of which somehow heightens the fear factor.)

Similarly, no investor wants to learn what “100k OP_RETURN” means, or develop an opinion on whether it poses an existential threat to Bitcoin, as one noted developer has recently been warning.

It appears that publishing 100 kilobytes of malware code in Bitcoin blocks via the OP_RETURN function does not cause Bitcoin to be “knocked offline.”

But I’ve reached that conclusion by reading Twitter replies, which is no way to run an investment portfolio.

Similarly, I’m reliant on experts to parse both the game theory of the Bitcoin protocol and the code that enables it for me — a dependence that makes bitcoin feel more like a risk-on speculation than a risk-off asset.

Of course, gold is not free of risk, either.

Jeff Bezos might announce tomorrow he’s sending a robot into space to mine gold from asteroids, or scientists might announce they’ve used fusion energy to make gold from mercury — either of which would surely crash its price. 

But, as DE Shaw frames it, gold’s potential to “crash differently” is what makes it valuable to investors.

I’d also add that the downside risks to gold are upside risks for society: unlimited commodities from space and unlimited energy from fusion reactors would be great news for the stock market.

Bitcoin, by contrast, might crash because North Korea built a quantum computer, a solar flare knocked out the world’s electrical grid or Larry Fink was catfished into sending all of BlackRock’s bitcoin to a love interest in Myanmar.

None of these things would be good for the stock market — and that makes bitcoin less valuable to investors.

If these risks sound unconvincing, ask yourself what the biggest holders of US treasurys would buy if they lost faith in the US dollar: Gold or digital gold?

Early evidence suggests it’s gold.

Central banks — already in the process of diversifying away from US treasurys — are expected to purchase about $106 billion of gold this year, but next to nothing for BTC. 

(El Salvador may have topped up its holdings; it’s hard to say for sure.)

It might be different next year, of course. 

DE Shaw’s thesis on gold is based on the observed behavior of investors, and behaviors can change — perhaps because investors’ perception of Bitcoin changes or because the investors themselves change.

Both are likely to happen over time, to the benefit of Bitcoin. 

One perception that Bitcoiners should not try to change, however, is bitcoin’s status as a non-productive asset.

Because gold has proven that trees really do grow into the sky — but only if they’re useless.

— Byron Gilliam

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