The recent bankruptcy of Mt. Gox curbed down the staggering rally of Bitcoin. This recent controversy raised the debate over the validity of Bitcoin. Despite the securities issues related to this currency, the current price of Bitcoin remains high at over $600. After all, the virtual currency offers some advantages over regular money such as instant money transfers with little to no regulations. But considering Bitcoin as an investment, is it the new gold — a substitute investment against the potential devaluation of the U.S dollar? I think there are three reasons why Bitcoin isn’t the new gold?
One of the reasons for the drop in its price is the security issues related to Bitcoin.
1. Security issues
Besides the latest Mt.Gox controversy, Bitcoin has had its fare share of security issues including heists. But even users of PayPal, a global online money transfer company, which is fully owned by eBay (NASDAQ:EBAY), have faced frauds and scams. The main difference is that PayPal has ample funds to invest towards improving its security. Just in 2013 the company earned for eBay $6.6 billion. This gives a lot of funds to increase security and keep PayPal from facing security breaches. This kind of security risk is less common in gold. Besides security issues, Bitcoin remains a risky investment.
2. Riskier than U.S dollar or gold
The risk of the potential devaluation of the U.S dollar has increase in the past several years, mainly after the 2008 financial meltdown. These circumstances resulted in a shift towards safe haven investments such as gold. The shift in market sentiment towards risk aversion was also accompanied by the Federal Reserve’s decisions to purchase long term securities, which resulted in an increase in the U.S monetary base. These factors enabled the price of gold to reach $1,900 back in 2011. Gold enthusiasts tend to use SPDR Gold (NYSEMKT: GLD) to invest in gold. And up until the middle of 2012, the price of gold and SPDR Gold rallied. Since then, however, gold and SPDR Gold haven’t performed well as the market sentiment has slowly shifted back towards taking more risk.
But the FOMC’s ongoing policy to purchase long term securities left the fear of the potential rise in inflation. These circumstances raised the demand for alternative money such as Bitcoin. But this currency remains very risky, which puts into question its value. E.g. in the past year, the standard deviation of the daily percent changes of Bitcoin’s price was 7.6%. In comparison, during that time frame, the standard deviation of the Euro/USD was 0.4% and USD/Yen was 0.4%. The standard deviation of the price of gold was 1.4%. This means, Bitcoin is much more volatile than leading currencies or gold, and even though Bitcoin might be considered an alternative to U.S dollar; it’s still much riskier. The last issue to consider is this currency’s underlying value.
3. No underlying value
This is one the main issues that Bitcoin investors face: Gold and U.S dollar have their underlying value: Gold can be used to make jewelry and U.S dollar is backed by the Federal Reserve. Does Bitcoin have a base value? What if tomorrow no one believes in Bitcoin anymore? What will become of Bitcoin? Therefore, the virtual currency doesn’t have a base value or someone, who backs up the currency.
Bitcoin is still live and kicking even after the recent fall of Mt.Gox. But this event only puts a spotlight on one of Bitcoin’s main problems — security. But this isn’t the only problems Bitcoin enthusiasts face. The currency’s high volatility and lack of base value will keep daunting Bitcoin investors.