Jewellery is an integral part of the gold market. A large portion of gold demand is deeply connected to cultural and religious beliefs, especially in India and China. Gold is also widely used in high-end electronics – including for components in computers, mobile phones and other technology (which, interestingly, are needed to ‘mine’ cryptocurrencies).

This sets gold apart from many assets, giving it a unique dual nature that historically has allowed it to perform well in times of economic stress as well as benefiting from long-term economic expansion. This underpins gold’s strategic role in portfolios as a source of returns as well as an effective diversifier.⁵

In contrast, cryptocurrencies are digital (non-tangible) assets and, in our view, their current primary – if not only – source of demand is for investment (Table 1). For example, Bitcoin’s recent performance and volatile behaviour may suggest that it primarily responds to price momentum, which is usually linked to more speculative than strategic positioning.

Table 1: Gold has more diverse sources of demand than cryptocurrencies

Stylised overview of sectors of current demand for gold and cryptocurrencies*

Gold is a unique and scarce natural element 

One of the most referenced similarities between gold and cryptocurrencies is scarcity. Gold’s above-ground stocks grew at a rate of 1.7% through mine production in 2020 (Chart 1) – and that rate has not changed much over the past 20 years.⁶ The stock of Bitcoin is currently increasing at an annual rate close to 3% and is engineered to slowly decline to zero growth around the year 2140. 

While both gold and Bitcoin are finite, Bitcoin’s pre-determined number of units in existence may seemingly create an advantage. However, gold’s relevance has been cemented by a combination of elemental physical and chemical properties, as well as a good balance between availability and scarcity. Thus, while there exist other metals and precious metals, such as silver, palladium or platinum, gold was by far the preferred asset used in currency standards and has remained a key component in foreign reserves even after the end of the Bretton-Woods system.  

In contrast, nothing prevents additional – and possibly more efficient⁷ – cryptocurrencies from replacing existing ones or potentially adding to the overall total supply. The crypto space has exploded in recent years, and it is estimated that there are more than 10,000 cryptocurrencies available through various online platforms.⁸

At present, Bitcoin has benefited from its name recognition and large network effect, but the space is highly competitive, and it is still too early to know how this issue may play out. For example, Bitcoin Cash, which follows the same structure but allows an increased block size to reduce costs and increase speed, was launched a few years ago.⁹ Various other Bitcoin spinoffs (or ‘forks’) followed.¹⁰ And while they are not always prevalent, they are more than just a proof of concept that could result in unforeseen expansions to supply. 

Gold production and ownership is diverse

Gold mining is well distributed around the globe. The top five gold producing countries are China, Russia, Australia, the US, and Canada, with various Latin American and African countries not far behind. Average annual production is evenly distributed across regions, with Europe the only continent accounting for less than 10% and no continent capturing more than 25%.¹¹

Equally, ownership of above-ground stocks is widely distributed. The US Treasury is the largest known single holder of gold but only owns 4% of all above-ground stocks. Almost 50% exists in the form of jewellery (distributed globally), while 21% is owned by a large number of investors – individual and institutional – in the form of bars, coins and gold ETFs.¹²

Concentration risk has been flagged as a key issue for cryptocurrencies. The number of Bitcoin ‘miners’ has been whittled down from thousands to just a handful of key participants. As reported by Bloomberg, “five mining entities – all of them based in China – control 49.9% of all computing power on the network, the highest concentration of mining power ever, a new analysis from TokenAnalyst found”, which, if increased, could pose severe risks to the network.^{13, 14} 

Furthermore, while the number of Bitcoin holders has risen over the past year (Chart 2), ownership is very concentrated – just 2% of Bitcoin holders own 95% of all available Bitcoins.¹⁵ As a counter-indicator of performance, perhaps as a by-product of the aforementioned concentration, large spikes in the number of unique addresses have historically coincided with significant pullbacks in price. 

Gold and crypto prices behave differently 

High potential reward brings added risk

Cryptocurrencies have captured the imagination of investors with their exponential growth over the past few years, likely in part due to widespread asset price inflation on the back of ultra-low interest rates. Bitcoin quadrupled in price in 2020 alone and has increased ninefold over the past two years.¹⁶ These gains have led some institutional investors to consider, or make some incremental level of investment in, Bitcoin over the past year. However, as with any other financial asset, reward does not come without risk. Not surprisingly, Bitcoin’s ascent has been accompanied by substantial volatility and drawdown risk (Table 2 and Chart 3). 

Bitcoin has been three times more volatile than the S&P 500 or the NASDAQ composite over the past two years, and more than four and a half times more volatile than gold. 

Table 2: Bitcoin is significantly more volatile than the S&P 500, the NASDAQ composite and gold

Summary of key risk metrics based on weekly returns* 

Bitcoin has lost 2.5% or more once in four weeks on average compared to once in 12 weeks on average for the S&P 500 or NASDAQ, or once in 13 weeks on average for gold. Finally, Bitcoin’s Value-at-Risk (VaR) has also been considerably higher. On any given week over the past two years, investors had a 5% chance (95% VaR) of losing at least US$1,382 for every US$10,000 invested in Bitcoin – almost five times more than the VaR for an equivalent investment in gold. And while investors may choose to embrace high-reward tactical assets such as Bitcoin, they still need the appropriate tools to manage the additional risk. In our view, a higher exposure to cryptocurrencies warrants a higher allocation to gold.

Diversification is not just about low correlation

The correlation between gold and Bitcoin is low, ranging from -0.5 to 0.5 most of the time. And while it was positive on average during 2020, it is still by no means consistent in one direction (Chart 4). This indicates that gold and Bitcoin are not behaving as substitutes.

Furthermore, if Bitcoin were a replacement for gold, it would behave similarly to gold in terms of its reaction to the performance of other assets – in particular, equities. And while both gold and cryptos have generally had relatively low correlation to the equity indices such as the S&P 500 or the NASDAQ composite, it is the correlation when equities fall that matters most to investors as this is usually when diversifiers are most useful.

Here, gold and Bitcoin stand apart. Gold tends to show a negative correlation to equities during significant stock market falls – as seen by the behaviour between gold and NASDAQ (Chart 5a). In contrast, Bitcoin has been equally likely to rally or fall in periods when the NASDAQ tumbled (Chart 5b).

Bitcoin has yet to prove itself as a safe haven

Bitcoin trades like a ‘high-octane’ tactical asset. At times, market participants have noticed ‘safe haven-like’ behaviour in Bitcoin, as it has appeared to directionally move in a similar way to some traditional hedges, such as gold. However, there is no consistent trend.

For example, in March 2020, Bitcoin fell by more than 40% from peak to trough, ending the month down 25% and behaving more similarly to US technology stocks than gold. In contrast, while gold initially fell in March – by 8% from peak to trough – it quickly rebounded to end the month back to the level where it started, and then continued the upward trend as investors added hedges.¹⁷

Improving risk-adjusted returns

Some studies have suggested that adding Bitcoin to a hypothetical portfolio would have increased risk-adjusted returns.¹⁸ Our own equivalent analysis shows that over the past five years, a 1% to 5% allocation to Bitcoin would have increased the risk-adjusted return of a well-diversified hypothetical portfolio (Chart 6).¹⁹ However, the improvement would have come from Bitcoin’s rapid price appreciation and not from a reduction of portfolio volatility, as one would expect from a diversifier or safe-haven asset. In contrast, gold’s portfolio impact over the same period would have come from both a contribution to portfolio returns as well as a reduction in volatility. This highlights gold’s relevance as a strategic risk-management tool in asset allocation. 

Our analysis also shows that the same hypothetical portfolio with a 2.5% allocation²⁰ to Bitcoin and a 1% to 10% allocation to gold²¹ would have improved risk-adjusted returns even further over the same period. 

Furthermore, a 1% allocation to Bitcoin alongside a 10% allocation to gold resulted in risk-adjusted return equivalent to a 2.5% allocation to Bitcoin without gold, but the portfolio with gold would have had a significantly lower maximum drawdown. Overall, this not only suggests that Bitcoin fails to replace gold’s role in a portfolio, but also that adding Bitcoin to a portfolio may warrant a higher allocation to gold, likely as a way of managing the additional volatility. 

Interestingly, we also found that a 1% allocation to Bitcoin – often viewed as a tech investment – would have given the same risk-adjusted return as a 7.5% allocation to major US tech companies – in particular, the so-called FAANGs.²² Yet, the allocation to FAANGs would have also resulted in a lower maximum drawdown. 

Bitcoin has so far improved the efficiency of portfolios through extremely high returns, which are by no means guaranteed to continue at the same rate.

Gold’s liquidity helps investors manage risk

Gold trades in a well-established and liquid market. Collectively, gold trading volumes exceeded US$180bn a day on average in 2020 between over-the-counter transactions (primarily through spot), futures and gold ETFs.²³ This in turn helped keep bid-ask spreads of most gold-traded instruments quite tight – usually less than a couple of basis points – thus giving investors the ability to easily enter or exit their gold positions.²⁴

In contrast, Bitcoin spot trading volumes – which can vary widely from source to source and are not always easy to verify – were estimated to be less than US$2bn, on average, in 2020, with a range up to US$4bn.²⁵ And while volumes seem to have increased substantially so far in 2021 reaching levels close to US$10nb,²⁶ reporting in online platforms is not regulated and may not be homogeneous. 

Additionally, the number of Bitcoin transactions as a function of its market cap has decreased to almost zero (Chart 7). We believe that this trend could indicate insufficient liquidity in the market if many investors, or even one large one, were to attempt to exit the market. And anecdotal evidence suggests that bid-ask spreads not only remain wide but vary substantially.

An evolving regulatory environment 

Some crypto enthusiasts have argued that Bitcoin could replace traditional currencies in transactions.²⁷ While some vendors do accept Bitcoin, on average only about 340,000 Bitcoin out of approximately 18 million in existence are used for daily transactions, which is less than 2%.²⁸ In comparison, the US dollar transacted nearly US$6trn per day on average in 2019. At the time, this represented 40% of the total M2.²⁹

This may also be in part because Bitcoin lacks the regulatory framework to appropriately function as a means of exchange. Furthermore, limitations of the network itself could prevent widespread adoption.³⁰ Bitcoin’s network capacity is fewer than 10 transactions per second, approximately, compared to VisaNet – Visa’s payment network – which reportedly can handle up to 65,000 transactions per second. This limitation is well known, and many possible solutions have been suggested, but these would either change Bitcoin fundamentally or rely on less secure but higher capacity parallel (‘off chain’) networks such as Lightning.³¹, ³²

Perhaps more importantly, widespread adoption of cryptocurrencies would likely result in more extensive government regulation.³³ We believe this may stem from two key considerations: consumer protection and policy efficacy. For example, effective monetary policy requires a central bank to be able to control money supply. At a hypothetical extreme, if individuals do not transact in an official currency but in an independent cryptocurrency, monetary policy becomes moot. Of course, government intervention would occur before that happened. And while regulation may not remove the viability of cryptocurrencies altogether, it may change their investment proposition, objectives and, likely, their performance. 

In recent years, partly because of concerns surrounding ‘stablecoins’ such as Diem (formerly known as Libra),³⁴ governments have looked more closely at digital assets. Specifically, there has been growing interest in the development of digital versions of national currencies, also known as Central Bank Digital Currencies (Focus 1). This may, in turn, catalyse changes to the regulatory environment of cryptocurrencies.³⁵ 
 

Gold is proven and established

Our analysis suggests that gold stands apart from cryptocurrencies in general and Bitcoin in particular. Gold is an effective, tried and tested investment tool in portfolios. It has been a source of returns rivalling that of the stock market over various time horizons; it has performed well during periods of inflation; it has been a highly liquid, established market; and it has acted as an important portfolio diversifier, exemplifying negative correlation to the market during downturns.

The recent performance of cryptocurrencies has been noteworthy, but their purpose as an investment seems quite different from gold. The crypto market is still in development, and liquidity is scarce. We believe that their price behaviour at this point, while still attractive to many investors, seems to be driven in large part by high return expectations – fuelled by momentum and aided by low interest rates.

Gold, too, is likely to perform well in a low-rate environment, but its behaviour responds to four key drivers that, based on our analysis, underpin the relevance of gold as a strategic asset (Focus 2).

This explains not only why gold is uncorrelated to all major assets held in the typical investor portfolio but also why – fundamentally – cryptocurrencies do not replace gold’s role in a portfolio. Indeed, our 2019 investor survey indicates that gold and Bitcoin can play different roles in portfolios: investors see Bitcoin more often as speculative while they see gold as a means to protect wealth (Chart 8). Similarly, our conversations with institutional investors seem to suggest that gold and Bitcoin are seen as having different value propositions.

As such, as financial markets continue to evolve and new technologies develop, we believe that gold’s unique attributes and its contribution to investment portfolios make it a relevant long-term strategic investment.