Crypto series: Gold v Bitcoin debate hints at Bitcoin ETF fears

Scott Longley


The momentum behind at least one Bitcoin ETF proper being launched soon would appear to be increasing after comments from Cathie Wood, the chief executive of Ark Investment Management, on Bloomberg TV to the effect that a closed-ended fund was likely "in months" with an ETF likely to follow "within two years".

We already have Swedish fund manager XBT Provider's two Bitcoin ETNs and the company is promising a third Ethereum-based fund in the coming weeks.

Still, discussions in some quarters remain notably more circumspect in their assessment of the investment case in Bitcoin. A recent precious metals primer from the analysts at Goldman Sachs makes an attempt at a compare and contrast between gold and cryptocurrencies as stores of value and comes to the considered opinion that Bitcoin and its ilk are not "the new gold", despite their popularity.

In dismissing the comparison, moreover, the analysts at Goldman Sachs point to a number of factors that might help explain some of the wariness on the part of recognised global exchanges and should give any investor considering cryptocurrencies pause for thought.

One is durability. Though physical storage for cryptocurrencies is unnecessary, any system you employ for storing your Bitcoin key numbers is vulnerable to hacking, indirectly through your online wallet or other services (including the exchanges), through the user's own computer or smartphone or, in the case of Ethereum, through vulnerable smart contracts.

Allied to worries over what would happen to a cryptocurrency's infrastructure and network in a crisis - and comparing that with gold's performance through wars and other disasters - and you can see why gold wins out on security.

The panic room

Regardless of whichever system a Bitcoin ETF would resort to, it would undoubtedly face searching questions around storage security, particularly give the high amounts of Bitcoin that would likely be involved and the high visibility of the fund.

Both would make the fund an attractive target for hackers and fraudsters.

Cryptocurrencies doe have the edge when it comes to portability, however, when it comes to divisibility, another area where it would appear to have an edge, there are more questions to be answered.

While gold is not usually produced below a weight of 5 grams, the smallest Bitcoin is 1 satoshi - and 100 million of these go to make one Bitcoin. As Goldman Sachs note, the currency is close to being infinitely divisible which would appear to give it the edge in this sense.

But there are other issues which cloud this argument around transaction fees. "As the block chain has become longer, the network has become slower and miners have started to demand hefty transaction fees on top of the seniorage revenue from creating new bitcoins (which has fallen dramatically)," the analysts note.

This has led to much higher transaction fees for users than in previous years, up to $2 compared to just a few cents less than three years ago.

Any proposed ETF fund would have to factor this into their calculation, but this isn't the only cost associated with cryptocurrency transactions. The extreme volatility associated with Bitcoin in its short history comes with costs attached as any merchants accepting Bitcoin would demand a large volatility premia to hedge their FX risk.

As an example, they point to a simple Black-Scholes model for a three-day US dollar/Bitcoin put option that would suggest, on historical average volatility, a premium of around 2.3% would be required.

Say Goldman Sachs: "This means that, under normal circumstances, a seller who accepts Bitcoin for a transaction, then changes it into US dollars the next day and waits for clearance over the following two days, ought to be charging a 2.3% premium."

A not-so-scarce resource

All of which suggests that an investor in a Bitcoin ETF would find it expensive to trade in and out, based on the underlying asset. All of that, and on top there are fears over the intrinsic value.

As the Goldman Sachs say, unlike with "elemental" gold, there are a profusion of alt-coins now coming to market that, at the very least, muddies the waters for Bitcoin and would arguably add a decided layer of uncertainty for any ETF fund.

Alongside the competing cryptocurrencies, the proliferation if highly dubious ICOs and the potential for further 'hard forks' of the existing networks throw further spanners in the works for any potential fund or securities regulator.

"This ability to easily create alternatives, with high degrees of substitutability to the original, means that there is effectively no control over supply at a macroeconomic level and hence no intrinsic value due to rarity," says Goldman Sachs.

These are words that will be resonating with any authority looking at the potential for overseeing a Bitcoin ETF and might signal that the supposedly unstoppable momentum might be about to meet a barrier that might yet prove to be immovable.


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