• Klaus Meitinger

The digital gold.

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Bitcoin. In view of the monetary dilution of all paper currencies due to the extremely expansive monetary policy, investors are looking for alternative store of value. The first choice is gold - proven for centuries. With Bitcoin, perhaps another alternative is now emerging.

The unease is growing. De facto, the central banks are already providing direct state financing, the Lerbach-based Kompetenzkreis criticises and fears that the purchasing power of paper currency will be eroded in the future. "History shows that someone always usurps the interpretive sovereignty over existing money and says: For certain reasons we need more of it", David Oyen, from Plettenberg, Conradt & Cie. family office, considers. "At that moment people are looking for another store of value that cannot be multiplied at will."

In the past, wealthy people almost automatically ended up with gold. Gold is durable and difficult to mine. "This is a basic requirement. If it had been easier to mine gold, the precious metal would not have been considered a store of value and no one would have held the yellow metal," explains Manuel Andersch, Senior Currency Analyst at Bayerische Landesbank. "In the end, the market intuitively chose the most stable element it could get."

In the meantime, however, many who are thinking about a plan B in terms of the monetary system also end up with Bitcoin. They ask themselves: Is digital gold perhaps even the better gold?

"First of all, in terms of physics, Bitcoin is as real as gold," explains Andersch. When digging for it, IT engineers work instead of miners, calculators instead of excavators, and electricity is used instead of diesel. But compared to gold, Bitcoin still has a few major advantages. "It is easier to transport, much faster to transfer, and the state cannot access it. It doesn't know who to approach. Bitcoin is not a legal entity. It exists because of 10,000 computing nodes connected to a network worldwide. Governments cannot shut them down or hold them liable," explains Philipp Sandner, an expert in crypto currencies at the Frankfurt School of Finance & Management.

But the most important characteristic of Bitcoin is its programmed scarcity. With gold, more is found in one year, less in the other. And the mining efforts are also dependent on the gold price. With Bitcoin, on the other hand, the development of supply is clearly predetermined. The maximum "money supply" is limited to almost 21 million Bitcoins. And the money supply growth decreases drastically at regular intervals.

In the ersten Jahren, 50 Bitcoins were dug every ten minutes. This rate has halved every four years since then. First to 25. In the next step to 12.5. And in the last halving on May 11, 2020 to 6.25. "It was a stroke of genius to decouple the offer from the price of the Bitcoin and the mining efforts - i.e. the computing power of the miners. If the price rises or more computing power is added to the system, the degree of difficulty for prospecting new Bitcoins will be adjusted upwards accordingly. This ensures the targeted output volume," explains Andersch.

This is guaranteed by a global peer-to-peer network. Getting this entire network to adopt a new supply profile (i.e. software protocol), Andersch says, is virtually impossible.

The recent halving was celebrated not only in the Bitcoin community as a step into a new epoch. Media interest was also high. "It was like a kind of wake-up call. Look, the idea behind it is actually different from what conventional monetary policy does. It's actually happening as programmed. This made many people realize for the first time that Bitcoin is in principle just as suitable as gold as a store of value," explains Andersch.

To prove this scientifically, the expert uses the so-called stock-to-flow analysis. "In the raw materials sector, we have always thought about how to grasp the quality of a monetary good, which makes an asset really 'hard'. The stock-to-flow ratio has proven to be a useful criterion in this context."

When calculating the ratio, it is not the absolute scarcity of an asset that plays the dominant role, but the relationship between the inventory and the current production. In absolute terms, for example, the stock of palladium is much smaller than that of gold - it is just five percent of it. This does not make palladium a harder asset, however, as the new supply of palladium (flow) is not only relatively high, but can also be easily expanded and dilutes the stock when the price rises. "Many precious metals such as palladium, which are mainly used as industrial metals, therefore have a low stock-to-flow ratio," Andersch informs.

The attractiveness of gold is that its supply cannot be expanded at will. Worldwide, there is currently a stock of around 200,000 tonnes. Around 3000 tons are mined every year. The annual growth (flow) of new gold thus meets an already very large stock. "At the current rate of production, the market needs 60 years to produce the same amount of gold. The stock-to-flow ratio is accordingly 60," explains Andersch. That is a lot. Silver, for example, brings it to around 22, palladium to just over one, and platinum only to 0.4.

"Gold has had to work hard to achieve this status over thousands of years. Due to high production costs, a lot of time and low industrial use, such a large inventory was slowly built up. But what is decisive is that gold could only achieve such high rates because people were prepared to use this precious metal almost exclusively for the storage of value", the analyst explains and concludes: "That is why a high stock-to-flow is also an important basic prerequisite for a monetary good to be used as a store of value at all".

Bitcoin is now repeating this development, which took gold hundreds of years to develop, virtually in fast motion. "After the halving in May, Bitcoin has now already achieved a similarly high stock-to-flow value as gold - within only eleven years," Andersch calculates and continues: "Bitcoin was designed as an ultra-hard asset. In 2024, when another halving is imminent, the hardness level will be further increased to a level of more than 100 - never before in human history!

What impact such a monetary standard will then have on the investment decisions of wealthy people, of course, no one can know today. "The fact is that historically, the asset with the highest stock-to-flow ratio has always been used as a store of value. If Bitcoin should really become the store of value of the 21st century, it is because its properties - especially its high degree of hardness - are preferred to those of alternative forms of money," Andersch makes clear.

The crucial question for investors is now: What would such a development mean for the price of Bitcoin? "Of course it stands to reason that the hardness of Bitcoin has something to do with its value. However, a price path cannot be neatly analytically proven from the stock-to-flow model," says Andersch, "the stock-to-flow analysis initially only shows that Bitcoin could be used as a new, modern store of value. Ultimately, however, it is always a question of supply and demand. Only if more people use Bitcoins as a value store at current prices and therefore buy than people sell in relation to them will the price rise.

"But there are certainly indications of this," Philipp Sandner reflects. First of all, the narrative around the Bitcoin has changed over time. In 2009, the crypto currency was still considered an attempt to create an electronic means of payment. Due to the possibility of paying anonymously for illegal transactions as well, Bitcoin quickly ended up in a kind of dump. Financial institutions regarded it with suspicion.

"In the meantime, its function as electronic cash hardly plays a role at all. Instead, its use as an alternative asset dominates," Sandner informs, "and the legal foundation is also becoming more stable. Meanwhile, the safekeeping of crypto-currencies is legitimized by the BaFin, as long as the laws regarding money laundering and taxation are observed. Even asset managers may invest in Bitcoins for third parties.

Now, according to Sandner, a quite logical development sequence is beginning: "The law is there, legitimacy is established, software is developing, lawyers understand the system. Banks are starting to take an interest, are launching products, installing a reliable brokerage, a better order system. And that changes the potential buyer base.

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While in the past almost exclusively private investors invested in Bitcoin, the conditions are now being created so that even professionals can execute larger orders quickly, at efficient market prices and with regulatory security.

"The big story, therefore, is that Bitcoin could establish itself as a 'financial asset' in the future, allowing portfolios to be further diversified. If institutional investors were to start investing only a minimal proportion of their portfolios there, demand would rise rapidly," Daniel Oyen points out.

A comparison of the market values of Bitcoin and gold shows what this could then mean for the price development. At a rate of 1700 dollars per troy ounce, the world's total gold holdings are worth between eleven and twelve trillion dollars. The market value of Bitcoin at a price of $10000 per Bitcoin is around $180 billion. That is just between 1.5 and two percent of the market value of all gold holdings.

"This is the starting point," Oyen summarizes. "We know that after the next halving, Bitcoin 2024 will be the world's hardest product, twice as hard as gold. It is possible that Bitcoin could then partly replace gold as a store of value. And large investors could discover Bitcoin. That's a lot of subjunctive, sure. But the subjunctive suggests that it could be possible. Given the asymmetric return profile, I find it interesting to invest one to two percent of the portfolio there already now. After all, I can only lose 100 percent, but gain many times more." ®

Author:  Klaus Meitinger