3 Reasons Why Bitcoin Isn't the New Gold

The recent bankruptcy of Mt. Gox curbed 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 more than $600. After all, the virtual currency offers some advantages over regular money, such as instant money transfers with few, if any, 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 bitcoin isn't the new gold.

The chart below shows the sharp rise in the price of bitcoin in the past six months. At one point, bitcoin passed the $1,000 mark. Since then, however, its price came down to the $600-$900 range. 

Source: Blockchain.  

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 fair 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 scams. The main difference is that PayPal has ample funds to invest toward improving its security. Just in 2013, the company brought in $6.6 billion in revenue for parent company eBay. This provides cash for investing in security and keeping PayPal from facing security breaches.

This kind of security risk is less common in gold, because it is mostly traded in the Chicago Mercantile Exchange, which isn't as heavily used as PayPal is. Moreover, gold trading is very limited to a few exchange markets and is heavily regulated  so that heisting gold derivatives is as likely as robbing Apple shares. The recent breach in Mt. Gox is still unclear but some analysts suspect the security breach was in  bitcoin's protocol: Hackers were able to deceive Mt. Gox's software into assuming transactions didn't go through. It's unknown how much Bitcoin inventors and exchange companies such as Bitstamp, the world's largest bitcoin exchange, invest in the currency's security. But the recent collapse of Mt. Gox suggests the virtual currency's level of security isn't enough. Furthermore, such publicity is likely to impede bitcoin's broader acceptance. Besides security issues, bitcoin remains a risky investment .  

2. Riskier than U.S. dollars or gold
The risk of the potential devaluation of the U.S. dollar has increased in the past several years, mainly after the 2008 financial meltdown. These circumstances resulted in a shift toward safe-haven investments such as gold. The shift in market sentiment toward 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 toward taking more risk.

But the Fed's ongoing policy to purchase long-term securities left fear of a potential rise in inflation. The inflation never materialized, but these circumstances raised the demand for alternative currencies such as bitcoin. But this currency remains very risky, which puts into question its value. For example, 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 the 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 of the main issues bitcoin investors face: Gold and the U.S. dollar have their underlying value: Gold can be used to make jewelry, and the U.S. dollar is backed by the Federal Reserve. Does bitcoin have a base value? What if tomorrow, no one believes in bitcoin anymore? 

The takeaway
For now, bitcoin is still alive and kicking, even after the recent fall of Mt. Gox, which put a spotlight on one of bitcoin's main problems: security. This isn't the only problem bitcoin enthusiasts face, though. The currency's high volatility and lack of base value will keep haunting bitcoin investors.

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Read/Post Comments (6) | Recommend This Article (2)

Comments from our Foolish Readers

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  • Report this Comment On March 14, 2014, at 8:04 PM, MotleyBurger wrote:

    Yawn. Another negative article hyperfocusing on temporary elements tied to its current status as a new currency. Things that adoption, growth, maturity, can and the massively growing infrastructure being built on top of the Bitcoin protocol will easily address. Why don't you go out there and learn what's going on in the industry, and start reporting on the immense value it's bringing to humanity on a million different fronts? The unending flexibility and potential of this protocol for the first "programmable money". Write something unique.

  • Report this Comment On March 14, 2014, at 8:05 PM, MotleyBurger wrote:

    Apologies for the typos. Trying to do this on my phone!

  • Report this Comment On March 15, 2014, at 9:20 AM, PragueBob wrote:

    Sorry, but your reason #1 is simply not valid. The technical flaws that helped bring down Mt. Gox have nothing to do with the security of Bitcoin. Mt. Gox was in fact a technical disaster, flawed in more ways than one. The security of Bitcoin itself up to the point of this writing is, on the the other hand, flawless.

  • Report this Comment On March 16, 2014, at 3:10 AM, andyg2 wrote:

    The recent breach in Mt. Gox is still unclear but some analysts suspect the security breach was in bitcoin's protocol.

    Actually no, the breach is known and was a problem with MT Gox software, not the bitcoin protocol.

    No underlying value: Gold can be used to make jewelry, and the U.S. dollar is backed by the Federal Reserve.

    What is the intrinsic value of jewlry? It's just stuff that people like, surely if jewelry has intrinsic value so can a collection of zeros and ones. Also, the US dollar is backed by absolutely nothing except debt, infact it's negatively backed.

    High Volatility = high loss or high profits, over the last year (despite nay sayers) investors have seen high profits.

    Bitcoin has the potential for unlimited growth, is inflation proof and many are speculating it to be worth $100,000 per coin in a year or two so even very modest investments have the potential to make substantial returns.

    Try it, invest just $10 in both gold and bitcoin today. In 2 years you may have between $9 and $11 from your gold but you could have between $0 and $1000 from your bitcoin. Yes you could lose but anyone who invests what they can't afford to lose is a fool.

  • Report this Comment On March 16, 2014, at 3:11 AM, andyg2 wrote:

    The recent breach in Mt. Gox is still unclear but some analysts suspect the security breach was in bitcoin's protocol.

    Actually no, the breach is known and was a problem with MT Gox software, not the bitcoin protocol.

    No underlying value: Gold can be used to make jewelry, and the U.S. dollar is backed by the Federal Reserve.

    What is the intrinsic value of jewlry? It's just stuff that people like, surely if jewelry has intrinsic value so can a collection of zeros and ones. Also, the US dollar is backed by absolutely nothing except debt, infact it's negatively backed.

    High Volatility = high loss or high profits, over the last year (despite nay sayers) investors have seen high profits.

    Bitcoin has the potential for unlimited growth, is inflation proof and many are speculating it to be worth $100,000 per coin in a year or two so even very modest investments have the potential to make substantial returns.

    Try it, invest just $10 in both gold and bitcoin today. In 2 years you may have between $9 and $11 from your gold but you could have between $0 and $1000 from your bitcoin. Yes you could lose but anyone who invests what they can't afford to lose is a fool.

  • Report this Comment On March 16, 2014, at 1:07 PM, NealGafter wrote:

    "... and the U.S. dollar is backed by the Federal Reserve"

    No, it is not. You cannot redeem your dollars for a portion of the Federal Reserve. Dollars are backed by the same thing as Bitcoin: the belief that others will accept it as payment for goods and services. And for both dollars and bitcoins, that belief appears to be correct, at least for the time being.

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