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Cryptocurrency backed by gold – Amazing or Stupid idea?

One of the unacknowledged axioms of modern trade, with the possible exception of stupid trade, is that trade in anything is somehow contingent on how willing other people are to invest in that thing. Put differently, trade in anything is contingent on the willingness of others to be willing to invest in it.

Everybody agrees that gold is not a currency. It’s a store of value, which is why it is used as collateral against loans. That’s why it doesn’t lend at a commercial bank. But, being worth something, gold has a special utility to people who also prefer it as a store of value over other investments — people who like using gold coins, bills or silver coins to receive payments. And in recent years, that utility has been bolstered by technological advances, including Bitcoin.

As long as the gold we choose to trade with is real gold, we have used it as collateral, and its value has not changed. In fact, it has gone up — gold hit $12,000 per ounce in February and is now trading at around $14,000. But the cryptocurrency we trade with is not real gold, and so its value has changed dramatically. Bitcoin is not even tangible — it is a program with a ledger, which many people use to transact.

So far it seems to be faring far better than other cryptocurrencies, since its value is changing on a daily basis — it’s almost as if its “coins” are themselves being traded, not issued by an operating company — but at this stage there are plenty of doubts. Its investors can trade virtual gold with each other, but they can’t give gold outright to others. Also, the exchange business can’t be as efficient as it looks on paper — you need a certain level of trust between parties to be truly effective. And none of these problems will change anytime soon. If the novelty of cryptocurrency is holding off its “toxicity,” that’s because investors are still in the process of coming to terms with it.

In the meantime, most other people will just sit on the sidelines, just as they have all through history. The exchange system will continue to perform merely as the first phase of a series of increasingly complex electronic markets, all of which eventually grow smarter, less turbulent and more efficient.

The days of gold as a financial instrument will, on this view, end in 2020 or so, when, without a new explanation to the contrary, its value will shift from being based on its use in financial transactions, to being based on the assets and traits of the individuals who own it.

And, judging from the current trajectory, this won’t be very useful. There’s nothing wrong with people using coins or bills or coins plus any other combination of physical or digital properties in order to receive payments, so long as the value is based on something more valuable than mere desire. But there’s no real-world reason for investing in gold right now — far fewer reasons than there are for owning an avocado toast-like cryptocurrency.

So the world has been trading in gold as collateral for a good deal of time. The first phase in that trade was good — the world withstood the effects of the financial crisis in good shape. But in the second phase, both gold and crypto are either failing or heading for failure. This makes a strong case for reducing gold’s use as collateral and replacing it with one based on something we know — gold.

The rewards of reducing coin use will be well worth the effort.

To be clear, my case for gold is not confined to bitcoin’s bad behavior — not by a long shot. But bitcoin and other cryptocurrencies are inventions, which require time to mature before they are “solved.” And a root problem with cryptocurrencies is that, except in rare cases, no one knows for sure what the ultimate value of the asset being traded is. It’s a bad trade at the moment — bitcoin’s value, though it is not really in a bubble, is on the fritz, rising and falling, without any clearly identifiable patterns or upticks — but it could be useful to a much wider community in the future. It is probably now simply a Rorschach test — a reflection of both momentum and misunderstanding — for lots of people. And, with deeper history, we can probably estimate that bitcoin will eventually become useful, and even useful enough to trade.

But it won’t be useful now. Just as gold is worth more as collateral than it is with no intention of being traded, so is bitcoin.

In other words, the latest over-hyped technology is probably not the great new thing we were told it would be. But then, it’s not even the best innovation we’ve had in a while.