Can crypto replace gold in your portfolio?

The extraordinary returns given by cryptocurrencies over the past year have drawn the attention of investors. From millennials to seasoned investors, everyone is inquisitive about virtual currencies. But often, comparison is made between cryptocurrencies and gold due to their limited supply and their role as alternatives to fiat currencies.

So, how do they stack up? Let’s take a look

Gold has a dual nature

Gold is used not just as an investment, it is used for multiple purposes such as jewellery, components in computers, mobile phones and other technology, which, interestingly, are needed to ‘mine’ cryptocurrencies. Though in some countries cryptocurrencies are used as a means of payment as well, their role is largely limited as an asset in India.

According to a recent report from the World Gold Council titled ‘How gold’s role in a portfolio differs from cryptos states, “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…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. In contrast, cryptocurrencies are digital (non-tangible) assets and, in our view, their current primary – if not only –the source of demand is for investment.”

Gold is a scarce natural element

While Bitcoin supply is pre-determined, there are many other cryptocurrencies that have come up recently. Compared to gold, the supply of cryptocurrencies has increased manifold in recent years.

The report states, “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. In contrast, nothing prevents additional – and possibly more efficient – 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.”

Gold and crypto prices behave differently

A higher exposure to cryptocurrencies warrants a higher allocation to gold because of the high risks involved with cryptocurrencies. “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. This indicates that gold and Bitcoin are not behaving as substitutes,” according to the WGC report.

An evolving regulatory environment

It is perceived that evolving regulatory frameworks may change the value proposition of cryptocurrencies.

“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,” the report noted.