What the gold price drop says about Bitcoin

DeFi development could improve gold while giving Bitcoin a new place to flex its advantages over gold.

The Bitcoin sell-off to date isn't too bad, by Bitcoin standards. It's hovering around $8,500 at the time of writing, putting it only about 19% down from its recent highs of $10,500. It's not great either. By failing to consistently hold above $10,000, many market-watchers appear to have shelved their hopes for a massive bull run.

Much of the speculation around Bitcoin prices in recent weeks has been tied to discussions of Bitcoin's prospects as a safe haven asset, and how the coronavirus outbreak may be impacting its price movements.

This naturally leads to comparisons between Bitcoin and gold, which is considered one of the more prominent safe haven assets. True to form, gold has been on a tear lately. At least until it encountered a sharp sell-off last week, dropping about 6% in the second half of last week.

What caused the gold sell-off and what, if anything, does the reason say about Bitcoin?

BTCUSD chart by TradingView

Reasons being

There are three closely-related explanations being given.

The first is that this is just a natural pull-back as gold takes some time to cool off after its gains. Another is that, as equity markets continue slumping, traders are liquidating gold to avoid being margin called. Basically, as the stock markets fall, people are dipping into their gold reserves to help cover the losses.

The third is that gold has spent the last odd six months being treated as a profitable and risky trade, rather than a safe haven, which has resulted in volatility and this sell-off.

"Gold rallied with stocks because at the time it was a risk-on investment. For around 6 months now gold is a crowded trade. Investor positions are around 80% of the annual supply and could come to market at any time when investors change their minds," said Georgette Boele of ABN Amro.

"If risk aversion were to result in a market panic, investors will find cash and very liquid assets attractive. They will probably liquidate gold investment positions."

Implications

One apparent takeaway may be that bonds and cash still trump gold and Bitcoin in times of trouble. But it may depend on what kind of trouble you're in. If the trouble is that the markets aren't doing too hot, you probably prefer bonds and cash over gold and Bitcoin. If the problem is more apocalyptic in nature, that preference may shift.

The problem, as Raoul Pal says, is that you usually can't get to one without going through the other.

As I got asked a lot today about gold:

Gold is dangerous in an illiquidity event but priceless in an insolvency event

The problem is, one usually precedes the other....

— Raoul Pal (@RaoulGMI) February 29, 2020

Opinion: Ecosystem and gold token development may be good for Bitcoin

If we look at the reasons for this gold plunge, and if we assume that Bitcoin is aiming for the same mental real-estate in traders' minds, what can we learn?

First, that an expanded DeFi ecosystem for both Bitcoin and gold could change these kinds of dynamics considerably. Specifically, the ability to more easily and safely earn yield or dividends on large Bitcoin or gold holdings by lending it without risking one's capital.

A key reason for gold's rise in the last odd year is the spread of negative rates. This is also apparently some of what contributed to its fall. Basically, gold is nifty for retaining value, but not so good at earning money. Given the choice, most traders would prefer to make money rather than just retain money where possible. But once the equity markets look fragile and negative yields become the norm, the idea of simply retaining value with gold starts looking much more tempting.

Gold can also be a beneficiary of these changes, in the form of gold tokens. These can be thought of as gold-pegged stablecoins if you're feeling more crypto, or gold ETFs on the blockchain if you're feeling more traditional. It's the same thing in the end, making it possible to earn yield on gold holdings.

The widespread ability to safely earn yield from large gold or Bitcoin holdings would be a potential game-changer for their status as safe haven assets, making them more compelling even before the world tips into negative yields. We can see from the causes of the recent gold price drops how this could have changed things considerably.

Of course, the space isn't there yet. DeFi rates are still just a question of supply and demand, and the only reason they're so high right now is because demand for loans is outpacing the supply of money. It's likely that rates will naturally shuttle downwards as the space grows. Meanwhile, incidents like the twin bZx exploits just go to show that there are still a lot of other risks to account for.

But if and when it does get there, Bitcoin may actually start to enjoy its edge over gold. One of these edges is the fact that Bitcoin can eliminate counterparty risk where tokenised gold can't.

The value of tokenised gold is based on the assurance that one can exchange the token for actual gold. While stablecoin issuers go to great lengths to build trust, there's still no 100% guarantee that the stablecoin is worth anything in the end. Bitcoin doesn't have this problem.

Plus, as a purely digital asset, Bitcoin can allow for more decentralised and liquid global markets than gold can. This has been an ongoing problem for the gold markets.

Gold's current price decline suggests that, as a result of market behaviour, it's not the perfect safe haven asset. Then again, Bitcoin certainly isn't either. Bitcoin has yet to start seriously competing for the same slice of the market as gold, the Drop Gold campaign notwithstanding.

But once we start seeing more blockchain tokenisation of gold, and the benefits this can bring compared to physical gold, or non-blockchain digital gold, the benefits of Bitcoin relative to gold may become more apparent.

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Disclosure: The author holds BNB, BTC at the time of writing.

Picture: Shutterstock