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Unless you’ve been living under a rock for the past 15 years, one of the biggest developments in the field of currency has been the growth and adoption of digital currencies such as cryptocurrencies. Once derided as a tool only for cybercriminals and terrorists, digital currencies have entered the mainstream.
To digital currency supporters, digital currencies such as cryptocurrencies are the wave of the future, a replacement for gold, and the only way to ensure our freedom. To detractors or skeptics on the other hand, the replacement of physical cash or commodity money with digital currency is the first step towards totalitarianism.
So who is right? Will digital currencies become the dominant form of money and even replace gold as a safe haven asset? Or will the next financial crisis expose the weakness of digital currency for all to see?
It seems like only yesterday that Bitcoin became the next big thing, but the cryptocurrency’s roots date back to 2009, in the aftermath of the 2008 financial crisis. Bitcoin’s creator, Satoshi Nakamoto, sought to create a digital currency that could overcome many of the problems inherent with central bank money creation.
Bitcoin was slow to catch on, with bitcoins initially being worth only fractions of a penny. But as Bitcoin caught on, the value increased, until now each bitcoin is worth over $40,000.
The growth in popularity of Bitcoin spawned an entire crypto industry, spurring the creation of hundreds, if not thousands, of cryptocurrencies and other forms of digital currency. Digital currencies have continued to grow in popularity, but how long might this continue?
Digital currency is any currency or money-like asset that is stored digitally or exchanged on computer networks, mostly through the internet. In many cases there is no physical form to these digital currencies, and they can’t be converted into cash or other physical forms.
There are numerous types of digital currency in use today. But it’s important to remember that just because something is money that can be transferred digitally doesn’t mean that it is a digital currency.
When you swipe, tap, or insert your credit card at a point of sale, that transaction processes electronically. And you may very well pay off your credit card bill online.
But just because the money in your bank account may be able to be moved online doesn’t really make it a digital currency, because underpinning all of the money in bank accounts is an amount of physical paper money.
So what kinds of true digital currencies are there? Let’s take a look at some of them.
First we’ll look at tokens and virtual currencies. By this we’re primarily talking about the types of currencies that you’ll come across in computer games and online experiences.
For instance, the once popular Second Life features Linden dollars as its in-game currency. Or if World of Warcraft is more your thing, in-game “gold” is the form of currency.
Many of these tokens and virtual currencies may have limited ability to exchange them into fiat currencies. And their exchange rates may fluctuate over time, as the supply of the tokens or virtual currencies may be at the discretion of the game developer.
While these tokens and virtual currencies may not be adopted on a wide basis, they predate cryptocurrencies and other forms of virtual currency and in a sense can be thought of as leading the way toward the creation and adoption of cryptocurrency.
Cryptocurrencies are digital currencies that are normally designed to be decentralized networks not dependent on any one issuing authority. In the case of Bitcoin, for instance, bitcoins are “mined” by a network of computers, who are then rewarded with bitcoins for the work they do.
The purpose of cryptocurrencies like Bitcoin is to eliminate one of the problems inherent in fiat currencies, namely that the currency issuer can continue issuing additional units of currency ad infinitum. This inflation of the currency supply reduces the value and purchasing power of each unit of currency.
Bitcoin and similar cryptocurrencies solved this problem by fixing the supply of currency units, then instituting a creation process that slowly issues the currency units over time. As we’ve seen over the past 10 years, Bitcoin’s price has risen from fractions of a penny to over $40,000, meaning that its purchasing power has increased significantly.
Compare that to the US dollar, which has seen its purchasing power reduced by 25% over the past 10 years, and by 87% since 1971.
One of the perennial knocks on cryptocurrencies is that they aren’t backed by anything. They’re essentially a bunch of ones and zeroes created on a hard drive somewhere and that only exist in digital form.
If you lose that hard drive, your cryptocurrency is lost forever. Because of that ephemeral nature of cryptocurrencies, some crypto enthusiasts sought to create something different, cryptocurrencies that were backed by something tangible.
That gave rise to stablecoins, cryptocurrencies that were backed by fiat currency or some other monetary asset. Thus each unit of a stablecoin currency could be backed by a certain number of dollars, or US treasury securities, or some other asset.
The purpose of stablecoins is to keep the value of the currency unit stable, enabling it to be used as a medium of exchange. This was done in order to counteract one of the perceived flaws of Bitcoin and similar cryptocurrencies, namely their volatility.
Asset-backed digital currencies can sometimes be considered stablecoins, such as cryptocurrencies that are backed by tangible assets like gold. But not all asset-backed digital currencies are cryptocurrencies.
One of the first asset-backed digital currencies was e-gold, founded in the mid-1990s as a digital currency that was backed by gold and that offered immediate payment settlement. Due to lax adherence to federal regulations, e-gold was eventually shut down around 2008.
But despite the ups and downs of asset-backed digital currencies, they nevertheless remain popular in some circles. And when all is said and done, asset-backed digital currencies may be what end up being the winners in the digital currency arena once everything shakes out. We’ll just have to wait and see.
The last important type of digital currency is central bank digital currency, a relatively new entrant to the market. Central bank digital currencies (CBDC) were once something that relatively few central banks wanted to create.
But China’s testing of its digital yuan has spurred other countries to action. The Federal Reserve is now studying the feasibility of a CBDC, and numerous other central banks seem to be warming up to the idea.
From the perspective of a central bank, a CBDC has certain advantages. The central bank can control the currency in a way that it can’t with cash, including determining who can and can’t hold or use the CBDC.
All transactions using CBDCs would be traceable, which should virtually eliminate tax evasion, money laundering, and other financial crimes. But that would also eliminate financial privacy, which is why many Americans are so fearful of the introduction of a CBDC in the United States.
With digital currencies having only really entered the mainstream within the past 10-15 years, you might ask why someone would want to choose digital currency? Well, that depends on what you want to use digital currency for.
The two primary uses for digital currency today are as a medium of exchange and as a store of value.
As a medium of exchange, cryptocurrencies like Bitcoin have demonstrated that they can be used to transact everyday purchases at point of sale. But because of Bitcoin’s extraordinary price growth, its use as a medium of exchange has diminished, as people have started to purchase and hold it as a store of value or as a speculative asset.
Still, digital currencies can offer advantages when it comes to use as a medium of exchange, such as immediate payment settlement. In that way they can be used almost as digital cash.
But with numerous other methods of payment to compete against, digital currencies are finding it tough to make headway. Instead, they’re more often today held as stores of value or as speculative commodities.
Many people buying cryptocurrencies today are hoping to profit from price growth, hoping that they’ll return to their once stratospheric growth in price. While it’s unlikely that we’ll see price growth like the early days, Bitcoin thus far has grown nearly 170% in value this year, while Ethereum is up nearly 100%.
With those kinds of gains, it’s easy to see why people choose cryptocurrencies as a speculative asset. It seems like there’s always the potential for those kinds of gains.
The flip side of that, however, is that the volatility of cryptocurrencies means that those big gains can also very quickly turn into huge losses. Bitcoin has experienced a number of crashes already in its short lifetime, so holding cryptocurrencies as a speculative endeavor isn’t for the faint of heart.
While gold no longer serves as a monetary metal, it remains a popular safe haven asset and store of value. For many people, having the ability to hold physical gold provides them with a sense of security, a knowledge that they’re actually holding something of value.
But not everybody wants to store gold at home, given the potential for loss or theft. Many people choose to buy gold with a gold IRA, a tax-advantaged retirement account that holds and owns physical gold coins or bars.
A gold IRA can give you the ability to own gold with pre-tax dollars, just like your 401(k), 403(b), TSP, or IRA accounts. You can even fund your gold IRA with a rollover from those accounts.
With a gold IRA, you retain all the same tax advantages as any other IRA account while also gaining the benefits of owning gold, such as safeguarding your assets during times of crisis.
When times get tough, many people look to gold to help protect their wealth. Gold has a reputation for performing well when the economy is not.
During the 1970s stagflation, for instance, gold’s annualized rate of growth was over 30% per year over the course of the decade. And in the aftermath of the 2008 financial crisis, gold nearly tripled from its 2008 lows to hit an all-time in 2011.
Recently gold has once again hit new all-time high prices, with fear of an economic slowdown helping boost gold demand and gold prices. And if the economy falls into recession, the gold price could continue to rise.
Digital currencies have yet to face a major test during a financial crisis. Many proponents of Bitcoin claimed that cryptocurrencies were as good as gold, or that they could replace gold.
But we haven’t seen yet how cryptocurrencies will fare in the face of a major financial upheaval. The next major crisis will be the real test for cryptocurrencies, stablecoins, and other digital currencies to see if they pass the test.
If cryptocurrencies do in fact maintain their value during the next major economic crisis, maybe they will have established themselves as a viable store of value. But if prices fall and don’t recover, it might be time to head back to the drawing board.
That’s part of the risk of owning cryptocurrencies too. Anyone who owns them is still in many respects a beta tester, and the volatility that has seen cryptocurrency prices soar this year could end up hurting them during the next recession.
If you’re looking for a store of value, the question becomes do you choose a traditional safe haven asset like gold, or do you embrace new concepts like digital currencies? Ultimately the choice is yours to make, and will depend on your particular financial situation, your financial goals, and your appetite for risk.
If you can afford to lose tens or hundreds of thousands of dollars speculating that cryptocurrencies will be the next great safe haven asset, maybe cryptocurrencies are worth a look. Or if you prefer a long and well-established track record, maybe gold is what you need.
With thousands of satisfied customers and over $2 billion in precious metals placements, Goldco has a long track record of customer satisfaction and quality products. So if you do decide that gold is what you want, give us a call.
We have helped thousands of customers benefit from owning gold, whether they buy a few coins to keep at home or hundreds of thousands of dollars of gold coins and bars in a gold IRA. Call Goldco today to learn more about how you can safeguard your financial future with gold.
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