What’s a better store of wealth: Bitcoin or gold?

There’s been a lot of talk about the new currency on the block: the bitcoin.

The very word conjures everything from jubilant excitement and optimism about the future, to derision and antipathy.

Before we can assess whether the latest contender for the crown of “king of the currencies” has any real long-term staying power — and as such, would present a legitimate challenge to the traditional role that gold plays — a bit more understanding is needed.

So let’s start our look at the relative value of bitcoin to gold by investigating exactly what bitcoin is.

Bitcoin is generally referred to as a “cryptocurrency” because it uses cryptography to create and transfer money. Introduced to the world in 2009 by a shadowy figure by the name of Satoshi Nakamoto — no one knows if this is a man, woman or a group of people — bitcoins are “mined” by people with computers powerful enough to verify all transactions and solve algorithms that get harder to solve with each passing day.

This process limits the amount of bitcoins that can ever be created — 21 million, with the last one to be created in the year 2140. This is known because there only so many bitcoins are made available at a given moment. Rival computers compete for the bitcoin, and whichever computer can verify all of the transactions (which are called the “blockchain” in bitcoin parlance) and crack the algorithm gets awarded the bitcoin.

In the early days, and by early days we mean just a couple years ago, this presented an opportunity to enterprising individuals with a decent home computer and a belief in the currency. That was all it took to win a bitcoin. But the days of such easy money are long gone, and there is a well-founded belief that big Wall Street money is behind the firms with the type of ultra-powerful chips now required to win the coins. But more on that later.

It’s important to understand that the amount of bitcoins available is limited, and this sets the currency in stark contrast to all fiat currencies, which as we all know, can be printed at the whim of central banks, thus bringing eventual devaluation via inflation.

So the limit on production allows bitcoin to copy one of gold’s great attributes, but where it goes further is in the cost of transactions. Unlike gold there are no storage costs or shipping costs associated with bitcoin, and unlike gold, it is increasingly being accepted by retailers as an acceptable form of payment.

Such retailers are naturally motivated to adopt bitcoin, because unlike credit cards, which take a 2–3% bite out of transaction values, bitcoin transactions are basically free.

Individuals and institutions that have to transfer large amounts of money also like it because transfer fees are all but non-existent. When transferring hundreds of millions of dollars, this can save users hundreds of thousands of dollars in fees.

These are some of the currency’s merits. Its proponents would be happy if we ended our analysis there and just accepted the great bitcoin revolution. They would say that like the telephone and the Internet, it is merely the latest advancement of modern civilization, and to shun it makes one out-of-touch and antiquated.

And yet despite such appeals to the older generation’s technological insecurity by leaders of the tech avant garde — such as Marc Andreessen — proponents can’t ignore real problems that keep leaking through their holy grail.

The latest event to make the chalice teeter on the altar is the collapse of one of the currency’s most established exchanges: Mt. Gox. Bitcoins bought through the Tokyo-based exchange first fell to one-fifth of the going rate at other exchanges before the entire exchange went offline on Feb. 25, amidst allegations that it was hacked and robbed of $350-million worth of bitcoins. At press time, those holding bitcoins at Mt. Gox were seen as having little chance of recouping their holdings.

The Mt. Gox situation does more than just point to the uncertainty around any given exchange. It is a concrete example of the intrinsic value problem that sticks to bitcoin like a burr on a hiker’s sock.

While there is some debate over the characteristics of a solid currency, it is accepted that a given instrument should be durable, divisible, consistent and possess some form of intrinsic value.

And while bitcoin doesn’t have much trouble meeting those first three criteria, it does have trouble with the last one, which is demonstrated by the Mt. Gox scenario.

Imagine the place where you stored your gold went bankrupt. Provided they were just broke and not crooks, you would be able to recoup your gold and sell it somewhere else at roughly the spot price for gold. You can do that in part because gold does have intrinsic value. There is a real value that has been attached to the metal for thousands of years for its use in adornment, industry and as an inflation hedge amongst other factors.

Bitcoin, however, doesn’t share this feature. Its value is only derived from what someone will exchange for it. And because of its rather ethereal quality, it is subject to intense volatility: as the whims of users change the value fluctuates wildly. So bit coins can run up from $100 to $1,000 in a matter of months and collapse back down to $100 a few months later. This is hardly the type of stability an intelligent investor looks for in a currency.

And there are other problems as well.

There is the whole issue of how bitcoins are “mined.” As already mentioned, it is becoming increasingly difficult to mine them. So much so that the consensus opinion is that it is likely the big money has already cornered the market.

The situation means that one of the attributes touted by bitcoin proponents has already been violated. Bitcoin supporters believe they are democratizing currency. Allowing an average Joe with enough patience and time and a relatively modest outlay of capital, to mine riches of their own. This was the case in the early days, and there are plenty of rags to riches stories, but those days are now over.

Compare the situation to gold. In just five years mining bitcoin is already out of the reach of anyone but the most elite, whereas gold, after thousands of years, is still available to anyone with a pick axe, a nose for geology and a ton of good luck.

And while the opportunity for an average Joe to get stinking rich isn’t a characteristic of money, for a currency to have universal appeal, users don’t want to feel that only a tiny percent of the population can create them. It is disturbing enough to evoke a feeling of disgust, and there aren’t too many currencies that last that are associated with a feeling of disgust.

But if the idea of the super elite making billions more by being the only ones able to mine the currency doesn’t turn your stomach, perhaps its use for illegal activity will.

The much-vaunted anonymity of bitcoin has made it a haven for illegal activity. So much so that China recently restricted its banks from allowing bitcoin transactions due to the rampant money laundering it was being used for.

But on this point we should trust in tech guru Marc Andreessen. In a recent piece for Seeking Alpha, Andreessen assured readers that the currency is getting a bad rap for aiding criminals.

“Every transaction in the bitcoin network is tracked and logged forever in the bitcoin blockchain, or permanent record, available for all to see. As a result, bitcoin is cons
iderably easier for law enforcement to trace than cash, gold or diamonds,” he wrote.

While noted for his investment prowess, Andreessen clearly has a problem with short-term memory, as just a few paragraphs earlier in the same article he assured readers that bitcoin users never have to worry about being hacked, because there is no way for hackers to steal personal information. So which is it? Can the police trace the bad guy or can no one ever know my identity?

And lest you think that such ramblings are the product of some mental lightweight, Andreessen is definitely a heavy in the bitcoin world. He is not only the co-founder of Netscape but is also the Andreessen in Andreessen Horowitz, a venture capital firm that is financing one of the biggest pushes to corner the bitcoin market. So forgive him if his greed for mining bitcoins has caused his rational faculties to fail him.

In the old days they called it gold fever. Today, who knows what the kids will call it. Either way, if such flaws wind up contributing to the currency’s demise, gold investors could reap the benefits, as investors always flock to the tried-and-true once the new sensation has lost its sizzle.