Central banks are pressing ahead with digital currencies (CBDC). The first to make a splash is the Bahamian “Sand” Dollar.

The Bahamas? Its currency is pegged to the US dollar, so it has leapfrogged the Federal Reserve and enabled the US dollar to enter the digital world.

The Chinese renminbi is close behind and there are thought to be eight CBDCs in the planning stage. Before Mark Carney was the governor of the Bank of England, he had been experimenting with digital currencies while at the Bank of Canada. They couldn’t make it work because blockchain technology hadn’t been invented. That came about in 2009, when bitcoin was launched.

But don’t we already have digital money?

No, we don’t.

I just tried to send €600 to a colleague in Amsterdam for some software work. There are several problems with this simple transaction:

  • It takes 2-4 days. Same day transfer requires a £15 charge.
  • Sluggish transaction speed slows down the global economy as the money is locked up while in transit. That reduces the “velocity of money” and the potential for more economic activity as businesses wait to be paid.
  • The GBP/EUR exchange rate was 1.112. My bank charged 1.068 for 2-4 day delivery or 1.041 for fast delivery. That is a charge of £22 and £37, or 3.7% and 6.2% respectively – a huge drag on business.
  • My bank didn’t allow me to process the transaction automatically because the IBAN code (an international banking reference) wasn’t recognised despite being correct. I had to pick up the phone and sort it out.
  • With 300 banks in the UK and 50 in the Netherlands, much can go wrong. And it often does. The current system of complex references is no longer fit for purpose.

When the UK has a digital pound, and the Netherlands a digital euro, I would be able to bypass both my bank and my colleague’s bank. The digital transaction would be direct, cheap, secure, seamless and instantaneous.

The transaction would be faster than the same day, and there would be no £15 charge. I would swap pounds for euros via an online exchange which would have low dealing charges and get me much closer to the 1.112 exchange rate that the banks enjoy when dealing between each another. I will effectively have the privileges of becoming my own bank.

This will all become possible courtesy of CBDCs. They have used bitcoin’s underlying technology and will use it to distribute their own fiat currencies such as the euro, pound and dollar.

It means the Bank of England can send you money directly without depending on the high street banks. It gives them more control of monetary and fiscal policy. And you know how much these good folks like control. It allows you to propel yourself into a brave new world, where the banks are left for dust.

It was bitcoin’s blockchain technology that has made all of this possible. In short, the blockchain enables the CBDCs to move currency, both at home and abroad, without being copied, printed or forged. Not only can CBDCs interact with other CBDCs, but they will open up the world of digital assets to the many.

But let’s take a closer look at what made it all possible.

The bitcoin boom

On 3 January 2009, the bitcoin source code was released by the pseudonymous creator, Satoshi Nakamoto. Not much happened that year other than a few geeks testing the system. But in 2010, bitcoin started to be traded with a price measured in cents. The idea took hold and the price leapt ahead.

Bitcoin average price by year

Source: ByteTree.com

The average price retreated in 2015 and 2019, yet the progress during other years has been extraordinary. The consensus view in the bitcoin market is that having settled down since 2018, it is ripe to shoot higher, just like it did back in 2016 after a three-year rest.

Today there are a little over 18.5 million bitcoins collectively worth approximately $250 billion. You might think that’s a lot, but according to the World Gold Council, the world’s gold is worth $12 trillion. People close to the bitcoin market are upbeat because they see bitcoin catching up with gold. There are risks to this scenario, but it is looking increasingly likely.

But why compare bitcoin to gold at all?

I have studied the gold market since 1999 and have found it fascinating. Along with silver, it has played a central role in monetary systems since the early days of civilisation. That proved particularly useful when communications were poor, money was weighed, and information was exchanged by ship. Exchange rates were fixed to gold, because gold is gold, wherever you are.

The gold standard came under pressure in the late 1960s. Currencies were fixed to the price of gold, ensuring price stability. Yet fixed rate systems have their own problems as Asia discovered in the late 1990s when they crashed off the US dollar peg. And in 1992, the UK suffered a similar fate when we crashed out of the ERM.

Fixed-rate systems always come under pressure, and the euro is a good example. Italy, Greece, Ireland, Spain and Portugal are struggling to breathe living with a highly valued euro, a price that seems to suit the Germans. The euro is held together by desperate measures, but the odds are that the euro project will eventually buckle under pressure.

We know this as there are so many historical precedents. In the early 1970s, as the US dollar was forced to devalue against gold. This brought the end of an era and the gold price rose 27-fold by 1980, leaving a trail of inflation in its wake. Investors flocked to gold to protect themselves from devaluation.

With the response to the credit crisis and Covid-19, history is repeating itself. Government borrowing is unsustainable and sooner or later, currencies will see an acceleration in their loss of purchasing power.

Today, gold no longer has a formal role in the financial system, but the central banks and investors are drawn to it because it protects them from the assured deterioration of purchasing power in the fiat currencies over time.

There are periods when fiat currencies have been stable, generally when interest rates have been higher than inflation. But today, it is the other way around, and investors are running for the lifeboats.

Bitcoin versus gold

The merits of gold are proven whereas bitcoin is the new kid on the block. With limited supply, bitcoin was designed to become digital gold. It is secure and robust, yet has the advantage of being able to transact within an instant, all over the world. While shy of 5,000 years of credibility and trust that gold has, there is light at the end of the tunnel.

With over a decade to establish itself, bitcoin presents itself as gold’s digital competitor. Those problems I mentioned earlier with my bank transfer to Amsterdam aren’t solved by gold, but they are with CBDCs, bitcoin and other digital assets.

The CBDCs are a game changer because they will provide everyone with a digital wallet. It will resemble an app or a website and be easy to use, but behind the scenes it’s completely different from your online banking.

The record keeping or your balance isn’t held on a single ledger at your bank, it will be held on the blockchain of which there can unlimited copies, that all update together, while protecting your privacy. This “distributed ledger” ensures widespread trust, as everyone can see what is happening in real time.

The CBDCs may not provide full public access, and they may censor certain transactions, but private digital currencies will help to overcome this. PayPal has integrated bitcoin, and other tech companies will inevitably launch their own challenges to CBDCs. You can already trade using “digital dollars”, known as “stablecoins” in the digital economy, and they are becoming increasingly popular.

The point is that when everyone has a digital wallet, courtesy of CBDCs, then all of a sudden bitcoin no longer looks so alien. As people become familiar with digital assets, bitcoin will naturally assume the role that gold has served over the years, and especially for the younger generation. That is not to say that gold will fall by the wayside, but there will be a vibrant, digital alternative.

The traditional financial world has been conditioned to believe bitcoin is bad. The banks and regulators have put huge obstacles in its path, yet it has thrived regardless. With CBDCs on the way, the banks will be leapfrogged, and risk being left behind. The banks resist the digital economy because it leaves them behind to rot.

The investment case for bitcoin

Assuming there are 200,000 tonnes of gold in the world, worth $1,900 per ounce, that values today’s stockpile at $12.2 trillion. With just over 18.5 million bitcoins in circulation, and if bitcoin managed to match the valuation of gold, the bitcoin price would rise to over $600,000: a 50-fold gain.

Better still, I believe gold will rise to $7,000 by 2030 as I outline here in a piece for the London Bullion Market Association (LBMA).

If that proves to be correct, then the upper bitcoin target can be raised in proportion.

It is a bullish forecast for sure, but not an impossible one. After all, the government debt pile keeps on growing, while the future tax base cannot possibly support it. The system will crumble, and investors will flock to alternative stores of value such as gold and bitcoin. While I would agree bitcoin has a long way to go to match gold’s credibility, the internet is an unparalleled force for spreading ideas.

Building bitcoin’s credibility

Gold is beautiful, desirable, and inert. It is dense, rare, difficult to extract, and steeped in history. But against that, it is heavy and difficult to physically move. Bitcoin may not work as jewellery but is as rare as gold and over time, will become even rarer.

But the central banks don’t buy gold because it’s pretty. They turn to it because of its liquidity during times of economic stress.

According to the World Gold Council, gold trades $145.5 billion per day, which is not dissimilar to the almighty S&P 500. Liquidity in itself has value, as investors are willing to pay more for something they know they can easily sell on when financial markets are in turmoil. Today bitcoin trades around $3 billion per day, which has grown from zero in ten years.

Gold has low volatility, which is important because investors welcome stability. Gold’s volatility is historically similar to 20-year US Treasury bonds, which are deemed to be as safe as you can get.

Bitcoin volatility has historically been off the scale, but is calming down. It may surprise you to learn that bitcoin’s volatility is now lower than the “must have” stocks such as Amazon, Google and Apple.

The final point is gold’s deep investor and highly credible investor base. It includes the world’s central banks, the mega rich, established institutions and billions of individuals either through jewellery or bullion.

Being so widely held builds trust and stability. It drives the liquidity and the associated low volatility. When the price falls, there’s always a buyer, and when the price spikes, there’s always a seller. This maintains an air of calm.

Bitcoin will inevitably become more widely distributed over time. And as it does, liquidity will continue to grow, and volatility will continue to ease. This all seems likely to happen because it is an ongoing decade-long trend. It took gold 5,000 years to get to where it is, but I suspect bitcoin will be much quicker. That is of course, unless you want to bet against the internet.

A million-dollar bitcoin target may seem to be farfetched, but the case is more rational than many think. It would surprise me if bitcoin were to supersede gold, but anything is possible.

Before 2008, negative yields and quantitative easing seemed farfetched, yet they are all around us. In this mad world we live in, it pays to keep an open mind.

What are the risks of buying bitcoin?

Don’t bet the farm on crypto. Nor anything else, for that matter. Bitcoin, like all other cryptocurrencies are very high risk and only for money that you can afford to lose. As an unregulated asset (like physical gold) you don’t have the protection of the financial ombudsman if something goes wrong or its stolen so you need to know what you are doing and how to store it.

And don’t watch the daily price moves if you’ve got a weak disposition. Given bitcoin’s remarkable upside potential, a modest position within your diversified portfolio is all that is required.

Charlie Morris
Editor, Southbank Investment Research