Wharton’s Rahul Kapoor and Lehigh University’s Natalya Vinokurova explain the risks associated with a common argument for investing in Bitcoin: comparing it to gold.
The following article was written by Wharton management professor Rahul Kapoor and Natalya Vinokurova, associate professor of management at the College of Business at Lehigh University.
Bitcoin is now priced at almost a hundred thousand dollars with a total market of almost two trillion dollars. A common argument promoting investment in Bitcoin compares it to gold — a time-tested store of value and a safe haven for generating significant investment returns. How credible is that analogy, and more importantly, what is the risk that comes with it?
Let’s think about where the great financial crisis of 2008 came from. Investors accepted the analogy of mortgage-backed securities (MBS) to bonds. MBS are a class of investments that entitle the investor to a fraction of cash flows of a portfolio of mortgages in the securities’ collateral. While MBS carried risks that were quite different from bonds (such as the systemic risk of a house price correction across the economy), they were rated by the same credit rating agencies as bonds.
Consequently, even conservative investors such as pension funds were willing to invest in these new supposedly safe securities. However, the analogy masked several aspects of the financial system: leverage in the system, lack of transparency about which investors owned what, the absence of a unified regulatory framework, and inadequate risk management tools. Combined, these factors turned MBS into the opposite of safe assets both for the investors holding them and the society at large.
Analogies are powerful mechanisms to help people and organizations make sense of a new idea or innovation. However, they almost always carry the risk of masking features that could be fundamentally important in the role that the innovation plays with respect to its intended use, resulting in unintended negative consequences, such as the financial crisis of 2008.
Digital Gold?
Bitcoin, launched in 2009, has been increasingly referred to as digital gold, emphasizing its modern digital nature as a store of value, with limited supply that is decentralized (not controlled by central banks) and operating on blockchain technology architecture. Accordingly, it has been pitched as a vehicle for investors enthusiastic about technology and seeking long-term financial gains that provide a hedge against inflation and are immune to economic cycles.
Buyers and institutions are increasingly explaining their decision to invest in Bitcoin and Bitcoin Exchange-Traded Funds (ETFs) in terms of it being the new digital gold. For example, the BlackRock chief executive, Larry Fink, was previously a Bitcoin critic, and in July 2024 he said he had been “wrong” about Bitcoin and now believes Bitcoin is “digital gold” and a “legitimate” financial instrument. State Street forecasts that cryptocurrency ETFs will surpass precious metal ETFs in North American assets by the end of 2025, becoming the third-largest asset class in the $15 trillion ETF industry.
While the similarities between Bitcoin and gold, emphasized in marketing campaigns and expert commentaries, are appealing and reasonably uncontroversial, they mask some important differences concerning the structure of value and the nature of ownership.
Unlike Bitcoin, gold has physical properties as a precious metal that are attractive for many applications, including jewelry, electronics, and medicine. In fact, it is estimated that more than half of the global gold reserve is used in such applications, with the rest held by central banks or private investors.
Moreover, the quality of gold (with respect to the metal purity) can be ascertained through simple scientific tests. Accordingly, the structure of value for gold is much more tangible and transparent than that of Bitcoin. While gold has a history of holding its value in times of societal cataclysms such as wars, it is not clear that Bitcoin could survive a major power grid failure.
The lack of transparency in the value structure of Bitcoin has led to speculative trading, involving individuals who don’t have the expertise necessary to understand the basis of value or critically evaluate the prospects of long-term returns.
Reminiscent of the Past
While the blockchain ledger provides a public database of Bitcoin ownership and transactions, there is little information about who owns what. This dearth of public and common knowledge about who owns Bitcoin is eerily reminiscent of the aftermath of the MBS crisis in which major financial institutions discovered — to their surprise — that they held the risk that they believed they had passed on to other players.
Today, pension funds from Wisconsin, Michigan, the UK, and Australia have begun investing in Bitcoin, primarily through regulated U.S. ETFs. This move is driven by Bitcoin’s substantial value increase and a pro-crypto U.S. administration. This is a pattern that is quite similar to pension funds investing in MBS without fully understanding the risks.
It has been estimated that a large majority of Bitcoins are owned by individual investors who own a small fraction of a single Bitcoin. This fragmentation and lack of transparency of ownership of a speculative asset presents systemic risk. The opaque structure of value, the absence of a unified regulatory framework, and the willingness of major financial institutions to sell these arcane products to less sophisticated investors suggest that Bitcoin has more similarities with MBS than it has with gold.
A critical ingredient of the 2008 mortgage crisis was the willingness of leaders of major financial institutions to go along with leveraged trading in securities that they did not understand due to the fear of missing out (FOMO) on the next big thing. These are exactly the patterns we are seeing in Bitcoin trading today.
The striking parallels between Bitcoin and MBS suggest that history may be repeating itself. In fact, the negative consequences of the analogy of Bitcoin to gold might be even more severe than the analogy of MBS to bonds. While most MBS at the end of the day were backed by real assets — mortgages on real houses — Bitcoin is not backed by any real assets.
If you are not in the business of speculation, steering clear of investing in Bitcoin — or for that matter any cryptocurrency — may be the best way to avoid the fallout from another misguided analogy.
