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3D rendered illustration of gold bars and golden currency symbols. Stock exchange and banking concept.

Gold has been a highly popular tool for hedging against investments in currencies, commodities and other financial instruments. Hedging allows investors to offset losses in an asset class, generally currencies and stocks. But recent months have seen investors look towards cryptocurrencies as a possible hedging tool. The astounding rise in the values of Bitcoin and other cryptocurrencies has attracted many investors, who believe that cryptos can prove to be an effective hedge against the instability in the prices of fiat currencies. But, do cryptos really qualify as an effective hedge against losses?

Gold as a Safe Haven

Gold has been seen as a safe haven by investors over the years, whether it was the financial crisis of 2008, the stock market crash or the Eurozone crisis. Gold prices have continued to rise over time, even when the world economy faced severe financial problems. The price of gold more than doubled from $869.75 in 2008 to a record high of $1,895 on September 5, 2011. But gold prices too are speculative and can have high peaks and low valleys. We can gauge this from the fact that gold price as of April 2018 is hovering around $1,300 per ounce.

Gold has proven to be an effective investment in the long run, mainly because it is the standard on which the value of all money is based. In addition, the weakness of the fiat currency system has made investment in gold quite popular. Gold provides a safety net against currency depreciation. So, can cryptos do that too?

Can Cryptos be as Good as Gold for Hedging?

Looking at the features of various cryptocurrencies, it is difficult to envisage that they will prove to be good hedging tools against currencies and stocks. Here are some reasons why:

  • Not backed by physical commodity: Fiat money refers to legal tender currency that is not backed by a physical commodity. Cryptocurrencies are similar to fiat currency, since they are also not backed by any physical commodity. Although they are yet to be recognized as legal tender, they are used for online transactions in a number countries. Also, several countries are considering launching their own digital money. And, hedging one type of currency against another does not make sense. When we compare cryptos with gold, gold has an edge because of its limited supply. While the supply of cryptos is also artificially constrained, it may not serve the same purpose.
  • Liquidity: Gold is one of the most liquid assets available and can easily be converted into cash, irrespective of the country you are in. But the same is not true in case of cryptocurrencies. Cryptos are still very far from being accepted all across the globe. Also, the huge variety of cryptos available in the market makes it difficult for them to emerge as a good hedge against fiat currencies.
  • Too much variety: With over 1,700 different cryptocurrencies floating in the market, it is difficult to envisage which ones will emerge as a good hedging investment and which ones will vanish over time. Experts expect only a few cryptos to survive and emerge as strong investment candidates. Also, once a country like the US launches its own digital currency, all private currencies are likely to be rendered illegal. The uncertainty about the survival of cryptocurrencies after a few years allows gold to emerge as a stronger hedging tool.
  • Cyber security: Instances of hacking of crypto exchanges or digital wallets have raised concerns about the security surrounding the storage of digital currencies. And, this can be a major hindrance in making cryptos an effective hedging tool.
  • High volatility: The sharp volatility in the value of Bitcoin and other cryptos points to the huge speculation in the market for digital currencies. So, it looks difficult that cryptos can be used for hedging for now.

Apart from these features, the fact that cryptos have been around only for a few years, in comparison to gold, which has been used as a store of value for thousands of years makes the precious metal a better option for hedging. Also, gold has a low or negative correlation with stocks and bonds, especially during periods of economic recession, making it a powerful hedge. No such correlation has been established between cryptos and other currencies or stocks so far.

Disclaimer

If you liked this educational article please consult our Risk Disclosure Notice before starting to trade. Trading leveraged products involves a high level of risk. You may lose more than your invested capital.

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