*This article is contributed by By Victor Argonov, Analyst, EXANTE*

There is still a great debate about which is the best asset to protect investors in difficult times: cryptocurrencies or gold.

Cryptocurrencies are often compared to gold. They have a number of features in common – independence from governments, limited emission, and a user consensus ascribing value to them. This is especially true in the case of bitcoin, the first cryptocurrency that still retains the status of the “default crypto”, just like gold retains the status of the most important precious metal.

However, cryptocurrencies are also vastly different from metals: they are a lot easier to trade. Physical gold is extremely difficult to buy, sell, and trade across national borders, and nearly impossible to use as legal tender. Gold turnover is subject to heavy taxation, and many prefer to invest in precious metal accounts instead of physical gold. Cryptocurrencies, on the other hand, are easy to buy and sell, can be freely traded across borders, and their use as legal tender is becoming increasingly more common.

These similarities and differences between cryptocurrencies and precious metals are common knowledge. However, one crucial question remains unanswered – how much they are able to function as a protective asset, retaining their value during crises.

Theoretical Considerations

Currently, one of the key arguments against the use of cryptocurrencies as protective assets is their high volatility. BTC cost $0.1 in 2010, $1,000 in late 2013, $200 in late 2014, $19,000 in late 2017, and around $7,000 today. Even just in 2019, which can hardly be called a particularly volatile year, its exchange rate still fluctuated by a factor of four over the year. Crashes are commonplace on the market, and no matter when you buy cryptocurrency, there is no guarantee that your capital is not going to halve in a month.

On the other hand, the key argument for keeping one’s funds in cryptocurrency is its tendency to grow in value as the number of its users increases. Cryptocurrency emission is limited by algorithms. With BTC specifically it is actually decreasing, which minimizes inflation. Currently a few dozen million people on Earth use cryptocurrencies, and their number doubles every year. Even 2018, disastrous as the year was, saw the number of users increase from 18 to 35 million. At the same time, the potential new audience is still huge, and in tandem with guaranteed low inflation it usually stimulates growing exchange rates, regardless of the bubbles that may occur.

The increasing number of crypto users not only boosts the cryptocurrencies’ exchange rates and capitalization, but gradually decreases their volatility as well. Here is a rough comparison, which nonetheless illustrates the situation. Over the four years between 2010 and 2013 the BTC exchange rate changed by four orders of magnitude, while in the next four, including the dip in 2014 and the enormous bubble in 2017, it only changed by two orders of magnitude. It is true that even the modest fluctuations in 2019 are huge compared to the traditional stock and currency markets, but this is a predictable consequence of the low market cap, which is currently at around $200B. Even when taken individually, the world’s largest companies like Facebook or Saudi Aramco have market caps several times that amount, while those of the global stock and currency markets have several orders of magnitude that market cap. So the current volatility of the cryptocurrencies may simply be a sign that they are still in their infancy.

Practical Evidence

There are many known cases of cryptocurrencies serving as a protective asset, primarily during national currency crises. In 2018 the national currencies of Turkey, Argentina, and Venezuela experienced drastic devaluation. While previously citizens of these countries tried to buy dollars in similar situations, this time many people turned to cryptocurrencies. As an example, in August 2018 the number of cryptocurrency users in Turkey was double the average number for Europe.

The cryptocurrencies’ protection against fiat currencies’ devaluation is not limited to unstable countries with only a small share on the global market. For example, statistics show that the BTC exchange rate usually increases as the Chinese yuan’s rate drops.

However, none of these examples make cryptocurrency unique. When one country’s fiat currency devalues, any other country’s fiat currency may serve as a protective asset if it is more stable. What makes gold unique is that its role as a protective asset is universal. Not only does it protect its owners from national currency devaluation, but from stock market crashes as well. Gold exchange rate is not particularly stable and has its own fluctuations, but it is fairly independent of stock index fluctuations. Does cryptocurrency have the same advantage? As practice shows, no.

From 2014 to 2017 BTC’s exchange rate usually changed in the same direction as the indices, and often with much greater amplitude. In the fall of 2018 it briefly looked like the situation was changing. The 2017 bubble had already deflated, and the volatility of the digital assets dropped by several orders of magnitude (as it usually happens after bubbles). When American stocks started dropping in price due to the trade war with China, BTC did not follow the market’s lead and had indeed served as a protective asset.

However, it was unable to cement that role. November already saw a new cryptocurrency crash that was followed by the infamous crypto winter. Whether it was chance or an expected event, it roughly coincided with the maximum dip in the stock market. The indices recovered due to the negotiations between the US and China in the spring of 2019, and so did the cryptocurrencies.

Very Risky, But Still A Protective Asset?

Overall, the properties of gold and cryptocurrencies as protective assets are very different. If you are afraid of your national currency experiencing inflation, cryptocurrency can protect your capital, but if you are a stock investor, expect cryptos to dip during a crisis as well. The reason for this is simple: despite their advantages, cryptocurrencies are still considered a very risky asset compared to securities and gold. They are exactly the assets the investors try to get rid of as soon as possible during difficult times.

On the other hand, in the long term cryptocurrencies are still a protective asset. If you are not afraid of long exchange rate dips and are not prone to dumping all your assets during crashes, you will probably be rewarded over the years. While cryptocurrency growth on the scale of 2010-2013 is unlikely, their exchange rates are still expected to multiply in the next few years. To date, every bubble on the crypto market resulted in a substantial growth of the exchange rates. For example, the BTC rate of $3,000-4,000 during the crypto winter of 2018-2019 was vastly higher than in any year before the 2017 bubble.

The only thing that can seriously undermine the global positive trend of the cryptocurrencies is a complete ban on them by leading countries. However, this seems unlikely. With every year, more and more influential financial communities join the cryptocurrency market, and they would not want to leave it.

The increasing popularity of cryptocurrencies will eventually slow down their upward trend, but is also likely to greatly decrease their volatility and make them more similar to traditional protective assets like gold. How close that similarity would be is, as yet, unknown.