Opinion The Gold-to-Digital Central Bank Investment Scenario

The Gold-to-Digital Central Bank Investment Scenario

August 3, 2019

The concepts of gold and cryptocurrencies are clearly inexplicably linked in the minds of the general public. However, they are also in a similar relationship when it comes to some experts in the field, while others are pointing to a possibility of these two having an even stronger connection in the times to come.

This time, that connection is the potential of banks, including those that are central ones, to actually ditch gold in exchange for crypto. Even though this very notion could be able to make many financial professionals roll their eyes, there is a surprising amount of logic behind that possibility. Of course, it is still incredibly distant as an actual option, but it, if nothing more provides an interesting thought experiment in the age where bitcoin is used for gambling as much as for direct payments or even loan acquisitions.

Gold Buying Spree

Over the past couple of months, many central banks began what could only be described as a buying spree. Its target is nothing else than gold, one of the oldest and most famous mediums of wealth transfer and storage. While all of them, openly or not, shun bitcoin and other cryptocurrencies, many pivoted back to gold as if this is not the 21st century.

Russian central bank, for example, currently holds over $100 billion of gold. That is over 2,000 tons, while it purchased an additional 20 tons recently which took the number over 2k. Other central banks around the world took on a similar process of gold procurement, as many liquidated their reserves of other foreign currencies. Some even ditched what was a long-standing reserve fiat currency for most of them, the US dollar.

Precious Metal Frenzy

Anthony Pompliano, a cryptocurrency investor, revealed that the world’s central banks bought more than $15 billion in gold during the first half of 2019. The figure was first reported by Financial Times which said that central banks accounted for one-six of the total gold demand in the first six months of this year. Of course, $15 billion is just 0.2 percent of the total gold market capitalization.

Still it is one of the biggest mass accumulation of gold in the written history, including times that are hundreds of years in the past. Pompliano is claiming that these monetary bodies are hedging their bets on the USD even though the Dollar index keeps trending pretty high. But, behind it, there are serious and deep-rooted concerns. These mainly include the notion that the US economy, as the leading monetary force in the world, could lose this position.

This is fueled by the hirer interest rates, but also the rise of other fiat currencies and the ongoing trade war with China, which got another flare-up recently. There are also plenty of macroeconomic risks that are fueling these fears. Among them are the collapse of the EU banking sector, global unrests and geopolitical tensions like the situation taking place in the Gulf of Oman.

Weirdly enough, the risks also cover, in a sense the rise of the alternatives to fiat money. Here, cryptocurrencies like bitcoin take a central place. Gold is seen as a natural alternative to a powerful hedge fund but for many, cryptocurrencies could also get this role.

Central Bank Crypto Purchases

So, in this atmosphere of uncertainty, could central banks decide to start buying cryptocurrencies as an additional way of hedging against unexpected moments in the markets? Pompliano believes this is a real possibility. From a purely investment standpoint, investing in bitcoin does make sense. The primary reason for this is the asymmetric risk-return potential, providing a lot of profit potential with relatively small downside factors.

Currently, the BTC network is valued at $200 billion. Global wealth is measured in hundreds of trillions. So, in theory, if bitcoin managed to pull only one percent of global wealth, it would get a 500 percent boost and end up with a price of $50,000 per coin.

Pompliano believes that once banks recognize this potential, they will start buying BTC. In fact, he believes that in this role, bitcoin makes more sense than gold. But, it is important to underline just how fringe that possibility seems right now, even with all of the global geopolitical and economic instability.

Crypto Purchase Consequences

Five years ago, suggesting that bitcoin would be something central banks would even consider purchasing would have been madness. Today, for many, the possibility is still more than distant and riddled with questions about the nature of that process. First, it would come with a situation that is a form of self-fulfilling prophecy.

A central bank buying bitcoin would want to see its value increase over time. The very act of buying crypto, even in the case of a small nation that is not that relevant in the world of the global economy, the news would be a bombshell. In less than a day, such a venture would become known and discussed across the globe. In the ever-connected world of social media, esports, constant video content and other similar things, no central bank could keep crypto purchases a secret. As a result of the attention, like it always happens and which Facebook Libra perfectly demonstrated, the prices would likely skyrocket.

Traders and investors would expect that the same occurs again with some other bank and thus the price would react in the same manner. Secondly, with that setup, the volatility would go through the roof as well, leaving banks with an asset that they cannot figure out, just like everyone else.

Opportunity for Small Central Banks

Thanks to the problem of volatility, it is really hard to imagine any major central bank purchasing crypto. However, because of that guaranteed attention, a small central bank belonging to, let us say, a country wishing to boost its tourism potential, could employ such a move. Its authority would not be building a hedge, but acting as a vehicle of national promotion, showing a country as both forward-thinking and tech-savvy.

These two factors historically managed to help smaller nations with their development. But, besides such a gimmick possibility, the chance of, for example, any European central bank buying crypto, remain incredibly small.