Applying the Gold Silver Ratio to Cryptocurrency

Cryptocurrency is still relatively unexplored by the majority of consumers. Many people have heard of Bitcoin, but not of its “little brother”, Litecoin. If you are familiar with the world of cryptocurrency and Litecoin (LTC), chances are you have heard Litecoin described as the silver to Bitcoin’s gold. This is the relationship that was envisioned by the creators of Litecoin, who wanted to make a coin that “would be silver to Bitcoin's gold.” After LTC implemented SegWit there has been a renewed interest in the world’s second oldest cryptocurrency. There has also been a surge in articles referencing the relationship between BTC and LTC with gold and silver. This got me thinking, what kind of analysis could be done by studying the relationship between gold and silver and applying it to Bitcoin and Litecoin?

Is it fair to compare cryptos to precious metals? If we do make the comparison, how we can apply our knowledge of the precious metals market to cryptocurrency? The analysis that follows is not meant to be a sure way to predict price, it is intended to be an intellectual exercise, exploring relationships between assets, although there may be value in some of the price analysis.

One well known price indicator used for precious metals is the gold to silver ratio.

What is the gold to silver ratio?

The gold/silver ratio represents the number of ounces of silver which are required to purchase a single ounce of gold.

How the Ratio Works

According to Investopedia.com the ratio functions as follows…

“When gold trades at $500 per ounce and silver at $5, traders refer to a gold/silver ratio of 100. Today the ratio floats, as gold and silver are valued daily by market forces, but this wasn't always the case. The ratio has been permanently set at different times in history - and in different places - by governments seeking monetary stability.” source

Investors use the gold/silver ratio in order to accumulate more ounces by rebalancing their portfolio between the two assets when prices hit historically extreme levels.

The current gold/silver ratio is roughly 75:1 and is generally considered to be at a historic high.

What can we learn by applying the gold silver ratio to Bitcoin and Litecoin?

Applying the gold silver ratio to Bitcoin and Litecoin

If we operate under the premise that Bitcoin and Litecoin are the respective gold and silver of the cryptocurrency world, what happens when we apply the gold silver ratio to the two coins?

As I stated before, the current ratio has been around 75:1

For the purpose of this article, I will be using the following fixed prices for BTC and LTC in USD. Prices have been rounded up to whole numbers for easy math. Prices as of 5/31/2017 12.00 pm EST.

Bitcoin = $2300.00

Litecoin = $25.00

Current Bitcoin Litecoin ratio

Ratio $2300.00/$25.00 = 92:1

Current gold silver ratio

Now apply the current gold to silver ratio 75:1 using Bitcoins Price as the gold benchmark

$2300.00/75= $30.70 LTC

Applying historical ratios

The gold/silver ratio has varied throughout history based on mining output and government regulation.

There are a variety of ways to determine what the gold/silver ratio “should” be. Let’s use the following two methods.

Historical Average

Historical average around 15:1

$2300.00/15= $153.00 LTC

Mining Output

Some in the mining industry have claimed that currently 9 ounces of silver are mined for every 1 ounce of gold.

Mining output 9:1

$2300.00/9 = $255.55

Ethereum and Dash?

Litecoin aims to be the silver to Bitcoin's gold and while that may soon be true, with the successful SegWit implementation, two other cryptocurrencies may provide a more accurate comparison.

Dash

Dash aims to become the “go to” crypto for everyday transactions. With faster transactions and lower fees, many people have switched from using Bitcoin to Dash for smaller transactions. Silver has historically been used as “The people’s money” for small everyday transactions.

Dash = $140.00 USD

Current Bitcoin Dash Ratio

$2300.00 BTC/$140.00 DASH = 16.4

Interestingly the Bitcoin Dash ratio almost perfectly hits the historical average.

Ethereum

Ethereum has become the go to platform for developing DAPS or Decentralized Apps. Ether is a fuel for operating the distributed application platform Ethereum. The expansion of apps on the Ethereum blockchain is increasing the demand for Ether. Ether is the fuel that powers the new DAP industry. Silver is a precious metal and an industrial metal. Silver has a multitude of industrial uses and is valuable because of its unique properties.

Ether = $230.00 USD

Current Bitcoin Ethereum Ratio

$2300.00 BTC/ $230.00 ETH = 10

Conclusion

Of course, we cannot make a direct comparison between Bitcoin, gold, Litecoin and silver or any other cryptocurrency for that matter. Although they are all stores of value and are subjected to scarcity, their uses, markets and potentials vary greatly. Industrial use and the physical properties of precious metals cannot be captured or exactly replicated in cryptocurrency. Even so, it is still interesting to see how the gold to silver ratio could be used to project price or used as a trading methodology.

Bitcoin and Litecoin operate in free unmanipulated markets and price is not set through a fix or by ETFs. Recently, the precious metals industry has been plagued with lawsuits and investigations into alleged price manipulation.

Maybe the true value of the ratio is to reverse the calculations and determine fair value of gold and silver based on Bitcoin and Litcoin.

Already there are serious initiatives to create gold/silver backed cryptocurrency. Perhaps the future is a merger of the two asset classes into a new hybrid asset that provides the benefits offered by crypto, of free markets and transparency and the historical pedigree and tangibility offered by precious metals.

Food for thought…

(This is not financial advice, rather it is an intellectual lesson and exploration into the relationship between Bitcoin and Litecoin.)

Note: The numbers used are rough estimates and are subject to change based on fluctuations in market prices.

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