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The commodities markets are some of the oldest trading markets in the world. The basic idea of trading wholesale goods between parties is as old as commerce itself. Recently though, the commodities markets did something very unusual – they added a new commodity; Bitcoin.
Bitcoin is an electronic pseudo-currency that is independent of any state or country. The currency is created by computers solving complex math problems with currency released slowly over time. The basic idea behind Bitcoin is that the currency is free from the interference of any government or central bank. Because the amount of the currency in circulation cannot be controlled by central banks, its value is independent of inflation. One might suppose that would make Bitcoin more stable as a form of money. In fact the opposite is true.
Because Bitcoin is not really used in any meaningful way for commerce, but instead exists mainly as a speculation instrument, its price has been extremely volatile. In the last year, a single Bitcoin has been worth anywhere from less than $200 per coin to more than $400 per coin. If U.S. dollars fluctuated in relative value in that way, no one could use the currency for trade. Fortunately, Bitcoin does not have that issue, and trading volumes have largely held steady in the currency despite its volatility over the last year.
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Bitcoin’s appeal for many early adopters was based on the lack of regulation around the currency. That is now changing as the Commodity Futures Trading Commission (CFTC) moves to regulate the currency as a commodity. This move should change both the commodities markets and the Bitcoin markets. Evidence of the latter has already started as the CFTC moves to clamp down on unregulated trading of the currency. Bitcoin will never again be the freewheeling libertarian ideal that it once was. Instead, it is moving to a different phase of its lifecycle – as a monetary hedge against inflation.
As the CFTC continues to crack down on the unregistered trading in the Bitcoin markets, the investor base of the asset should start to change. Institutional investors who need to follow laws and regulations consistent with fiduciary duties could never have invested in Bitcoin before. Now that the CFTC is regulating the currency, it is much more defensible as an investment. Over time that will lead to a change in the investor base holding Bitcoin and likely a change in the character and volatility of the market for Bitcoin.
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Bitcoin as a currency will likely also change the commodities markets too. Commodities trading has traditionally been a market of hedgers and speculators dealing in very traditional products from lumber to cattle. Bitcoin is the opposite. Where oil drilling and cattle production involve the use of real assets and traditional production processes, Bitcoin is the epitome of a 21st century product.
Now of course, most commodities contracts are never completed and instead are simply traded between speculators, but even so, Bitcoin trading represents a new era of purely electronic commerce. Trading in the commodity itself will require new teams of traders and supporting personnel who understand the currency and can make an intelligent forecast about supply and demand going forward. Banks and trading firms will also need to find potential end users who are interested in hedging some sort of risk using Bitcoin. Without such hedgers, speculation in the commodity is moot since there is no ultimate demand for the product.
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All of these changes will take time to implement and Bitcoin for now will continue to be outside the mainstream of investment assets. But over time, Bitcoin could become an alternative investment choice for those who want to store value in an asset that is independent of the value of the U.S. dollar. That could include many foreign nationals who do not understand the U.S. economy, yet do not trust the currency of their own government. That level of global acceptance could take decades to build, but for the first time, with the implicit backing of the CFTC, Bitcoin may actually have a viable future as a true investment product.
By Michael McDonald of Oilprice.com
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Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…