Last week, the top U.S. derivatives regulator announced that is starting to work in new measures to address concerns about digital currencies and related products like the futures contracts. The Commodity Futures Trading Commission(CFTC) will host a meeting of one of its advisory committees at the end of this month to outline a regulatory strategy for Bitcoin and other crypto-assets.
The potential regulations are likely to be equivalent to the ones imposed on other market commodities. This is mostly due to the fact that the CFTC has long seen Bitcoin as a commodity which was the main factor that opened the door to the future contracts now trading in the CME and Cboe exchanges.
The view of Bitcoin as a commodity is certainly debatable. For years, financial gurus, blockchain technologists and regulatory agencies have struggled to classify Bitcoin within the existing ecosystem of financial products. The U.S. Securities and Exchange Commission(SEC) has labeled certain digital tokens as securities while the CFTC sees first-tier cryptocoin protocols as commodities. The struggle is partially a consequence of the unique characteristics of Bitcoin and other cryptocurrencies which are different from anything financial markets have seen so far.
A New Asset Class
The efforts for fitting Bitcoin into an existing financial asset class have been mostly a channel to establish the right regulatory framework and less about truly understanding the role of the cryptocoin in financial markets. Initially, the market rushed to categorize Bitcoin as a currency because it can be used in financial transactions. However, the comparison between ends there as Bitcoin has very little in common with fiat currencies. The behavior of the two asset classes are so far apart that Bitcoin has become a vehicle to hedge against weakness in currency markets in a manner similar to gold.
Bitcoin has also been labeled as a security but the similarities with this asset class are few and far between. Finally, entities such as the CFTC seen Bitcoin as a commodity mostly due to the finite number of Bitcoin that will ever be available in the network. Within this group there are experts that see Bitcoin as an asset value holder that can be an alternative to the way and other precious metals are used.
As the relationship between Bitcoin and financial markets evolves, I believe we will arrive to a consensus that Bitcoin is neither a currency nor a security or a commodity but rather a new class of asset. Bitcoin combines characteristics of traditional financial assets with features that are very particular to digital assets produced in blockchain networks. If Bitcoin is a new asset class, then we will lined a regulatory framework tailored to its unique characteristics.
Bitcoin as a Commodity and the Importance of Production Costs
The segment of the market that sees Bitcoin as a commodity typically believes that the cryptocoin is severely overpriced compared to its production costs. One of the axiomatic rules of commodity pricing states that, over a long period of time, assets tend to trade at prices relatively close and predictably correlated to their production costs. For instance, gold future contracts are pricing the precious metal a little above $13,000.00 a troy ounce while its cost of production is about $600; not a massive difference. In the case of Bitcoin, the cryptocoin traded last night for about $15,3000.00 while the cost of production is about $3200.00 depending on the region; that’s a 5x ratio. Commodity trading wisdom suggests that Bitcoin prices will gravitate towards the production cost if demand dries up. Obviously, that scenario seems highly unlikely but is another one of the examples that challenge the classification of Bitcoin as a commodity.