I am not the most technologically clued-up person. In fact, I recently bit the bullet and switched from PC to Mac. I can’t tell you how hard and frustrating the experience was for me. Basic commands that had become second nature, and innate behavior were more than challenging. The first day, I spent over an hour searching for a document, and two minutes after I closed it I could not find it again. At the young age of fifty-eight years old, I blame that experience on technological retardation with a little pre-senility in the mix. My proclivity to tasks which require mindless repetition is why it took me so long to realize that digital currencies were not just another video game for those younger and more adept at handling the technological world.
I only began using online banking in the past few years; I am a late bloomer when it comes to almost every new technological advancement. However, I am a student of history, politics, and the human condition. I had an epiphany about a year or two ago, probably around the time of Brexit. The U.K.’s rejection of the European Union and subsequent election in the U.S. that revealed the nationalistic fervor of more than a handful of people was a sign to me. The rejection of globalism, in a world that gets smaller each day because of technology, is nothing new. In many ways, these elections rejected the new status quo in favor of a simpler time. The growth of the digital currency markets is one of the most significant commentaries that challenges two institutions, money and government. While many in powerful positions would like to see the crypto-revolution fail, it is not going anywhere soon. In fact, we are just in the early days of instruments that will become as common as ATMs, cell phones, and cars with push button ignitions.
Bitcoin and Ethereum lead the pack
The last seven years have been an incredible period for bitcoin and blockchain, but 2017 has been a game changer. The two leading cryptocurrencies have appreciated to levels that were beyond the wildest dreams of even their most ardent supporters last year at this time. Source: Bitcoin Price Index - Real-time Bitcoin Price Charts
As the chart dating back to 2010 highlights, Bitcoin moved from 6 cents in 2010 to $958 at the end of 2016. On a percentage basis, the rise was nothing short of incredible. At the end of 2016, many detractors when it comes to the concept of digital currencies decried that 2017 would be the year that the bubble bursts. However, nothing could be further from the truth. As the graphic shows, Bitcoin has exploded higher by more than eleven-fold and was trading at over the $11,700 level on Tuesday, December 5 as it closes in on its next milestone at $12,000. On a percentage basis, the appreciation in Ethereum has been even more impressive this year. Source: Ethereum Price - CoinDesk
Ethereum closed 2016 at $8.41 and has moved over fifty-five times higher as of December 5.
Those who called the price appreciation in the digital currency markets bubbles in 2016 are eating their words as 2017 comes to an end. The calls that the Bitcoin phenomenon is the most significant bubble since tulip bulbs in Holland in the 1600s does not appreciate that there is a critical difference between the two. Bitcoin is a disruptive technology when it comes to money and banking; tulip bulbs were not a product or idea with the potential to change the status quo in a meaningful way.
Over 1300 competitors and some disappear into a black hole
As of Tuesday, December 5, there were a total of 1325 digital currencies with a total market cap of over $358 billion. Bitcoin owns the lion’s share with almost $200 billion. There were eight cryptos, of whose cap exceeds $5 billion, 18 over $1 billion and 87 with over $100 million. The exponential growth of the new asset class has been unprecedented, and while there are and will continue to be lots of teething pain, it is hard to argue with the overall performance and growing acceptance of the sector.
The Chicago Mercantile Exchange in a rush to keep up with the trend will commence trading in Bitcoin futures on December 18. Last Friday, the Commodities Futures Trading Commission blessed the CME product. Chairman J. Christopher Giancarlo said, “Bitcoin, a virtual currency, is a commodity unlike any the Commission has dealt with in the past.” He added that the exchanges “have agreed to significant enhancements to protect customers and maintain orderly markets.” On December 1, the CME put more meat on the bone when it announced that standard margin rates in commodities futures which range from 5-10% of contract value would not apply to the Bitcoin derivatives. According to Terry Duffy, the Chairman of the CME Group, initial margin will be at 35% and the futures will be subject to a variety of risk management tools including position and intraday price limits, and some other risk and credit controls. Meanwhile, the futures will be cash settled based on the CME CF Bitcoin Reference Rate (BRR), a once-a-day reference rate for the U.S. dollar price of Bitcoin. Since November 2016, the CME and Crypto Facilities Limited have calculated and published the BRR which aggregates the trade flow of major Bitcoin spot exchanges during a calculation window into the U.S. dollar price of one Bitcoin as of 4:00 PM London time.
I continue to believe that cash settlement is a mistake, as smooth convergence between futures and the actual Bitcoin market would be best served by offering market participants the ability to make and take delivery of Bitcoin, and eventually other digital currencies through a secured, approved, and monitored exchange warehouse mechanism. Such a structure would create additional comfort in the market as many Bitcoins have already been lost over the past seven years. A recent article in Fortune Magazine estimates that nearly four million Bitcoins with a current market value of around $45.2 billion have been lost forever for a variety of reasons. Another issue for many considering dipping a toe in the digital currency market is the potential danger of hacking and problems in cyberspace with digital wallets and other forms of storage for Bitcoins. If the CME or another exchange put its weight behind a physical delivery mechanism, it would go a long way to dispel some of the concerns in the market and increase the addressable audience for trading, investing, and speculation. However, the exchanges appear to be chasing the Bitcoin volatility and volume to enhance earnings rather than with an interest to further develop and nurture the market. With a cash settlement, Bitcoin and future digital currency futures will be the ultimate in trading sardines for the pleasure or pain of an expanding addressable market.
Cryptos will change the world for financial institutions when it comes to fees
Aside from the wild world of leverage in the exchange-traded futures and options contracts, digital currencies are likely to change the way the world looks at money and banking. We have heard a tremendous amount of push-back from status quo bankers like Jamie Dimon of JPMorgan Chase, and he is not alone. Their objections are likely a hope rather than empirical evidence that the market will fail. Bitcoin, blockchain, and other digital currency instruments will have a significant impact on fees banks and credit card companies charge customers. Fees at JPMorgan and all commercial banks are at risk, and so are fees and earnings at American Express, Mastercard, Visa, and all credit card companies. Therefore, the objection from Mr. Dimon and others could be a fleeting hope of preserving the status quo to protect vested interest. Banks and financial institutions themselves will not be able to crush the markets for digital currencies that chicken has already flown out of the coop.
Governments will try to end the madness
The power over the future of the digit currency revolution is in the hands of governments around the world and they should be panicking. One of the primary attractions of Bitcoin and its brethren is that they are borderless and fly beneath the radar of central banks, governments, and regulators around the world. The CFTC has embraced Bitcoin with its blessing of the CME derivative products, but they are one of few.
When it comes to governments, controlling money supply is an imperative. A former colleague who is active in introducing new digital coins to market these days recently said, “Who says the government should control my money?” The answer to that question is easy; it is the governments that need to retain that control. China and Russia have already imposed rules on trading, but they have done little to slow the use of these instruments in the two centrally planned nations.
Meanwhile, the International Monetary Fund in a report over past months seemed to accept the growth of the new market suggesting that it will not be long before the first government issues a crypto. Venezuela, to save the nation’s collapsing economy, plans to create “the Petro” as a way to defeat the “financial blockade” imposed by U.S. sanctions. On Sunday, December 3, President Nicolas Maduro announced plans to roll out a crypto backed by the country’s oil, gas, and diamond reserves. Other countries around the world are also planning digital releases. Sweden may be the first country in Europe to bring a digital instrument to market.
Will the first government-issued digital currency instrument be the reserve currency of the world?
At over $350 billion the digital currency market is growing by leaps and bounds, but it still pales in comparison when it comes to the size of the other world currency markets. However, the moment of truth for the new asset class may come when the first mainstream government rolls out their version. The dollar is still the reserve currency of the world because of the perceived strength and stability of the greenback. Central banks hold dollars as foreign exchange reserves which results in the dollar’s status around the globe. Rather than thinking of how to regulate the cryptos, governments should get busy issuing them.
If there is a rush to embrace a government-issued crypto, it could change the world of international banking a lot faster than most people believe possible as others will follow in short order. Given the trend of the disruptive technology, a few decades from now the reserve currency of the world could be a digital instrument issued by a government.
Status quo bankers and government officials would love nothing more than to separate blockchain technology from Bitcoin and its digital currencies, but the two work hand-in-hand. Bitcoin gave birth to blockchain and ignoring that fact is like ordering a hamburger in a Chinese restaurant. I am anxious to see the market action when it comes to both price and volume in the CME futures over coming weeks. If the Bitcoin futures contract turns out to be one of the most successful new products offered by the world’s leading futures exchange, it will be another sign that the world of money and banking has changed forever and there is no going back.
Each week in The Hecht Commodities Report, I provide subscribers with up, down, or neutral price bias based on a combination of fundamental and technical analysis. The report is a useful ready reference for investors who trade or invest in futures and options markets, in ETF and ETN products, as well as all asset markets.
As a holiday special, I will be offering a two-week free trial for The Hecht Commodities Report in December. The free reports will be available late in the day on December 13 and 20. The price will also be going up as of January 1, 2018. But if you subscribe before December 31st, you’ll be grandfathered in at the current low price for the lifetime of your subscription. I will begin covering Bitcoin and other digital currency instruments in then report in the weeks ahead.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.