(Oct 15): A decade after the global financial crisis, the landscape of the US financial services ind
SINGAPORE (Dec 18): The launch of bitcoin futures, on Dec 10 on the Cboe Futures Exchange and on Dec 18 on the CME Globex platform, would seem to herald a maturing of the cryptocurrency. “You move from a one-way street to a two-way street. So, that is good for the market,” says Steen Jakobsen, chief investment officer and chief economist of Saxo Bank.
A futures market allows participants to buy or sell something for delivery at a later date. They are usually formed because producers and users of a commodity want to lock in prices. Farmers sell crops that are still growing and airlines buy jet fuel they will need in months ahead. Currency futures are used in a similar way. An exporter might want to sell US dollars it is to receive for the sale of its goods and buy its home currency to pay its workers. Conversely, an importer may need to buy US dollars to spend on goods it buys. Lubricating these futures markets are traders, who may look for arbitrage opportunities or simply take a directional view on the underlying commodity or asset.
However, bitcoin is a long way from being a widely used currency like the US dollar. John Woods, managing director and chief investment officer for Asia-Pacific at Credit Suisse, notes that the daily transaction value for bitcoin is US$100,000 ($134,710) to US$200,000. By comparison, credit card transaction value was about US$700 million a day last year. “It seems to be more of a vehicle for speculation, and not for the day-to-day purchase of goods and services,” Woods says.
Indeed, bitcoin is more of a commodity than a currency in some ways. The producers of bitcoin are known as miners. Their mining rigs consist of computers powerful enough to solve a cryptographic puzzle. The first to solve the puzzle is rewarded with some bitcoin. The puzzles become more difficult when there are more miners. And, as they become more difficult, the electricity and computing resour-ces required to generate each bitcoin rises. By some estimates, if the bitcoin network continues growing at its current pace, it could consume as much power as Denmark by 2020.
Yet, bitcoin is not a commodity like oil, copper or timber, in the sense that it is not used for some productive purpose. Both the Cboe and CME bitcoin futures are cash-settled futures. When the futures contracts mature, the seller delivers — and the buyer receives — cash rather than bitcoin.
So, what is the point of having a regulated futures market for bitcoin? “Bitcoin futures open up the market to many institutional investors who would like an exposure to the cryptocurrency market without having to go through the hassle of opening an account with bitcoin exchanges, managing bitcoin wallets and storing the underlying assets securely,” says Bobby Ong, co-founder of cryptocurrency ranking app CoinGecko.
Werner van Rooyen, head of marketing at cryptocurrency exchange Luno, says many funds and institutional investors want to enter the digital currency space but cannot do so because their mandates limit them to trading on established exchanges such as Nasdaq and Cboe. “We’ll probably see more platforms and funds give investors access to bitcoin and other digital currencies, [both directly and] indirectly through contracts or derivatives,” he says.
This could, no doubt, result in even more speculation on bitcoin. Yet, proponents of the cryptocurrency expect that it will be much more widely used in the future. “If you believe a digital society needs digital cash, and you believe in financial privacy, then bitcoin could solve these issues. If it is successful in the long term, it will be worth way more than it is today,” says Arthur Hayes, CEO of cryptocurrency exchange BitMEX. He expects the price of bitcoin to hit US$50,000 by end-2018.
Ville Oehman, fund manager of the Cryptocurrency Balanced Large Cap Fund SP at Helvetic Investments, says: “It’s one of the most transparent asset classes, since you have a -real-time audit of all units in circulation. National currency supply or even precious metals supply is not nearly as transparent as cryptos.” Helvetic Investments, a locally licensed fund manager, launched its US$200 million diversified cyrtocurrency fund for institutional investors earlier this month in response to strong demand. “Discussions with private banks and family offices signal a rapidly growing interest for 1% to 5% allocations to this emerging asset class,” Oehman says. “I wouldn’t be surprised if bitcoin tops US$100,000 in 2018.”
The big question is whether such a new currency or asset — if bitcoin is indeed either of these things — would be able to sustain such a high value for long. In fact, some detractors say the design of bitcoin limits its potential as a modern currency.
“The bitcoin blockchain’s protocol remains hard-coded to cap both the terminal supply of bitcoins available in the long term at roughly 21 million ‘coins’, and the number of transactions that can be included in one ‘block’ of the chain at a time,” says Alberto Perrucchini, next-generation research analyst at Julius Baer. “Both features limit the long-term nominal coin supply as well as the velocity of the cryptocurrency, which means, as per our current knowledge of monetary systems, that the price level of the economy will have to adjust downwards as the number of bitcoin transactions increases.”
The idea that something that costs 10 bitcoins today might cost just five bitcoins in the future might be appealing to people who have endured hyperinflation. In reality, deflation weighs on economic activity. “Widespread adoption of the cryptocurrency as it currently exists would have crippling deflationary effects on the global economy, promoting further bitcoin hoarding and harming consumption and investment. Other pernicious side effects of the nominal coin supply and velocity caps include ever-higher transaction costs, much slower settlement speeds and extremely high energy inefficiency,” Perrucchini says.
Then, there is the possibility of the established banking system simply adopting the underlying technology of bitcoin to deliver much of the cryptocurrency’s benefits. Bitcoin was conceived as a way to facilitate online transactions without the need for financial institutions to serve as trusted third parties. “The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions,” says the paper that first introduced bitcoin.
Countries such as Canada and Singapore are experimenting with digital versions of their own currencies. The result could be lower transaction costs as well as an enhanced ability to track down parties involved in illicit activities. Ironically, the image of bitcoin remains tied to its use in the black market. “When thought of purely as a payment instrument, it seems more likely to be attractive to those who want to make transactions in the black or illegal economy, rather than everyday transactions,” said Reserve Bank of Australia governor Philip Lowe in a recent speech.
As the price of bitcoin has soared, one increasingly popular use for it has been to drum up media interest in cryptocurrencies and fundraisings involving cryptocurrencies. Jon Russell, a writer on the website TechCrunch, has received multiple emails from these so-called bounty hunters, “all of which are repetitive and devoid of information, [and come] across as desperate and stupid”, he says. “Most initial coin offerings have what are called ‘bounty campaigns’ designed to raise visibility of a project.” He doubts that the spamming campaigns are doing much good.
Such activities are unlikely to help the legiti-macy of bitcoin, even as a futures market widens interest in this leading cryptocurrency.
This article appeared in Issue 810 (Dec 18) of The Edge Singapore.