Crypto currencies have grown from obscurity in 2010 to a burgeoning asset class in 2017. At first, Bitcoin and other digital means of exchange grabbed the interest of computer savvy individuals who set up systems and invested lots of money in electric bills to mine the coins. However, over recent years, it has been the blockchain technology that has captured the attention of central banks, regulators, and financial institutions that see blockchain as a revolutionary tool. When it comes to tracking ownership and bringing operations and settlement procedures into the twenty-first century, blockchain the brainchild of the inventor of Bitcoin is likely to be the technology of choice. Recently, the new Chairman of the Commodities Futures Trading Commission has embraced blockchain and set up a laboratory environment to “promote responsible FinTech innovation and fair competition for the benefit of the American public,” according to the regulator’s website.
Meanwhile, Bitcoin and other digital currencies continue to develop, and in 2017 we have witnessed a spectacular rise in their values.
A spectacular rise
The appreciation in Bitcoin has been nothing short of astonishing. Source: Bitcoin Price Index – Real-time Bitcoin Price Charts
In 2010, Bitcoin was trading at 6 cents, and on July 31, 2017, the price of the digital current was $2813.14. The explosive rally in Bitcoin picked up a head of steam in 2017 as it closed at the end of 2016 at $956 and has almost tripled over the first seven months of this year. Bitcoin briefly traded above the $3000 level over the past weeks.
The price path of ethereum, another digital currency has been equally, if not more, awe-inspiring. Source: Bitcoin Price Index – Real-time Bitcoin Price Charts
As the chart shows, ethereum moved from $1.35 on September 6, 2016, to over $200 having traded to a high of over $380 on June 18.
To say that the rise in the values of digital has been spectacular would be an understatement.
Options will increase trading activity
Last week, the Commodities Futures Trading Commission approved LedgerX as the first regulated Bitcoin options exchange and the CFTC authorized the company to provide clearing services for swaps. The chief executive of LedgerX is Paul Chou; a former Goldman Sachs trader told Bloomberg that the company plans to offer one to six-month Bitcoin-to-dollar options in late September or early October. Chou mentioned that options on ethereum and other digital currencies are likely to follow the Bitcoin offering.
Options on the digital currency market are the first derivative instruments to be introduced into a new sector of the currency markets. While the CFTC has defined or classified these instruments as commodities for regulatory purposes, they are clearly growing as pan global means of exchange. While derivative instruments tend to increase volume in underlying instruments, the next critical test for the cryptocurrency market will be the introduction of ETF products, but that depends on another regulatory body.
The next step is ETF products
Several months ago, the Securities and Exchange Commission denied an application by the Facebook famous Winklevoss twins for a Bitcoin ETF product. The SEC expressed concern about Bitcoin’s susceptibility to fraud writing, ““Regulated markets related to the underlying asset provide a necessary deterrent to manipulation. To the extent there is some question as to the degree to which Bitcoin is subject to manipulation… regulated markets relating to Bitcoin would help answer that question and address instances of such manipulation.” There seems to be some inconsistency in Washington DC these days when it comes to the cryptocurrency market; the CFTC has approved derivative options on the digital currency in the wake of a denial for a derivate ETF by the SEC.
I believe it is only a matter of time before ETF and ETN products on Bitcoin and other digital currencies begin trading on regulated exchanges and when it comes to the ETF market, watch out, they could create a spark that could take the price of Bitcoin even higher in the future.
If ETFs do for cryptocurrencies what they did for gold, the upside could be explosive
To me, Bitcoin and other cryptocurrencies, have some of the same properties as precious metals. While gold and silver are physical assets that can be held in one’s hand, digital currencies exist in a computer wallet somewhere in cyberspace. However, both precious metals and digital currencies are pan global assets, they transcend the control of governments and regulators and are fungible, or mutually interchangeable. While governments can impose rules and regulations for holding precious metals, it is virtually impossible to control all of the gold and silver floating around the world. When it comes to digital currencies, the current cyber landscape allows transfers all over the world with the push of a button.
In many ways, the gold ETF product GLD launched the price of gold to a new level after its release in November 2004. Before the introduction of the derivative product, the nominal price of gold had never traded above $875, the 1980 high. In November 2004 the yellow metal was trading at around the $450 per ounce level. Source: CQG
As the monthly chart of COMEX gold futures illustrates, gold took off in the wake of November 2004 and rallied to highs of over $1920 per ounce in 2011. While the introduction of the ETF product was not solely responsible for the rise of gold, it did contribute to its appreciation by increasing the addressable market for the precious metal. In the years before the gold ETF, the only avenues for investment in the precious metal were via the physical market, the futures and options on futures, and via investments in gold mining stocks. However, the ETF brought the opportunity to invest and trade gold directly to stock market portfolios which increased trading volume and interest in the metal dramatically by making it more available to a wider investing and trading audience.
The approval of an ETF product in Bitcoin or other hot digital currencies will forego the need for a computer wallet and will bring the market to anyone who trades or invests in equities. Massive amounts of capital in stock accounts as a result of IRA, 401Ks, SEPs, and other tax-protected vehicles are likely to increase interest and investment or trading volume in the cryptocurrency markets. Volatility can be an investor’s nightmare, but at the same time, it is a trader’s paradise. When it comes to price variance, there are no other assets that offer the kind of volatility the digital currency market has in 2017, and that is likely to increase trading volume if it continues.
A bubble that has not reached its high
Bitcoin and other crypto currencies are likely here to stay, but that does not mean that the price action has been anything short of a bubble worthy of some of the greatest bubbles in history. Tulip bulbs in the Netherlands in the 1600s could be the most analogous example of a market that experienced such dramatic price appreciation.
I believe that the digit currency markets display all of the characteristics of a classic bubble. However, when bubbles are forming it is nearly impossible to call the level from where they will fall and eventually find a base. The bottom line is that Bitcoin and other digital currencies are not tulip bulbs, they are a novel means of exchange that have garnered a tremendous and growing following. Watch for the introduction of ETF products which will expand the addressable market beyond those willing to take the risk of holding an asset in a computer wallet or with an esoteric brokerage company without a long performance history. The rise of gold in the aftermath of the rollout of the GLD ETF could stand as a role model for the Bitcoin market over the coming months once the regulators get their act together and approve the next derivative product in the market. The CFTC has taken the lead in authorizing options; it will not be long before the SEC follows with an approval of an ETF vehicle for this market.
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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.