Bitcoin is a Digital Commodity, Not Just a Technology

March 10, 2017

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A recent Bloomberg article argued that bitcoin is neither a real currency nor a commodity. Instead, the author argues that bitcoin is purely a technology and that looking at the price performance of gold versus bitcoin is like comparing “the prices of soybean futures and Intel stock.”

Comparing Gold and Bitcoin

Gold and bitcoin are regularly compared in the financial media as being two somewhat similar assets, which is not surprising as gold and bitcoin have a lot in common. Both have limited supply, require mining, have a relatively inert state, are portable, and have actual uses such as financial transactions in the case of bitcoin and, for example, for electronic circuits in the case of gold.

But there are also differences.

Bloomberg’s writer makes the argument that gold is a safe haven asset and an inflation hedge. But these statements, however, are not factually correct.

Several academic studies, including ‘Gold Returns’ by Barro and Misra and The Golden Dilemma by Erb and Harvey, have concluded that historical price data does not support the notion that gold is a good safe haven investment. The gold safe haven story is primarily propagated by gold funds, gold ETF providers, and gold vendors, and is a popular go-to story for pundits on CNBC and Bloomberg TV when discussing movements in the gold price. The reality is that gold only acts as a good hedge in the short term during periods of extreme market turmoil but not in the long run. That means unless you are actively trading in and out of the precious metal during times of collapsing markets, gold will not act safe haven investment in your investment portfolio.

It is also a fallacy that gold is a good hedge against inflation as Reuters, Forbes, and Bloomberg have reported. There is no clear correlation between the price of gold and the inflation rate in the US.

Bitcoin, on the other hand, has historically rallied in times of economic turmoil and market downturns suggesting that it may be a safe haven asset. We have been able to witness this during the Cyprus bank bail-ins in March 2013, during the height of the Greek debt crisis, and most recently after the outcome of the ‘Brexit’ referendum. During each of these events, the price surged. While it is clear that the argument bitcoin may be a better safe haven than gold, given its historical volatility and its relvatively short existence, it may not be appropriate to put the cryptocurrency in the category of a safe haven asset just yet.

As opposed to gold, some argue that bitcoin can also be considered a good hedge against inflation. Chris Burniske, blockchain analyst at ARK Invest, for example, believes that investors are buying bitcoin as they see it a good hedge against inflation.

Bitcoin itself is not subject to inflation due to its design. However, it can be used to hedge against inflation of fiat currencies provided the demand for the currency keeps increasing.

Of course, given the cryptocurrency’s short track record there is not enough historical data to cement the argument that it is a good hedge against inflation. However, during eight years of its existence, the rise in the price of bitcoin has surpassed increases in inflation in all developed, and the majority of developing, economies.

Is Bitcoin a Currency or a Commodity?

The ongoing discussion of whether bitcoin should be classified as a currency or a commodity is not only being held by members of the bitcoin community but also by financial regulators attempting to categorize the cryptocurrency for regulatory purposes.

Bitcoin the currency

Bitcoin can be referred to as a currency as it is a medium of exchange that is widely accepted and can be used to purchase goods and services online, often referred to as the ‘currency of the Internet.’

Even though the adoption rate by online vendors is still very low compared to other payment methods, there are services, such as All4BTC and bitcoin debit cards, which allow you to purchase almost anything online by acting as an intermediary bridging the gap between bitcoin payments and merchants that are only accepting fiat currency.

However, it has a long way toward being a unit of account and is a relatively small market, which is why bitcoin is not considered to be a currency, although it is a possibility in the distant future. The frictionless payment system, if developed properly, could become a major currency in decades to come. For example, head of Corporate Strategy at Microsoft, Charlie Songhurst stated in 2015:

“The power of friction-free transactions over the Internet will unleash the typical forces of consolidation and globalization, and we will end up with six digital currencies; US Dollar, Euro, Yen, Pound, Renminbi, and Bitcoin.”

Bitcoin the Digital Commodity

While bitcoin has some characteristics of a currency, the case is stronger that it is a commodity. However, it should really be classified as a new type of commodity – a digital commodity.

The basic definition of a commodity is that it is a basic good used in commerce that can be interchanged with other commodities of the same type and can be used as inputs for the production of other goods or services.

Contrary to the argument put forth by Bloomberg’s article, bitcoin falls under this category as bitcoins are homogeneous and the cryptocurrency is being used in commerce. Furthermore, bitcoin can also be used as an input for products and services as it is in the case of Counterparty.

In Economics, commodities usually refer to something that has the following properties; usually produced and or sold by many different companies and is uniform in quality between companies that produce or sell it. You cannot tell the difference between one firm’s product and another.

Bitcoin possesses both of these characteristics.

Mining is the process that brings more bitcoin into existence, with a variety of mining pools acting as ‘producers.’ Furthermore, bitcoin is sold by many different companies in a rich ecosystem of exchanges, BTMs, and peer-to-peer marketplaces.

Secondly, just like one ton of wheat in indistinguishable from another ton, one bitcoin is no different to another. There is no product differentiation due to the variety of mining pools, or even exchanges and BTMs. They are all producing and selling the same product. Maybe not a physical commodity, but definitely a new kind, a virtual commodity.

The US Commodity Futures Trading Commission (CFTC) agrees with this notion stating that “bitcoin and other virtual currencies are encompassed in the definition [of a commodity] and [are] properly defined as commodities,” and should, therefore, be regulated as commodities.

Where bitcoin differs from ‘traditional’ commodities is that as bitcoin cannot be physically held as a bitcoin is effectively computer code. Hence, the term digital commodity would be most fitting the describe the coin as it only exists in digital form.

Why Bitcoin’s Price Surpassing That of Gold Matters

Whether you consider bitcoin to be a currency, a digital commodity or just a technological fad, the fact that BTC-USD surpassed the value of one troy ounce of gold is an important milestone for investors looking at alternative asset classes for portfolio diversification.

If you are looking to add an asset with high expected returns to your portfolio and are also comfortable with adding risk, then bitcoin makes for an excellent addition as a new alternative asset class. Not only has bitcoin shown to rally during times of economic turmoil and uncertainty but it has also outperformed every single major traditional and alternative asset class since its inception. In the last five years, BTC-USD generated an average annualized return of 170 percent. Gold, on the other hand, returned -6.3 percent on an annualized basis in the last five years.

Additionally, BTC-USD‘s volatility scares many people and point to sudden downturns as a reason why its not a currency or commodity, but in fact, when unbiasedly evaluating the risks and the upside potential of bitcoin from cold data, we find out that bitcoin has a very favorable risk versus reward profile as compared to traditional assets.

It does not really matter whether you want to compare bitcoin with gold or any other commodity or currency. What matters for investors are returns, and the emerging cryptocurrency has outperformed all major asset classes since its inception and is on track to continue to do so in the near future.