Virtual Currencies as Commodities: Bitcoin and Beyond
Book: Commodities: Markets, Performance, and Strategies
Editors: H. Kent Baker, Greg Filbeck, Jeffrey H. Harris
Publisher: Oxford University Press, 2018
ISBN: 9780190656010
Bitcoin Walks Into a Commodities Book
Chapter 26, written by Lamia Chourou, Samir Saadi, and Azizah Aljohani, is about virtual currencies. Yes, in a book about oil, wheat, and gold. And honestly, it belongs here. In September 2015, the U.S. Commodity Futures Trading Commission (CFTC) officially ruled that virtual currencies should be considered commodities. So Bitcoin sits in the same legal category as crude oil and corn.
The chapter was written around early 2017, when Bitcoin was priced at about $1,069 and there were 722 different cryptocurrencies. A lot has changed since then, but the fundamental questions raised in this chapter are still relevant: What are virtual currencies? Are they currencies, commodities, or something else entirely? And how should they be regulated?
The Crypto Lineup
The chapter profiles the most prominent cryptocurrencies at the time:
Bitcoin is the headliner. Created by an anonymous group under the name Satoshi Nakamoto in 2008, it launched in 2009. Its market capitalization went from about $144 million in January 2013 to over $16 billion by January 2017. The key features: decentralized (no central bank controls it), traceable through a public ledger (the blockchain), and capped at 21 million coins.
Litecoin was invented in 2011 by a former Google engineer. It processes transactions about four times faster than Bitcoin (2.5 minutes vs. 10 minutes) and produces four times more currency units.
Darkcoin (now called Dash) is the privacy-focused option. It uses a protocol called DarkSend to anonymize transactions, unlike Bitcoin where all transactions are traceable on the blockchain.
Peercoin consumes less energy than Bitcoin and has no fixed upper limit on coins, making it inflationary by design.
Dogecoin started as a joke but deals in high volumes of low-value coins, making it more accessible to new users.
Primecoin offers faster payments (10 times faster than Bitcoin) and emphasizes security.
Currency, Commodity, or Both?
This is the classification puzzle that governments keep struggling with. Yermack (2014) argued that Bitcoin does not qualify as currency and is really a speculative investment. It is not tangible and has no inherent value since it is not backed by any government or commodity.
But it shares properties with both currencies and commodities. Like currencies, it can be used as a medium of exchange. Like commodities, it has a finite supply that creates scarcity.
The regulatory classification is a mess. In the U.S., the IRS classified virtual currencies as “property” for tax purposes. The Treasury Department’s FinCEN classified them as “value” for anti-money-laundering purposes. The CFTC classified them as commodities. Three different U.S. agencies, three different classifications. Canada treats them as barter transactions. China called Bitcoin a “virtual commodity” and prohibited banks from dealing in it. Russia moved toward outright banning crypto transactions.
As the IMF summarized, virtual currencies “combine properties of currencies, commodities, and payments systems” and finding a consistent classification even within the same country has proven difficult.
How Bitcoin Actually Works
The chapter provides a clear technical explanation. Bitcoins are created through mining, which is solving increasingly difficult mathematical problems. Miners are rewarded with transaction fees and new Bitcoins. About 25 Bitcoins are mined every 10 minutes.
Every transaction goes into a “block” that gets validated and added to the blockchain. This happens roughly every 10 minutes. Each transaction includes the sender address, recipient address, number of Bitcoins, and timestamp. The system uses public and private keys for security. The public key confirms payments, while the private key unlocks the wallet.
One important feature: Bitcoin transactions are irreversible. Once you send Bitcoins, there is no undo button, even if you make a mistake. This is the opposite of credit card payments where chargebacks are common.
The Volatility Problem
Bitcoin’s volatility is extreme. Between May 2012 and May 2015, its realized monthly volatility was 265 percent compared to gold’s 118 percent. The price went from $0.10 in its first two years to $1 in February 2011, then to $22 in June 2011, then to $979 in November 2013. After the Mt. Gox exchange was breached in 2014, the price crashed to $232 in August 2015 before recovering.
Several factors drive this volatility. The market is still young and thin. Large trades can move prices dramatically. Many people do not understand Bitcoin, which creates noise trading. News events, whether positive (NYSE investing in Coinbase) or negative (Mt. Gox hack, Silk Road shutdown), cause big swings.
Due to its finite supply, Bitcoin behaves more like a commodity than a currency in this respect. As supply growth slows and demand increases, the price should theoretically rise. But that assumes continued adoption and no massive speculative selling.
Research on Bitcoin is still limited. Kristoufek (2015) argued that Bitcoin’s value is driven by speculation rather than economic theory. Ciaian, Rajcaniova, and Kancs (2016) found that both market fundamentals and investor attractiveness affect Bitcoin pricing. Guesmi et al. (2016) found that hedging strategies involving gold, oil, developing market stocks, and Bitcoin significantly reduce portfolio risk.
Regulation Around the World
The regulatory landscape varies dramatically. The U.S. has been the most active, with hearings, guidelines from FinCEN, and state-level efforts like New York’s BitLicense framework. The U.S. government even auctioned off Bitcoins it confiscated from the Silk Road bust.
Brazil enacted a law in 2013 facilitating electronic currencies and later declared Bitcoin gains as taxable income. Canada classified Bitcoin miners as Money Service Businesses. The UK classified Bitcoins as “single purpose vouchers” subject to 10-20 percent tax. The EU issued warnings but passed no legislation.
In March 2017, the SEC rejected the first Bitcoin ETF application, causing a 16 percent price drop. The rejection was based on concerns that Bitcoin exchanges are unregulated and susceptible to manipulation.
The Future According to the Chapter
The chapter ends on a cautiously optimistic note. Despite the mishaps (Mt. Gox, volatility, regulatory uncertainty), the technology behind cryptocurrencies is here to stay. The distributed ledger technology has applications far beyond payments, including recording ownership of financial instruments, smart property, and even smart contracts.
Some predict that an evolved form of cryptocurrency could replace paper money by 2050, if backed by solid commodities. The chapter notes that the adoption of blockchain technology has the potential to validate every single transaction a person makes.
My Take
Reading this chapter in 2019 with some hindsight, the most interesting aspect is how the classification debate has evolved. The CFTC calling Bitcoin a commodity was a big deal because it opened the door for regulated futures trading. That actually happened in December 2017 when CME and CBOE launched Bitcoin futures.
The chapter correctly identified the core tension: how do you regulate something that was designed to be unregulated? The early approach of different agencies applying their own frameworks has created a patchwork that still is not fully resolved.
The volatility analysis holds up well. Bitcoin remains extremely volatile compared to traditional commodities. And the observation that large trades can move prices dramatically is even more relevant now that institutional players have entered the space.
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