What does it mean to “own a Bitcoin?” It means there is a recorded transaction on the Bitcoin blockchain where someone sent one Bitcoin to your public key address and that you (and you alone) know the address’s private key. Even if that terse description explains things, it does not help with the logistic details of how you go about doing this. It is complicated. But it is also complicated to physically buy and hold a bar of gold or a barrel of oil.
Bitcoin,
like many commodities, has been “financialized.” There are now financial
contracts you can buy and trade that might be just as good as (or better than)
having an entry on the Bitcoin blockchain. What do financialization and the
growing role played by centralized cryptocurrency exchanges mean for everyday
investors?
Investing in
Bitcoin by directly owning a Bitcoin on the blockchain creates a long position
that appreciates as the value of Bitcoin (in US dollars, say) increases. If you
owned a coin, you could sell it. There is no mechanism inherent to Bitcoin’s
blockchain that allows you to create a short position — just like you cannot
sell a physical bar of gold you do not have. Financialization facilitates the adoption
of long positions and makes the adoption of short positions feasible.
For many,
the easiest way to invest in Bitcoin is to use a financial institution like
Coinbase. This transaction is easy, in part, because Coinbase does not sell you
a Bitcoin. Instead, Coinbase issues you a liability denominated in bitcoins and
backs its liabilities with (bulk) transactions of bitcoins on the blockchain.
The tradeoff for the convenience of the transaction (and security) is the risk
you bear from the institution. This is analogous to “money” you keep in the
bank which is dollar-denominated bank-issued liabilities whose safety depends
on the health of the bank and regulation; your money is not dollars in a vault
somewhere.
The “how” of financialization matters?
Designing a
financial instrument involves many choices. Exchange-traded financial contracts
for typical commodities like oil are standardized. Some of these contracts,
such as many oil contracts, are settled physically requiring physical delivery
of an exact type of oil to an exact location. Other contracts are settled
financially where instead of oil you receive the cash equivalent of a barrel of
oil measured from some index price.
Why financialization matters
Financialization
changes the way people can invest in Bitcoin. The impact of financialization on
the price of Bitcoin is less obvious. Making it easier to buy bitcoins
increases demand, but exchanges that facilitate “short’’ contracts let
pessimists express their views. More subtly, financialization may change the
way people use Bitcoin. For example, Tesla’s ability and desire to accept
Bitcoin for payment may be enhanced by the ability to hedge price fluctuations
on an exchange. Conversely, the high leverage in some cryptocurrency exchange
markets may create instability cycles where volatility in cryptocurrency prices
dive which drives further volatility.
So, what do
financialization and the growing role played by centralized cryptocurrency
exchanges mean for everyday investors? It means it is easier to invest in
Bitcoin without owning Bitcoin directly. Exactly what this means for your
portfolio is a much harder question.
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