People talk about derivative markets as dangerous places for the uninformed.
Educated investors have said that zero or near zero interest rates cause distortions in markets.
Bonds which bear very little interest become overvalued at those times.
And cash has the nature of a zero coupon (interest rate) bearer bond. So when interest rates paid on bonds are every low, cash becomes more attractive than at other times. Cash competes with bonds when bonds pay under the fair rate of return.
And for that and also for other control reasons that they call regulation but is nothing of the sort, the indebted nations' central bankers want to remove cash and replace it with something that is not a bearer instrument, that is, their digital currency would be a trackable negotiable instrument upon which fees and charges may be levied. Like a bond.
So given this logic about these features of bonds, cash, and zero interest rate regimes, here is a question ...
Is a crypto currency a derivative of a bond, or not?
Because the bond market has been in a 36 year bull trend. So when bonds make their new trend visible, what of crypto-FX? I acknowledge that different FX can rise and fall against each other. But the BIS central bankers' united team want every FX to trend downwards at the same time so that everybody else's flight to safety is prevented. That, by the way, is tacit admission that their particular cash is a bond derivative - if bonds are going down cash will too, broadly speaking. People flee to bonds and cash when the economic outlook looks bad.
At the period that cash competes with bonds, zero interest rates or zero real rates, bonds can "lose out market share" and begin to move opposite to cash or a cash substitute, and act as if it were the cash of a foreign sovereign. So the amount of cash is kept low, a small percentage of the total amount of bonds. And nowadays, in addition to cash, the new cash substitute is the crypto currency. It's relative attractions arise from dissatisfaction with the aforementioned instruments. Crypto currency therefore derives it's value from them to a certain degree. When people are unhappy with bonds, cash or digi-cash become more desired and rise in value. Like bonds in the bonds market,or stock IPOs during bull Markets, increasing amounts of fresh digi-FX issues will be made available while demand is high. So digi-cash proliferates across brand names if not in each individual crypto-FX brand.
In which case, if crypto-FX is actually a bond derivative, a variety of contra-bond, then real (inflation adjusted) interest rates matter to it. If it is a form of cash, then sovereign risk matters to it too. Bonds are about power to take resources, or earn them, and trust of remaining around long enough to repay the buyer of the bond.
For instance, if a country is invaded and taken over by the country next door, both it's cash and it's bonds become worthless.
External sovereigns attitude affects the value of cash, especially when they are willing to take executive action. A sovereign has historically been able, given enough commitment and resources deployed, to kill the currency of another. Are those days gone? Even if they all agree to act together?
Could it someday turn out that selling digital-FX and buying gold may eventually be looked back upon as the killer trade.
On the other hand: if we value cash via it's being a sovereign bond derivative, then we should logically extend this method of valuation process to all other obligations of that sovereign to us too. Health. Pension. Future tax rates. Services. Energy supplied by the state or state regulated corporations. This can get as wide as you are willing to allow your thoughts to let it go.
But just for today. Seeing as Bitcoin, Ethereum, Litecoin, and other well known brands, are so much in the news.
So to return to the prime questions:
What sovereign power to withstand external sovereign attack does crypto-FX really have?
This remains to be seen.
So is a crypto currency a bond derivative? I think it is.
I am satisfied that it is a derivative of a sovereign bond, with added features. The need for digital money has been created out of market distortions during a massive global bond market topping process. The power of bond issuers to do what they want to their perceived enemies should be given great respect when making investment decisions.
I have not traded BTC, or any of the Alt-coins. I don't plan to. The reason I give myself is that the ability of sovereigns to break these independent cash alternative markets, or not, is out of my control. The timing or price levels that trigger their action is also out of my control. This bypasses my trading risk evaluation process and elevates risk but I can not calculate how high the risk is.
I sense that creating and selling digi-FX is the great trade. And that is simply a seigniorage trade.
The owners of armies, police, assassins, intelligence services, and taxation agencies, won't give up that trade lightly. You become the equivalent of a small country that is about to have war declared on it by a much bigger neighbour. That's if you are lucky enough to even receive a warning. Look at how they operate.
Swimming is fine. But observe the horizon carefully, and respect the great wave, for it may crush you. This sounds like some Japanese saying from hundreds of years ago, about the tsunami, but it's not. I repeat that my first sentence in this text was: "People talk about derivative markets as dangerous places for the uninformed."
It's my thoughts on this subject today.
The author posts daily commentary on the gold and silver markets in the TFMR forum: The Setup For The Big Trade. More information about the author & his work can be found here: RhythmAndPrice. The author advises that he trades and holds market positions in accordance with his own opinions.