Money generally serves three purposes: it acts as a store of value, it can be used to measure economic value, and it can be used as a medium of exchange. In other words, money can be “stored”, or kept for use at a later stage. It provides an indication of the value of something (that is, its price), and it can be used to acquire goods and services.
Fiat money is currency that has no intrinsic value (unlike gold) and has been established by law as money. Fiat money is created by a government, or governments, for use in a country, or a group of countries.
How do cryptocurrencies, such as Bitcoin and Ethereum, fit into this concept of money?
Anyone can buy cryptocurrencies, and many people are doing so, often for speculative purposes in the hope that they will be able to sell the currency at a profit.
In our view, cryptocurrencies should not be seen as a store of value, but only as a means of exchange.
Recently, cryptocurrencies have been at the receiving end of some very negative media coverage, which resulted in considerable volatility in their prices, emphasising the point that these currencies do not necessarily retain their value.
China has banned the trade of cryptocurrencies, while JP Morgan Chase has denounced their trade, saying any traders caught trading them will be fired. This makes all cryptocurrencies vulnerable.
The next few months should be interesting as the actions of large financial institutions and government regulations set a precedent for where cryptocurrencies are headed.
If you have bought cryptocurrency, what should you do now, and should you hedge your exposure?
If you are in a position to trade the currency in the short term, there are certainly profits to be made. However, it should not be seen as a wealth-accumulating asset, like equities, which are typically kept for longer periods and may generate a return in the form of dividends.
In order to hedge exposure to anything, you need to establish a correlation between that asset and other assets. This is unrealistic in the case of cryptocurrencies, because they do not seem to behave in accordance with financial instruments, and they do not respond to conventional market sentiment.
The simplest and “safest” way to mitigate the risk of selling your cryptocurrency for less than you paid for it is to hedge for fiat money, such as securing a firm dollar price per Bitcoin in the forwards (or derivatives) market. Options, for instance, will give you the opportunity to hedge your risk but not be forced to sell the cryptocurrency if the cryptocurrency market moves in your favour.
For those who are open to a bit more complexity a nd understand cryptocurrencies, there are platforms, such as Bitserve, Hedgy or Coinapult, where you can trade derivatives engineered for the crypto market. I would, however, suggest you research cryptocurrencies and how they are hedged before participating.
The hedging market for cryptocurrencies has a long way to go, but the viability and sustainability of these “new age exchanges” and hedging solutions will largely depend on the legislation making its way to market.
Bianca Botes is a corporate treasury manager at Peregrine Treasury Solutions.