Cryptocurrencies and digital ledgers may be both an opportunity and threat to traditional commodities derivatives markets and commodities indexing. As an alternative asset class, certain cryptocurrencies could offer diversification and inflation-protection benefits similar to commodities, particularly gold. As an investment vehicle and store of value, a limited history, extreme volatility, and weak regulation present challenges today, but there is no doubt that cryptocurrencies are beginning to play a more important role in investment portfolios. From an inflation perspective, the narrative centers around the belief that, as privately created assets with finite supply, cryptocurrencies cannot be printed like fiat currencies.
From a utility perspective, commodities have obvious real-world applications; they are the building blocks of the real economy, but digital assets also have an underlying use case aimed at utility. This utility could be privacy, instant settlement, trade finance, or supply chain management. Some cryptocurrencies that currently operate as speculative assets will likely begin to shift to a demand-driven market based on demand for the underlying utility, essentially giving them additional commodity-like characteristics.
Market participants have long eschewed many non-exchange (non-public) investment opportunities because of concerns about liquidity, transparency, and valuation frequency and visibility. Others have allocated to alternatives such as real estate and private equity via specialist vehicles that have traditionally attracted significant management and performance fees. The tokenization of real assets has the potential to address many of these concerns and broaden the potential investor base for alternative assets. Tokenization is a way to securitize real assets through which the asset is divided into shares or tokens that represent a predefined share of the underlying asset. The tokens are secured through the immutability of digital ledger technology and are tradeable via cryptocurrency exchanges or alternative trading systems. Tokens simply act as a means of trading, just as futures and exchange-traded products do for commodities today.
The tokenization of real assets may create further competition for traditional derivatives-based commodities investment instruments. So-called digital gold is already disrupting the retail gold investment market. Digital gold products enable investors to purchase gold directly without the chain of custody and financial product wrappers common with gold exchange-traded products. The underlying assets can be delivered at the request of the beneficiary. Tokenization may also play a role in improving the allocation, measurement, and transparency of non-price characteristics of commodities and real assets, such as carbon intensity.
The proliferation of stablecoins will affect the commodities markets. Stablecoins are cryptocurrencies pegged to fiat currencies or other so- called “stable” or reserve assets that are designed to minimize the price volatility of the stablecoin. Stablecoins are redeemable in the currency, asset, or fiat money on which they are backed. Commodity-backed stablecoins can be redeemed at the conversion rate fixed by the stablecoin (e.g., one gram of gold). Many market participants believe that fiat currency stablecoins will eventually form the basis of all global payment systems. Related to stablecoins are central bank digital currencies (CBDCs). CBDCs would allow individuals and businesses to directly make payments and store value using an electronic form of central bank money (Bank of England, 2020).
Digital ledgers and tokenization may disrupt and potentially improve the efficacy of risk management for physical commodity hedgers. The network of digital ledgers that are used to record transactions could improve the management of price and counterparty risk inherent in commodities production, trade, and consumption. It is anticipated that all trading ecosystems will be digital within the next few decades, including traditional exchanges. The commodity futures contracts that are so ubiquitous today may look quite different or at least incorporate different characteristics and trade in different ways in the future. This will also affect custody and the physical storage of commodities, both on and off futures exchanges.
