In this blog, we will briefly discuss what are cryptocurrencies, what you should consider before investing in them, and how you could invest in them as a South African investor.
What are cryptocurrencies like Bitcoin?
A cryptocurrency (like Bitcoin) is fundamentally a digital currency. It can be exchanged to or from other currencies like the US Dollar or the South African Rand. It can also be used to buy goods or services, provided that the vendor of those goods or services accepts the cryptocurrency.
Cryptocurrencies utilise encryption technology (i.e. blockchain technology) to:
- Regulate the creation of units; and
- Securely verify the transfer of funds from one party to another.
So, without the key to the blockchain (encryption) one would not be able to access that unit/s of cryptocurrency.
Cryptocurrencies are decentralised, they operate independently of a central regulator (e.g. Reserve Bank). Cryptocurrency miners (anyone can be a miner) mine for new units of the currency using blockchain technology. They manage the integrity of the system in a decentralised way.
When a new cryptocurrency is created, a cap on the number of units of that cryptocurrency is set. Cryptocurrencies thus have a built in limit of the total number of units that will be created. So, if the demand increases for the cryptocurrency, then the prices of those currencies will rise. In traditional currencies like SA Rand, the central bank can create more units at any point in time. The more they create, the more the currency can devalue (inflation).
Cryptocurrencies can be held in safekeeping in one of two ways:
- At the exchange where you trade them; or
- In a wallet that is in your safekeeping. The wallet is an electronic wallet, where you keep the keys to the units of the cryptocurrency you own.
What should you consider before investing in Cryptocurrencies?
There are hundreds of cryptocurrencies in issue. The current largest values are in Bitcoin, Etherium and Ripple.
Reasons to invest in Cryptocurrencies
- There is a view that cryptocurrencies will replace traditional government issued currencies in the future, i.e. traditional currencies will be disrupted. If this trend continues, then arguably, the value of cryptocurrencies (or at least the accepted ones) will rise relative to traditional currencies.
- Supply is limited from the outset. So, as demand for the cryptocurrency increases, the price will rise. This is a phenomenon that we are currently witnessing. From 1 May 2013 to 16 August 2017, Bitcoin has risen from USD117 per unit to USD4178 per unit, a staggering 3,470% return in just over 4 years.
- Cryptocurrencies are decentralised, therefore they are beyond the control of governments and government agencies. Its value cannot be changed by ‘printing’ more money.
Reasons not to invest in Cryptocurrencies
- If you don’t understand it, you should not invest in it;
- The value of a cryptocurrency is hard to determine, so how do you know if you are paying too much or too little? Could the current cryptocurrency prices be in a bubble? Cryptocurrency prices have been quite volatile. Whilst over the long-term, they have grown significantly in price, there have been periods of significant pull-backs (over 30%) in the cryptocurrency prices.
- From 9 June 2017 to 16 July 2017, Bitcoin decreased in value from USD2865 to USD1900, a 34% decline in value in about 6 weeks;
- From 4 January 2017 to 13 January 2017, a decline of 28%, from USD1100 to USD796 per Bitcoin.
- A currency is valuable if it can retain or increase its value and it can be easily used to pay for goods or services. If vendors do not accept a cryptocurrency, then its uses are limited, potentially reducing the demand for the cryptocurrency.
- Regulators could change the rules, making cryptocurrencies more restricted. This would require quite a concerted effort by all regulators worldwide.
- If you keep your cryptocurrencies at an exchange, the exchange could be hacked and potentially you could lose your cryptocurrencies.
- If you keep your cryptocurrencies in a wallet and you lose your wallet, you will not be able to redeem the value in the units that you hold – they are lost forever.
- How would you determine which cryptocurrency would be the winner? Would it be Bitcoin, Coinbase, Etherium, Ripple, or a new issue? At the moment, Bitcoin is the most popular cryptocurrency, followed by Etherium.
So, there is no clear cut answer on whether one should or should not invest in cryptocurrencies. If you are not experienced and knowledgeable in cryptocurrencies and you do wish to invest in them, then you should consider the following:
- Learn about them by reading up and following experts like @farzamehsani (Farzam Ehsani), @naval (Naval Ravikant) and others.
- Identify the cryptocurrencies that you want to invest in and where you could invest in those cryptocurrencies safely. Perhaps, you could start with one of the larger and more well-known and traded cryptocurrencies (Bitcoin, Etherium).
- Develop a strategy for investing in these currencies – consider investing in small amounts until you get more confident and you are more knowledgeable. Nothing beats experience for learning. Then you can revise your strategy – be more aggressive or reduce/stop your investments in cryptocurrencies based on your learning.
How does one practically invest in cryptocurrencies?
Cryptocurrencies are traded on exchanges. To our knowledge there are two Bitcoin exchanges available to South African investors: www.ice3x.com and www.luno.com. You are required to be FICAed before you can trade. Once your account is opened, you can then deposit the amount you want to trade in and put in an order for the trade on the exchange.
There are many more exchanges offshore, but you would need to use your offshore exchange allowance to be able to access those exchanges. Here you would also be able to trade in cryptocurrencies other than Bitcoin.
You should consider the safety of your cryptocurrencies. Each of these exchanges provide you with options on how you can improve the security of your Bitcoins. You can also consider other alternatives like keeping your Bitcoins in a Wallet. In a wallet, you can keep your Bitcoin keys, which means that it is in your safekeeping and not the exchanges safekeeping. However, if you do lose your keys, you will not be able to get your Bitcoins or exchange them.
If you have already been trading or investing in cryptocurrencies, then well done and good luck.
If you are considering investing in cryptocurrencies or have very little knowledge of cryptocurrencies then you should consider taking the steps outlined in this write-up.
My overall view is that the underlying technology to cryptocurrencies, i.e. blockchain is going to be a fundamental driver of disruption in financial services. This will thus continue to power the growth and usage of cryptocurrencies. There is also no doubt that there are risks in the cryptocurrency markets (over-valuation, regulatory, other not yet known). But my overwhelming sense is that this is a trend that will continue to grow.
It is thus advisable for all of us to become familiar with this phenomenon and be prepared to take advantage of it.