WITH the current need to diversify investment portfolios and seek alternative safe, stable, and profitable investments, every savvy investor must have a good understanding of cryptocurrencies in order to make informed decisions to invest in or decline investment in the asset class. As usual, we would try to be as simple as possible in this discussion and avoid technical jargon so that readers can understand the vital issues involved.
Cryptocurrencies are digital currencies, a means of paying for goods and services in cyberspace only. These currencies are decentralised, without a formal regulatory or verification system. However, because they are enabled by block chain technology, which is a system of recording and transmitting information in a format that makes it difficult to change or alter the data, the system theoretically regulates itself. The block chain technology is used by many other industries that need to store and move data safely and efficiently across cyberspace.
National Central Banks cannot regulate cryptocurrencies; it would be like trying to regulate the internet – no one country can police what comes in or goes out. The primary function of central banks is to regulate money supply, so one can understand that they would feel uneasy that another currency is circulating in their economy which they have no control over. How would they manage money supply? We cannot accurately measure GDP, if there is an alternative money world flourishing outside the central bank’s purview. Therefore, the development of effective up to date RegTech (regulation technology) is absolutely essential. The world is changing, and regulation must not be playing “catch up”. Paper currency is barely 150 years old. Imagine being the first farmer to be given paper money in exchange for cows. Before then, he would have been given gold or silver coins. If they accepted paper then, surely, we should accept digital currencies now.
Cryptocurrencies have facilitated financial inclusion in places like Nigeria where youths are the largest financially excluded demographic group. Many youths are now able to join the formal financial system. Whilst regular bank accounts require stringent KYC documentation, crypto accounts use biometric data to register account holders. Crypto transfers have no transaction costs. With the CBN seeking ways of increasing financial inclusion in the youth age bracket, this is a tool they should explore.
Bitcoin is the most prominent cryptocurrency, but it is not the only one or only type. There are essentially four types of cryptos – proof of work, proof of stake, tokens, and e-coins. Bitcoin falls into the last category of e- coins. Presently, there are about 5,000 cryptocurrencies globally and the number keeps increasing. The central banks of a few countries have already issued theirs and there are on-going plans within the European Central Bank to issue the e-euro.
Can cryptos (especially the e-coins) replace paper money? Money has three characteristics. It is a store of value, an accounting unit and a medium of exchange – these imply that its own value must be stable, so that goods and services exchanged for it can retain their value. (It is in this value stability requirement that the US Dollar excels over some other currencies). We have all seen how the value of Bitcoin has grown astronomically in the last year or so (especially after the world’s richest man, Elon Musk bought $1.5 billion worth). This volatility causes it to fail in the primary functions of money; but being it its infancy, it is expected to evolve and develop the required attributes of money. Until then, investors should consider e-coins as an investment asset not as money. An asset is a property that increases in value over time and delivers future economic benefit to its owner. In this wise, e-coins meet the categorisation as an investment class.
Every investor must determine if cryptocurrency investment is suitable for them. Do you have the mental strength to withstand the value fluctuations? If you decide to invest, ensure you do a thorough due diligence. Which crypto should you buy? Does it meet your risk appetite and revenue expectations? What percentage of your portfolio should be in cryptos? What is the tenure of the investment? Are you investing or trading? This column always advises that we avoid price speculation because the so-called trading algorithms do not deliver sustainable results. After investing, we must continuously monitor the investment. How is the e-coin performing? Has the price reached your self-imposed level (floor or ceiling) that you are unwilling to cross?
This week’s column is an introduction to an exciting new investment class. Readers need to go further to learn the workings of the specific crypto they would choose to invest in. Happy investing.
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