Cryptocurrencies are a contentious issue. Some countries are embracing it, others are rejecting the idea. It has helped create many millionaires, while it has also seen a lot of people defrauded out of their savings. Some people believe it to be the currency of the future, while others think it will never take off. Either way, it is an intriguing investment, but needs to be approached with extreme caution.
Citadel does not advise on cryptocurrency as an asset class because it is currently unregulated, and we cannot ensure the safety of our clients’ assets. This does not mean, however, that we cannot share insights with you, should you wish to dabble a bit in the cryptocurrency universe.
Bitcoin was launched in 2009. For five years it ambled along, and then it started to grow. By 12 April 2021, the value of a single coin peaked at $61 035.81 (approximately R896,785). If someone had invested $50 000 (approximately R734,638) in bitcoin for 2014, today they would be a dollar billionaire. And since the launch of bitcoin, thousands of cryptocurrencies have been launched all over the world, with varying degrees of success.
The Bitcoin story captured the imagination of investors. We have seen clients want to invest their life savings into cryptocurrencies and who all too often believe the people who say that they are guaranteed high returns from the investment.
However, there are also many stories of crypto scams which have seen investors lose billions by putting their money into dud crypto companies. The South African Mirror Trading International (MTI) scam garnered a lot of attention earlier this year, when it was reported that it was the biggest scam of its kind in the world. A few months later, another scam emerged out of South Africa – one that dwarfed the MTI debacle. Africrypt, run by the Cajee brothers, saw over R50 billion disappear in 24 hours with the brothers escaping to the United Kingdom. Although an investigation is pending, this type of news does not encourage investment into this asset class.
FINDING THE MIDDLE GROUND
As mentioned, Citadel does not advise on the unregulated crypto market, but we do have an understanding of the product. For those of you who are curious about cryptocurrencies, there are safe ways to make crypto part of a well-diversified portfolio.
An excellent starting point is to realise that not all crypto solutions are bad, but equally, many are scams. To truly understand the nature of cryptocurrencies, we urge you to conduct in-depth research, which probably extends beyond the scope of this article. However, if you do decide to invest your hard-earned cash in any asset class, be it a publicly traded equity like Amazon or a cryptocurrency, there is one point to remember. There are no shortcuts to investing.
We urge you to spend time on doing your homework. Make sure you understand what cryptocurrencies are, how they work, and who manages them. Today, it must be remembered that blockchains and cryptocurrencies are much like the dotcom companies of the 90s when the internet first emerged. Many dotcom companies were empty shells, riding the wave of the dotcom bubble. At the time, many investors, looking for a fast buck, were taught a very hard lesson around the value of doing sound due diligence before investing. Having said that, the quality companies, like today’s Microsoft, Google, Facebook, Amazon and Netflix proved to be extremely lucrative investments.
The reality is that the financial world is changing, and cryptocurrencies are part of that change. This is just the natural evolution of the digital disruption – libraries have been overtaken by Google, e-readers are replacing the paper book, Netflix has made the video store obsolete, and Facebook is the new coffee shop for catchups. This is the disruptive power of a digital world. Blockchains and cryptocurrencies could be the next chapter. Some, like Bitcoin and Ethereum offer a solid investment case, while many others are simply riding the crypto wave and will not last very long.
Bitcoin has set its sights on becoming the global digital store of value, like gold. But it is technical, and this is where an understanding of how cryptocurrencies work is essential. Bitcoin has a limited supply of coins. Right now, there are 21 million bitcoins available. Technically there are 18 million available, due to lost coins. Bitcoin is decentralised and therefore is not controlled by central banks. The currency cannot be printed and debased like fiat, or government-issued currencies. And, unlike fiat currencies, it can be transferred around the world in seconds, making it extremely cheap and therefore attractive.
Ethereum’s technology will allow plenty of decentralised finance applications like decentralised exchanges or peer-to-peer lending without the need for banks, insurance companies or other financial intermediaries.
Although these products are becoming more entrenched within the system, they are still relatively new and can offer great value to investors. So, if they are an asset class you may like to explore, now is the time to do your homework and look to identify the next Amazon. But we urge you to be very discerning in your search. Like Africrypt, many of these companies are fly-by-night or simply shell companies where scammers are looking to walk away with the wealth of unsuspecting investors.
UNDERSTANDING THE NEED FOR A WELL DIVERSIFIED, WELL-BALANCED INVESTMENT
Please be warned. Like with any asset class, it is foolhardy to think that a single investment will yield a quick fortune. Growing wealth is a long-term strategy. Ultimately, diversification helps to prevent financial ruin. While it is possible to grow your wealth exponentially in a very short time by concentrating your investments into a single asset, this requires you to pick all the right winners. But no one has a crystal ball and, in reality, it is tantamount to playing the lottery.
Citadel’s advice is always to avoid a situation where you go “all in”. We have seen too many cases where a strategy has failed and people have had to reset and start all over, from scratch. This is especially hard when people are near or have reached retirement age. A simple rule of thumb is, if you are planning to invest in a promising new business, an exciting publicly traded equity, or into something new like crypto, ensure you keep your allocation to a specific asset below 5%.
When it comes to an unproven and unregulated asset like crypto, it is also important to have a long-term view to the investment. You are probably guaranteed of one thing: plenty of volatility. We also urge you to use cash. Do not borrow money to make the investment. You will come off second best. The reason being that it is not uncommon for cryptocurrencies to swing 10% in a day and 50% in a month.
An investment into cryptocurrencies is not for the faint-hearted. You have to be able to unemotionally weather the ups and downs of the market. There is no jumping in and out as you see the market move up and down. As with other equity investments, it’s prudent to have a minimum five-year view of your crypto investment.
BE YOUR OWN CRYPTO BROKER
When it comes to a cypto-invesment, be your own broker. Go online and buy your own currency from a reputable platform. Normally, we would advise you to use a Certified Financial Planner® to help you with your investments, however, cryptocurrencies are a new product and reputable financial services companies, like Citadel, will typically be very cautious about advising clients on an unregulated product.
But there are safe sites to use when looking to invest in a cryptocurrency. Exchanges like Luno, allow investors to invest without the need of a middleman. We then urge you to use a “cold storage wallet”. This means that you take your crypto investment off the exchange and store it securely on a platform that is not connected to the internet, meaning nobody other than you can access it.
If you are nervous to invest yourself, we then advise you to avoid a cryptocurrency investment. In an unregulated market, if you entrust this process to someone who is not a registered advisor, you run the risk of bad advice or worse, fraud, where your ‘broker’ walks away with your money. In two of the biggest crypto scams, MIT and Africrypt, investors entrusted their money to a third party. They were lured with the promise of high returns and the middleman disappeared with billions.
A WORD ON TAX AND EXCHANGE CONTROL
Cryptocurrencies may be considered unregulated assets, but they are still taxable. The South African Revenue Services has said that if an investor holds the asset, or has the intention of holding the asset, for three years or more, it will trigger capital gains tax on the sale of the asset. Should an investor, however, actively trade the asset, the profit will be deemed as income and taxed according to the investor’s marginal tax bracket. So be sure to disclose your crypto investments to SARS and make sure you seek guidance from your tax advisor.
When it comes to moving cryptocurrency across borders and exchange controls, the South African Reserve Bank (SARB) is mandated to monitor and control funds leaving and returning to South Africa. Investors have an annual discretionary allowance of R1,000,000 to invest offshore and need to obtain approval for larger amounts. When such investments are made from a local bank account, these details are recorded with the SARB. Some investors buy crypto’s on South African exchanges and then send them directly to offshore exchanges, hence bypassing the SARB who cannot record the transaction. However, the SARB has issued a strong warning against this, and if you get caught doing this you will be penalised. So, we urge you to be transparent in your investments and trading.
THE WAY OF THE FUTURE
Blockchains and cryptocurrencies will play a major role in our lives in the future and will reshape the world of finance as we know it – investments, banking, money, insurance – so it is good to educate yourself and not ignore them. Beyond all the cryptocurrencies and assets, central banks are also developing their own digital currencies.
Two decades on from the dotcom boom, we are again watching a significant digital disruption. This time, however, it is in the world of finance. While some of the tech companies will become the Amazon’s of tomorrow, many will fail. So, our advice in a nutshell is: keep your allocation small, do not trade, do not borrow to invest, have a long-term view, and do not trust a middleman. And finally, start with research. This is a complex world and the more you know, the more likely you are to succeed.
If you are thinking about investing into cryptocurrencies, please feel free to chat to your advisor. Although Citadel does not advise on it as an asset class, we can offer a safe space for conversations about how you can protect yourself should you wish to include crypto into your personal portfolio.
Written by: Citadel Advisory Partner, Pierre Muller