In cyberspace, no one can hear you scream — so trade carefully
• Superficial attraction of cryptocurrencies should not blind investors to the dangers of a bubble
There are fortune tellers and powerful sangomas out there who can see to all your money problems, sort out delicate relationship issues and even counter the evil eye. I perhaps missed the decolonised tertiary syllabus at varsity, but there is always an element of mysticism that grips the human spirit.
It is perhaps this penchant for the supernatural that often leads us to believe that not everything in the world comes with a rational explanation.
In the financial world, the bubble label gets attached to many difficult-to-explain phenomena, but few have come close to the euphoria around cryptocurrencies. This prompted the highest-paid banking CEO in the world, Jamie Dimon of JPMorgan Chase, to portend recently he would fire anyone in his organisation who trades in bitcoin or similar currencies.
In SA, we have witnessed a proliferation of Ponzi schemes, the latest high-profile example being the MMM scheme.
Nearly all Ponzi schemes have the same modus operandi: investors are promised eyewatering returns over short periods. Early investors tend to do well and word of mouth leads to a growing number of investors being “suckered” in, but the actual investment strategy underlying the scheme always remains very obscure. In the end, the pyramid collapses when the payouts to investors inevitably exceed the new investment proceeds, preventing the scheme from continuing to rob Peter to pay Paul.
The first question is why so many of us believe in get-richquick schemes. I guess this is the same reason we have a series of adverts every January ranging from medicinal remedies to exercise regimes, which claim to be able to get rid of our December overindulgences effortlessly within weeks. While the majority of people will give up by March, there is always that one spectacular example of success, that unique someone who is prepared to testify to the validity of the formula. “I tried the fatkill remedy and I lost 20 pounds in three weeks!”
Similarly, in the financial world, there is nothing more convincing than an acquaintance claiming that they invested x and got 2x within a month. Who doesn’t want to look good? Who doesn’t want to get rich, quickly and effortlessly? Sign me up!
In the financial world, bubbles are always based on some shred of truth. Yes, in a digital world cryptocurrencies have a place. A medium of exchange, a currency accepted by major nations that can circumvent onerous financial regulation and be transacted securely — for now — and cheaply across borders, makes for an attractive alternative currency.
The recent online fanfare that Pick n Pay was accepting bitcoin in its store proved a damp squib when the company clarified that a pilot project had been on trial at its canteen store at its head office! In a world where central banks have printed more than $10-trillion since the global financial crisis, there has been a growing distrust in fiat currencies. Well, instead of trusting central bankers and governments — which issue currency legally — you would have to place your faith in a complex web of computers.
The bears have felt gold could be the answer, but then if the financial system is going to collapse, it’s pointless storing your gold booty in a bank safe. Enter cryptocurrencies — gold-like qualities but stored in ledgers safe from the doomsday of a global banking collapse. What’s not to like?
One of the key problems to bear in mind is that most cryptocurrencies are not regulated and are not legal tender per se in SA. Hence if you pay for a transaction using a cryptocurrency and the goods are never delivered, it is next to impossible to get the transaction reversed or even trace who the payment has gone to. In the cybersphere, no one can even hear you scream!
Starting off as “currencies”, digital currencies have become the favourite instruments of speculation. One of the key attributes of some cryptocurrencies — for instance, no more bitcoins will be produced after 2025 — has made them susceptible to a short squeeze by speculators, whereas other fiat currencies depreciate over time due to the constant printing of money.
Perversely, the fear of rampant inflation caused by quantitative easing initiated by global central banks pushed many speculators to seek alternative currencies. However, the alternative is far from safe. The bitcoin bubble is in fact one of the most extreme examples witnessed in recent times.
Over the past few decades globally, we’ve seen a number of bubbles: the property bubble in the mid-’90s, the dotcom bubble and silver in 2001. In nearly all cases, asset prices increased 1,000% or more, and they generally took at least a decade to inflate. In the case of bitcoin, prices went up more than 1,000% in a mere two years.
Just like at the peak of the financial crisis, financial engineers came up with derivatives of mortgage-backed products, infamously known as CDO Squared. Now we have MMM trying to relaunch its Ponzi scheme in SA and elsewhere with bitcoin as its currency of choice. So, while blockchain technology is here to stay and has an increasingly wide range of applications, it is a case of buyer beware if you start believing that cryptocurrencies are a sure way to riches, rather than — at best — another transaction mechanism. The recent investment by Rand Merchant Investment in Luno, a bitcoin exchange, reminds me of the old adage that in the gold rush, the people who got rich were the ones selling the shovels to the prospectors.
I may not be a sangoma, but I think I can help you with one financial matter: if you don’t want to become poor, don’t think of cryptocurrencies as the easy way to accumulate wealth. This first consultation is, by the way, free.