Much as many people who adopted cryptocurrencies such as Bitcoin made huge returns on their investment, you need to be aware of the risks involved in investing in digital currencies like this. Jonathan Adengo & Christine Kasemiire explore what you need to know about cryptocurrencies before investing.
In 2011, Dr Enock Nyorekwa Twinoburyo, a Ugandan economist owned an online forex trading account. It grew from $1,500 (about Shs5.5m) to about $7,000 (Shs25.5m) between May and September with minor withdraws. On a particular September night, he says he slept when his balance was $7,000 (Shs25.5m) with a running trade.
“In the morning, I found the ‘take profit’ had been triggered and the trade closed. I found a balance of $29,000 (about Shs105m),” he says.
He withdrew all leaving a balance of $10,000 (Shs36.5m). “I lost the remainder of $10,000 in less than a month,” he says.
Since then, he was shuttered and his hopes of online forex ‘spread betting’ dimmed.
Dr Twinoburyo says the global buzz today is on cryptocurrencies -commonly known as “digital gold”. For cryptocurrencies like bitcoin, he says he wants to watch the winners and losers.
If you have read anything on Cryptocurrencies (virtual currencies) besides the basics of what they are, you have probably heard about the stories surrounding the exorbitant returns investors have obtained from them.
Other names for cryptocurrency are digital currency, crypto, or virtual currency.
Ideally, Cryptocurrency is a form of digital money that is designed to be secure and anonymous. It is created from a technical term known as cryptography. Cryptography is a form of securing information through generating codes that form an algorithm (system).
Dr Twinoburyo says digital currencies operate through decentralised network not controlled by any Central Bank like it is for any form of fiat money such as the Uganda Shilling. The digital currencies rely on encrypted computer systems (cryptology) to manage the respective trade, control the supply and secure the transactions from any potential fraud.
Those who have used them say the information cannot be traced back to a known user, which is its main point of marketing to people that value privacy. With crypto currency, a third party such as a bank that is meant to authorise a transaction is eliminated, making transactions instant.
The five commonest crypto currencies according to coinmarketcap.com are Bitcoin, Ethereum, Ripple, Bitcoin cash and Cardano.
However, in Uganda, One Coin is the only currency trading.
Introduced in 2009, Bitcoin was the first digital currency to predominate the cryptocurrency domain. In July 2010, the Bitcoin price was just $0.06 (Shs219). The Bitcoin price crossed $10,000 (Shs36.5m) mark in November 2017 reaching just $12,000 (Shs43.8m) in December 2017 from below $5,000 (Shs18.2m) in September 2017 and $2,500 (Shs9m) in May 2017.
Much as Bitcoin is the first crypto currency ever on the market, according to Forbes, many attempts to create the digital money stemmed from 1998 with Bit money and Bit gold that were never completed.
In 2008, Satoshi Nakamoto (the name used by the unknown person or people who designed bitcoin and created its original reference implementation) wrote a paper called Bitcoin that was discussed in cryptography, and in 2009, the man whose real identity is yet to be determined made the debut for Bit coin currency.
Basing on naivety of people in dealing with it, trading with the digital currency took a while to hit the ball rolling.
Currently, there is a rush globally as new cryptocurrencies come up, with 1394 in existence.
Why care about cryptocurrency?
As Mr Srivastava narrates, cryptocurrency has a weight over its head. Bitcoin, for instance, has a challenge of overcoming its image as a means of encouraging criminal activity since during the ransom ware cyber-attack, the hackers asked that the money be transferred through Bitcoin.
However, he says people in Argentina and the Middle East are changing their money to cryptocurrency to avoid taxation and devaluation.
Narrowing down the risks, Mr Kaboyo says nobody has proper oversight and regulation to control market manipulation, fraud and operational risk.
“For example, its supply and value is not determined by any Central Bank but its value comes from computers that perform a series of complicated calculations to create new coins - a process known as mining,” he says.
Additionally the prices are not correlated with other asset classes which give the likes of bitcoin and other cryptos the hallmarks of a speculative investment.
Mr Kaboyo says other risks that the public should be aware of are; prices are very volatile, events surrounding cryptos are hard to predict. In the course of last year, there was 40-50 per cent market correction which is very unusual for any assets class, category of investors not very clear, illiquid investments because nobody is getting out.
Dr Twinoburyo says looking at the history of the Bitcoin price, 2014 marked a structural break from rapid hike in bitcoin price in 2013. The price had remained under $15 between 2010 and December 2012 when it started rising – reaching $980 in November 2013.
Thereafter, the price declined reaching $230 in September 2015 and closing 2016 at less than the historical high experienced in 2013. (What was the rate in 2016?)
Recent empirical work by Gandal and others (2017) suggests that the 2013 Bitcoin price spiral was associated with high in fraudulent trades and the lack of regulation in a decentralised network, leaving cryptocurrencies susceptible to constant attacks by financially motivated criminals.
He says in some cases, air transactions were carried out and other duplication of the trades were noted. The markets of these cryptocurrencies are thin and subject to manipulation which could be the explanation for the meteoric rise seen in 2017.
Hard to tax
Due to its decentralised nature, experts say a person can hide his net worth and black money from government because there is no tell of how much money one owns from the platform. This means Uganda Revenue Authority (URA) would have even more difficulty taxing people since they would have no record of an individual’s income or how much traders have earned through transactions, consequently, increasing incompliance.
Mr Ian Rumanyika, the URA manager public and corporate affairs, says the Authority recognises the challenge they have before them. Quoting statistics from Uganda Communications Commission (UCC), internet penetration is at 39.8 per cent in Uganda with projections of reaching 79 per cent in Africa by 2020.
He says the taxman is watching and recognises there is a lot of potential in e- commerce.
Recognising the potential of e-commerce, he says changes in the e-commerce environment are by the minute, and the tax man will unleash counteractive ways on how to tax it.
In addition, he says the gap in the Income Tax Act where Section 9 defines a residence of an individual as a permanent home in Uganda and Section 10 regards residence of a company based on incorporation and majority of operations being exercised in Uganda. This limits application of the law in an e-commerce environment.
The solution, he says, is a policy change whenever new developments are ushered in but stresses that it cannot be a URA initiative in solitude but rather all parties need to move at the same speed, for example, UCC and Bank of Uganda (BoU)among others.
Entrance of cryptocurrency in the economy eliminates the role of a middle man, (the banks) since transactions through digital currencies are instant and only between seller and buyer.
To the contrary, a study by Ryerson University in 2016 reported that financial institutions have shown willingness to adopt block chain technologies, to tap unchartered waters in a five-year timeline. But, it is unlikely that Bitcoin and Ethereum will be adopted.
Mr Anthony Kituuka, the managing director Equity bank, says although block chain is a new interesting way to manage funds transfer, little is known about it. He says banks are awaiting instructions from Bank of Uganda on how to go about it. He says as a bank, their aim is to protect their depositors’ money so they cannot make any step towards cryptocurrency without proper guidance from the Central Bank.
When asked at the International Monetary Fund regional outlook presentation in Uganda last month about digital currencies, the Deputy Governor Dr Loius Kasekende, said they are studying the realm of digital currencies and as such have no formal position yet.
In February 2017, Bank of Uganda issued a statement cautioning the public about investing in cryptocurrencies. China’s central bank followed by the Reserve Bank of India (RBI) in the first of week of December 2017 warned investors against betting on Bitcoin and other cryptocurrencies.
According to Wholesomeconsult managing director Ann Muhangi, cryptocurrency is the future, but the market forces are distorted. So there will be a crush and stability after.
Mr Kaboyo, however, says it is not wise to completely dismiss cryptos. The markets, regulators and other concerned parties should take time to understand their features.
In this digital era, cryptos are emerging as new class of digital assets, essentially virtual currencies, powered by an interesting technology known as Block Chain. The technology behind it should be understood.
From an investment perspective, he says trading and investing in cryptos may have the potential for huge returns, it may sound attractive, but one must consider the risks.
“Like any investment, be sure you weigh the risk versus the reward so that you can make the right investment choice,” he says.
How do cryptocurrencies work?
Mr Stephen Kaboyo, the managing director at Alpha Capital Partners Uganda, says at the moment, there is not much of an ecosystem surrounding crypto to allow fundamental analysis in order to understand them as an investment class.
“The public is investing with imperfect information and joining the herd of speculators, lured by high prices that keep climbing and this could easily lead to formation of a bubble that could burst and cause widespread losses. In my view, the public has been buying out of the fear of missing out,” he says.
Digital finance experts say the biggest hindrance of crypto currency is the mystified technicalities that most people have failed to understand in its application (how it operates).
It is based on this fact that digital currency has some people globally torn apart on whether to join the thrill or wait to see how it all unfolds.
Mr Phillip Muhiire, the assistant information technology and support manager at One Life, the distributors of One Coin in Uganda, narrates that the coins are made through a process called mining, using a computer server.
A customer registers for an account for which different packages starting with coins worth Shs700,000 are awarded. Currently, one coin is valued at Shs83,000. Each coin has a unique serial number to differentiate it from the rest.
Mr Muhiire says since the registration uses KYC (Know Your Customer). It requires a National Identity Card when the coins are bought, to customise and embed the buyer’s name.
The price of cryptocurrency is determined by forces of demand and supply. This means the more people seek for a particular currency, the more its price goes up. This is influenced by the people using it especially for transactions.
Supply of these coins is also usually limited. Bitcoin has a capacity of mining 21m coins while One Coin has a 120b mining capacity.
Since the pilot digital currency was in 2009, the big question is why come up now? Mr Amit Srivastava, the director at Sai Pali Group Limited, says virtual money has gained momentum because technology has penetrated the world greatly, evidenced by the boost of online transactions.
Since online businesses are proliferating globally and cryptocurrency is money used to buy and sell items off the Internet, he says the two move hand in hand to boost both of their usability.
“It all began when people started using it for exchange. You give it to someone and that person also sends it to another as payment for something,” he says.