Cryptocurrency. These days, everyone and their mom seem to be talking about it. We’ve all heard stories of investor unicorns who recognised the potential value of cryptocurrencies like Bitcoin or Ethereum in the early days and took swift action, ending up with jaw-dropping crypto-fortunes. This has naturally caused a flurry of excitement and questions surrounding the potency of cryptocurrency investments.
But in a world where a tweet from Elon Musk can send Bitcoin share prices plummeting, does cryptocurrency’s lure really outweigh its risk and volatility? And should IFAs, in good faith, be offering investment advice to clients about them? Let’s take a closer look at crypto and what you should do if your clients ask you for advice on it.
What is Cryptocurrency?
In short, cryptocurrency refers to digital currencies traded entirely online through a direct peer-to-peer network, without a centralised regulatory authority like a bank overseeing its manufacture and exchange. Instead, every transaction made is added to a collective ledger recording every transaction, known as a blockchain.
Because there’s no centralised authority overseeing the blockchain, it’s deregulated, and maintained by individuals all working to keep the blockchain up to date. Its value is in part derived from its scarcity, inability to be counterfeited thanks to blockchain technology and its instant transferability.
These factors build confidence in its value and continue to drive its worth. Like with gold, people cannot (yet) walk into a store and purchase things with cryptocurrency, but they can buy and hold it. Gold, however, has something that cryptocurrency still doesn’t: lasting value that’s been proven time and time again.
Is investing in cryptocurrency a good investment strategy for South Africans?
Recently, the South African government, working with the Intergovernmental Fintech Working Group (IFWG), revealed plans to begin regulating crypto-assets in South Africa. Their intention is not to regulate the assets themselves but rather the entities and organisations providing services related to crypto assets, known as Crypto Asset Service providers (CASPs).
Under this new act, CASPs will be required to register with the government, record all customer information, report transactions over a certain amount and report any suspicious transactions. They will be required to conduct risk assessments on customers, similar to regular banks and financial institutions. These new regulations aim to target the abuse of cryptocurrencies for illegal or nefarious purposes, such as money laundering or terrorism financing.
While this is certainly a step in the right direction, the highly decentralised and unregulated nature of crypto still makes it extremely volatile and risky to invest in. If investors are well-versed in blockchain technology and understand the risk they are taking on, cryptocurrency can be a viable means of diversifying a portfolio.
What to say if your clients ask you about it
IFAs in South Africa seem to be divided over the merit of investing in cryptocurrency. Some advisors do see value in crypto investments but suggest making only a menial investment because there is no underlying asset. Some advisors take a completely hands-off approach when it comes to cryptocurrencies due to their unregulated state. This absolves them of any responsibility for funds lost should the investment destabilise or lose value overnight.
If your client or clients ask about investing in cryptocurrency, you can help guide them to making the best decision by asking them a few key questions:
Why are you interested in cryptocurrency in particular?
Investors’ interest in crypto may be piqued after hearing stories of other investors who struck it lucky. This is a common problem reported, with many investors simply dumping money into Bitcoin or Dogecoin in the hopes of replicating “unicorn success stories” of other investors. Hype and excitement should never be the driving forces behind an investment.
Are you risk-averse?
Investing in cryptocurrency carries an enormous amount of risk. If a client is going to be constantly worrying about the state of their crypto investments, they’d be better off putting their money in a stable, lower-risk investment.
Are you prepared for potential (possibly total) loss?
As with any investment, financial gains are never guaranteed and investors need to understand the risks associated with the potential gains. If they are serious about investing in cryptocurrency, they need to have a complete understanding of what they’re investing in. Most importantly, they should never look at another investor’s success story as a blueprint for their own investment.
If clients indicate that they are serious about pursuing crypto investments, as an IFA, a safe recommendation to make is that they research blockchain technology carefully and keep the percentage of their portfolio they invest in crypto to less than 5% to minimise adverse risk.
Cryptocurrency as a whole is still in its relatively early days, and at this point, its future and legacy is anyone’s guess. It could one day become a regulated investment but, until we reach that point, it’s best to tread with caution when it comes to making investment recommendations for it.