There was a time, not so long ago, when everyone from the guy shining your shoes at OR Tambo International to your great aunt Milly had an opinion – if not a vested interest – in cryptocurrency. And now? Silence. Could it be that crypto has fallen out of favour? Or has it just gone mainstream?
Cool, mysterious new kid
Early iterations of cryptocurrency have existed since the 1990s and the concept of an encrypted digital currency was postulated in a paper by computer science professor David Chaum in 1982. But it was Bitcoin’s appearance in the public domain in 2009 that captured the world’s imagination.
Bitcoin’s origin story lies in a white paper posted to a forum on cryptography in 2008. The paper, titled Bitcoin: A Peer-to-Peer Electronic Cash System – which is available to read online for free, FYI – outlines the protocol for Bitcoin, as well as making a case for its usefulness as a more secure, incorruptible alternative to traditional fiat currency. It was authored by Satoshi Nakamoto of www.bitcoin.org. The only catch: Satoshi Nakamoto is a pseudonym. And, to this day, nobody knows who she, he or they really are. According to Forbes, the last reported email from Nakamoto was to another developer in 2011, in which Nakamoto said they had “moved onto other things”. Since then, the only time the Bitcoin creator has surfaced was in 2014 with one sentence in a forum dispelling a rumour about their identity.
In hindsight, crypto had all the ingredients to be a rapid success. For starters, there was that clandestine-cool factor it had going. In 2009, the world was in the grip of the global financial crisis since dubbed the Great Recession. People were angry, blaming the financial industry’s poor governance for their plight. And they were desperate, in the wake of massive retrenchments. The US Bureau of Labor Statistics reported that between 2007 and mid-2009 8.7 million jobs were lost in the US alone.
In the midst of all this uncertainty and resentment, enter Bitcoin: an unregulated peer-to-peer currency that promised to cut the Big Bad Banks and financial institutions out of the loop, allowing ordinary citizens to transact on their own terms.
At another time, the idea of a new, intangible currency created by an unknown shadowy figure might have seemed ominous. But amid the Zeitgeist of 2009, the idea of sticking it to the financial man was an appealing one.
“Cryptocurrency is a superlative financial technology that outmatches legacy fiat systems and holds the potential of being a long-term store of value,” says Earl Loxton, Chief Executive Officer of EasyCrypto. “It avoids the ‘middle-man problem’ of money, it removes a single point of failure through decentralisation, and it can inexpensively process global payments in minutes, 365/24/7. A result of the limited supply of some cryptos (e.g. Bitcoin) creates ‘digital scarcity’, which typically drives price appreciation.”
When viewed through the lens of behavioural economics, there were other factors at play in the rise of crypto, too. The scarcity aspect that Loxton mentions is a big one – that there is a finite number of Bitcoins that can be mined implies value. There’s a social norming aspect – the more people started talking about Bitcoin and subsequent cryptocurrencies, the more it felt like something to explore because “everyone else was doing it”. But there’s another possible reason for crypto’s rapid success and that was simply that people didn’t understand it – and they didn’t want to be seen to not understand it. So, like a nerdy teenager puffing their first cigarette behind the toilets with the cool kids, people bought in.
Not everyone was so eager, though. “PSG has never been pro investing in crypto, given that it is still a very new and very misunderstood area of the market,” says Adriaan Pask, Chief Investment Officer of PSG Wealth. “Despite recent progress, this area of the market still remains under-regulated globally. When the hype in Bitcoin reached fever point at the end of 2017, we started to warn our advisers and financial planners of the variety of risks investors face when they consider speculative investments, like cryptocurrencies.”
Since then, PSG Wealth’s stance has been that they will only be comfortable considering cryptocurrency investments when they meet a set of strict criteria, says Pask, namely:
- “There is credible research and oversight in place.
- There are accreditations and licenses required by professionals that use these products in their advice products, as is currently the case with other financial products.
- There is a central authority that takes responsibility for oversight.
- There is legislation in place to protect investors against possible criminal actions.
- The security infrastructure is controlled and managed better than it currently is.
- There is liquidity, regulation and transparency around the specific investment.”
Legislation catches up
The thing about money is that people tend to care about it, and it was only a matter of time before cryptocurrencies – of which there are now thousands – became regulated.
In December last year, PWC released a report showing the regulation of cryptocurrency in different countries. The results ran the full spectrum, from countries that had banned cryptocurrencies (China, Qatar, Saudi Arabia) to those with legislation in place across all categories (Japan, Cayman Islands, Bahamas, Gibraltar, Mauritius) and various other permutations in between.
South Africa was listed as having “process initiated or plans communicated” across most categories with anti-money laundering / counter-terrorist financing legislation thankfully already in place.
Indeed, in October last year the Financial Sector Conduct Authority (FSCA) announced the classification of crypto as a financial product in terms of the Financial Advisory and Intermediary Services Act, 37 of 2002 (FAIS) (“Declaration”). The Declaration was published in Government Notice 1350 in Government Gazette 47334.
For the purposes of the Declaration, the definition of crypto assets, as laid out in the SA Financial Regulation Journal, is “a digital representation of value that:
- is not issued by a central bank, but is capable of being traded, transferred or stored electronically by natural and legal persons for the purpose of payment, investment or other forms of utility;
- applies cryptographic techniques; and uses distributed ledger technology.”
The journal article also states that: “The effect of the Declaration is that any person who provides advice or renders intermediary services in relation to crypto assets must be authorised under the FAIS Act as a financial services provider and must comply with the requirements of the FAIS Act.” It goes on to explain what this encompasses.
Of course, this development has big implications for CPD and licensing. However, the FSCA also published a noticed (notice 90 of 2022) which exempts certain persons rendering financial service in relation to crypto assets from the application of section 7(1) of FAIS as long as they comply with certain criteria:
- They must submit an application to the FSCA between 1 June 2023 and 30 November 2023.
- They must comply with:
- chapter 2 of the Determination of Fit and Proper Requirements for Financial Services Providers, 2017
- section 2 of the General Code of Conduct (“GCC”)
- all other requirements in the GCC excluding section 13
3. They must be willing to provide the FSCA with any relevant information that it requests.
“This exemption excludes persons categorised as crypto asset miners, node operators, and financial services in relation to non-fungible tokens, in respect of whom it is already deemed to apply,” according to the article.
PSG Wealth welcomes the legislation, says Pask. “The latest developments in this space reaffirmed our views. This is a necessary step for us before we will even consider investing in cryptocurrencies, so we support the decision,” he says. “In addition, we believe the appetite for speculative investments like cryptocurrencies started to decrease in 2022 and will likely decrease as this year continues.”
Loxton also agrees with legislation around crypto assets but points out that it does not change the decentralised nature of crypto. “Legislation in crypto is a good thing, but the reason why may be confounding. Centralisation around a decentralised system is inevitable and necessary for society to transition safely onto the chain. Stated differently, crypto exchanges are needed to onboard people into crypto, and they must be regulated. Regulation brings forth best investment practices and ensures prudent cyber security measures are followed. Centralised nodes operating around a decentralised system is the path of least resistance to mainstream economic adoption. It is important to bear in mind that regulated crypto exchanges do not detract from the decentralised nature of crypto. Crypto remains decentralised regardless of the legislative changes underway,” he says.
Although some have commented that the legislation around cryptocurrency came about quicker than expected, Pask disagrees. “Internationally, legislation has actually been quite slow on crypto regulations. I think this speaks to the inherent complex and opaque nature of crypto, in addition to the infamously slow-moving nature of new legislation in general,” he says.
Loxton adds that the legislation has actually been a long time coming in South Africa. “Crypto legislative policy in South Africa has been formally deliberated by the IFWG well before it was announced by the FSCA,” he says. “The landscape of crypto policy harnesses shared rules across various international jurisdictions. E.g. KYC standards put in place by the United States Financial Action Task Force (FATF) are followed by a global stage of reputable crypto asset service providers.”
Meanwhile, back on the rollercoaster…
As South Africa and other countries get their legislation in order, cryptocurrencies, meanwhile, have had a wild ride. Already infamous for their volatility, they had a particularly bleak time of it in 2022. “While it is still a polarised world of those that love and others that hate crypto, no one can deny that the crypto market took a beating in 2022,” says Pask. “According to CNBC, ‘The crypto market has lost a little over $2 trillion in 2022 and popular digital coins such as bitcoin have fallen far below their 2021 highs.’ For the year to 31 December 2022, the Nasdaq Crypto Index lost 65.92%.”
Its cause was not helped by the collapse of FTX, one of the world’s biggest cryptocurrency exchanges, which many commentators have suggested seems to walk, look and quack like a Ponzi scheme.
However, despite a rocky 2022, cryptocurrency is not going anywhere. In January this year Forbes reported that bitcoin was on the up, back above $21 000 per bitcoin for the first time since the FTX scandal.
Transacting with cryptocurrency is also becoming easier. Crypto debit cards now allow users to spend Bitcoin at retailers that accept it and the retailer gets remunerated in fiat currency. The debit card providers have partnered with the likes of Mastercard and Visa to ensure the transactions are processed seamlessly.
And in the ultimate proof of mainstream adoption, retail giant Pick n Pay recently announced that it would accept payment in bitcoin at all its stores, charging a small service fee for the privilege – an average of 70c.
Impact on advisers
In a recent survey published in FA News, 90% of advisers said they were not assisting clients with investing in cryptocurrencies. However, 92% of clients are asking their advisers for guidance around cryptocurrencies, according to the survey. There is clearly a demand from clients, but so far advisers have been legally unable to respond to it. However, this doesn’t mean that they should not be learning about cryptocurrencies and staying abreast of developments in this space.
“Financial advisers need to be familiar with the basics of cryptocurrencies and how they work, as well as the potential risks and benefits of investing in them,” says Loxton. “This includes understanding the underlying technology of blockchain, as well as the economic and financial principles that govern their value. Intrinsic value discussions about crypto can be difficult to navigate because their markers of value are different to that of shares and government bonds.”
“It is also important for financial advisers to stay up to date on the regulatory landscape,” he continues. “In some countries, cryptocurrencies may be treated as commodities or securities, while in others they may be subject to more lenient regulations or be outright banned. Overall, it is important for financial advisers to approach cryptocurrencies with a level of caution and to fully educate themselves on the subject before making any recommendations to clients.”
“Even though we do not support the use of crypto in our advice process we do offer plenty of guidance to our wealth managers so that they can navigate crypto-related discussions,” says Pask of how PSG Wealth is navigating this issue. “This would include regular updates on how we view the associated risks and what we deem appropriate vehicles for providing wealth management services.”
Advisers may not feel comfortable speaking to their clients about crypto, but Pask believes it’s important for them to inform clients of the risks of investing in cryptocurrencies. “While it can be tempting for clients to buy crypto (especially if these assets rerate and speculative appetite grows), clients should never speculate with money they cannot afford to lose,” he says.
He adds that clients need to understand how crypto assets would fit into their broader financial plan – and that’s something advisers would need to assist them with. “While we do not currently provide advice on crypto assets, we believe there are various aspects that would require detailed consideration. It is important that clients understand their goals, how much risk can be taken and how any investment (crypto in this instance) aids in achieving that goal.
“A financial plan should also be clear and supported by a valid will. Given the nature of crypto assets, it is important to ensure the executor has the necessary information and access to fulfil the wishes of the client and ensure that beneficiaries receive the asset as intended. We are concerned that these complexities are currently not widely understood and planned for, where clients already own these assets. We therefore continue to watch developments in this space and will amend the guidance we provide to our advisers as new information emerges.”
Loxton agrees that crypto needs to fit into a broader portfolio and that advisers should help clients make wise decisions around it. “We recommend that advisers always consider a client’s ability and willingness to adopt risk alongside the broader context of their existing investment portfolio,” he says. “A 2.5%-5% allocation to crypto in a well-diversified portfolio has the potential to provide diversification benefits and outsized returns on the upside.”
As advisers begin to navigate this territory, they also need to keep in mind the risks associated with cryptocurrencies, says Pask. “Currencies are often considered as investment vehicles and not investments in their own right. For PSG Wealth, an accurate assessment of an investment’s intrinsic value requires a linked cash flow stream. This cash flow stream then needs to be discounted and valued to determine whether the asset is trading at a value under, or above, its intrinsic value. Without this assessment, we would contend that any allocation is highly speculative,” he cautions.
Also of concern is the volatility of cryptocurrencies, which makes them hard to plan around. “Cryptocurrencies have been subject to sharp and rapid changes in value, rendering their value highly unpredictable at any given time,” says Pask. “Also of concern is the fact that there are no specific licensing requirements for wealth managers. While some international asset managers did start to invest in some cryptocurrencies, they are still not recognised as a regulated product which advisers may give advice on.
“Credible research is also thin, which means risks are largely unknown and not actively monitored by mainstream investment research businesses or regulators. Another consideration is the complexity around taxing this digital currency. Although Bitcoin is not an official currency, most jurisdictions still require the payment of income, sales, payroll and capital gains taxes on bitcoins. In the US, the Internal Revenue Service (IRS) has stated that bitcoins should be treated as property, and not as currency for tax purposes.”
And then, of course, there’s the fact that crypto has been linked to nefarious dealings. “Crypto is further said to appeal to those engaged in illegal activities, because of its anonymity,” says Pask. “This, combined with a rise in digital crime, introduces the risk of fraud and theft.”
EasyCrypto has strict measures in place when it comes to the security of their clients’ investments. “Note that EasyCrypto does not keep assets on exchanges but harnesses the BitGo and Fireblocks custody solutions for the majority of client assets,” says Loxton. However, he shares these exchange-vetting tips:
- “We ensure the exchange is regulated by a reputable financial authority. This can help ensure that the exchange follows best practices for security and customer protection.
- We investigate what public information is available about security measures the exchange has in place to protect against hacking and other types of cyber-attacks.
- We look for an exchange that is transparent about its fees, policies, practices and holdings.
- We check what user consensus is via online reviews and look for areas of concern.”
It may have started out with a random white paper dropped into a chat forum by an anonymous developer with agenda unknown, but it’s clear that crypto has taken on a life of its own and it will impact the future of the industry. What’s more, the blockchain technology that underpins cryptocurrencies has even further-reaching implications for the finance industry. And whatever their reason for doing so, clients will continue to ask questions about it. Whatever our personal position on crypto may be, we need to understand it, and we need to prepare for those questions.