What is cryptocurrency?

An introduction to cryptocurrency

Cryptocurrency, or “crypto” hit the headlines in 2009, when Bitcoin launched, but its origins can be traced back to the 1980s, when it was called cyber currency. An American cryptographer called David Chaum invented digital cash, which relied on cryptography to secure and verify transactions, but the requisite protocols and software that would facilitate a true digital currency did not begin to be developed until the 1990s. So what is cryptocurrency?

Cryptocurrency as we know it now is a digital currency in which transactions are verified and records maintained by a decentralised system using cryptography, rather than by a centralised authority such as a bank. The digital money is created from code which is monitored by a peer-to-peer internet protocol. It can be digitally traded and functions as a medium of exchange. In other words, it is an encrypted string of data, encoded to signify one unit of currency which has the same value all over the world, i.e., no conversion/exchange is necessary.

Investing in crypto

When it was first launched, Bitcoin was intended to be used for daily transactions, from low-value commodities like a cup of coffee to assets such as a computer. High-value items like real estate were even deemed to be suitable for purchase by Bitcoin. However, the reality was a bit different. Crypto was considered…and used as…an investment medium. Bitcoin was on an upward trajectory and investors piled in, but the bubble may have burst. One Bitcoin is now worth around $17,000. It was worth c. $69,000 in November 2021. Some analysts think it is unlikely to recover to 2021 levels. Bitcoin and other cryptocurrencies, like non-digital assets, have been affected by macroeconomic pressures, including the war in Ukraine, inflation and the cost-of-living crisis, and uncertainty around rising interest rates in the US and UK. Crypto has also been impacted by forces related to its digital nature: China has made cryptocurrency transactions illegal and FTX, the largest global cryptocurrency exchange, has collapsed.

However, a long-term investment portfolio could benefit from holding cryptocurrency. Market experts believe that Bitcoin could rally, although that might not be in the near future. Crypto could help to diversify a portfolio and provide returns when other investments are underperforming. But it’s important to understand that crypto is unstable and volatile and carries risk.

Legal tender

Cryptocurrencies do not have widespread status as legal tender, but they are regarded as assets in South Africa and can be tendered to a creditor as a valid and legal offer of payment, if you can find a vendor who accepts crypto. The number of institutions accepting cryptocurrencies is growing, but they are mostly in the US for the time being. There, it is possible to buy a wide variety of products from e-commerce websites using crypto. Examples include technology and e-commerce sites such as AT&T and Microsoft. Some luxury goods retailers accept crypto as a form of payment, as do some car dealers, from mass-market brands to high-end luxury marques. In the US, it is possible to spend cryptocurrency at a retailer that doesn’t accept it directly by using a cryptocurrency debit card, such as BitPay. This feature does not yet exist in South Africa.

Cryptocurrency is neither issued nor governed by any jurisdiction and exists purely within the community of users of the currency. We’ll look at the regulatory framework for cryptocurrency in South Africa in a future article

Examples of cryptocurrency

Bitcoin is the most recognised cryptocurrency, as it was the first onto the scene. Others include Ethereum, Litecoin, Ripple, Tether and Binance Coin.

Bitcoin

Since there is no centralised third party involved, Bitcoin was created as a peer-to-peer value transmission system based on encryption. A useful tool for conducting business between two or more parties, the Bitcoin blockchain is immutable, meaning it cannot be altered in any manner. There are only 21 million Bitcoin that will ever be created.

Ethereum

Developed in 2015, Ethereum is a blockchain platform with its own cryptocurrency, called Ether (ETH) or Ethereum. It is the most popular cryptocurrency after Bitcoin. Ethereum is a system that allows users to create decentralised apps and organisations, keep assets, execute transactions, and communicate. Users retain control over their own data and what is shared, so personal information is kept confidential.

Litecoin

Litecoin is similar to Bitcoin but has been more innovative, developing systems for faster payments and processes to allow more transactions.

Ripple

Ripple is a distributed ledger system that was founded in 2012 by a company that has worked with various banks and financial institutions. Ripple can be used to track different kinds of transactions, not just cryptocurrency.

Tether

Tether is a stablecoin, which means it is backed by fiat currencies like the US dollar or euro and maintains a value roughly equal to one of those denominations. Theoretically, Tether’s value should be more stable than other cryptocurrencies, and investors who are concerned about volatility tend to prefer it.

Binance Coin

One of the biggest cryptocurrency exchanges in the world, Binance, accepts payments in the form of Binance Coin (BNB). Binance Coin has grown since it was introduced in 2017, and it does more than just enable transactions on Binance’s exchange platform. It can be used for trading and processing payments. Additionally, it can be traded or converted into other cryptocurrencies like Ethereum or Bitcoin.

As a matter of interest, non-Bitcoin cryptocurrencies are collectively known as “altcoins” to distinguish them from the original.

Cryptocurrency risks

Cryptocurrency is inherently risky. The same features that make it attractive contribute to its risk. Those who value the peer-to-peer concept and want to avoid “big finance” also need to understand that the lack of coordination and clarity on regulatory, financial, tax and legal treatment means crypto does not have the protection afforded other financial assets. Cryptocurrency investments are subject to far less regulatory protection than traditional financial products like stocks, bonds, and mutual funds. And, unlike government-backed money, the value of virtual currencies is driven entirely by supply and demand. This contributes to the extreme volatility seen in the crypto market and can result in both significant gains and big losses.

Cryptocurrency is favoured by cybercriminals making ransom demands because assets are hidden and untraceable. There are also scams directly related to cryptocurrency, and this type of crime is on the increase. These include: fake websites which feature bogus testimonials and promise attractive, guaranteed returns for continued investment; virtual Ponzi schemes where cryptocurrency criminals promote non-existent opportunities to invest in digital currencies and purport to pay huge returns by paying off old investors with new investors’ money; and “celebrity” endorsements, in which scammers impersonate well-known names and promise to increase the victim’s investment in the cryptocurrency but instead steal the funds sent to purchase the crypto. One of the saddest scams takes advantage of those looking for love online. Con artists (usually men) persuade people (usually women) they match with on dating apps to invest in cryptocurrency.

Lastly, crypto, like any online activity, is subject to hacking, where cybercriminals break into digital wallets and steal the cryptocurrency. The blockchain technology that underpins cryptocurrency is secure, and crypto is not easy to hack into. But it is not unhackable. It is also not immune from human error. Password amnesia can mean the loss of all one’s cryptocurrency.

Benefits of cryptocurrency

Despite the risk, there are benefits to cryptocurrency. It is easy to move and store. It is internationally available. It is governed, or rather ungoverned, by multiple jurisdictions. Brokers are unregulated, making it more accessible. However, this last point is being addressed by the South African Reserve Bank at present. The biggest benefit in the African context is that it is available to anyone with an internet connection, which potentially makes it a useful tool for the half a billion unbanked in sub-Saharan Africa. (Data from the World Bank shows that around 45% of people living in sub-Saharan Africa don’t have access to a bank account, which equates to almost half a billion people excluded from financial services.) However, crypto needs to be purchased initially and loaded into a digital wallet with tangible funds, usually a debit card or electronic fund transfer (EFT). A credit card may also be used but crypto purchases with credit cards are considered risky. Some exchanges and some credit card providers don’t support them. This hurdle needs to be overcome and some of the risks mitigated before cryptocurrency can be considered a viable solution for the unbanked.

For more information

SD Law is a firm of experienced attorneys based in Cape Town, with offices in Johannesburg and Durban. If you want to know more about cryptocurrency, or need assistance with other digital concerns, including compliance with POPIA, cyberbullying and cybercrime, call Simon on 086 099 5146 or email sdippenaar@sdlaw.co.za.

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