In cyberspace, no-one can hear you scream!

There are fortune tellers and powerful Sangomas out there who can address 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 which grips the human spirit. It also is this penchant for the supernatural perhaps that often leads us to believe that not everything in the world comes with a rational explanation.

In the financial world, the label of bubbles gets attached to many difficult-to-explain phenomena but few have come close to the current euphoria surrounding crypto currencies. This prompted the highest paid banking CEO in the world, Jamie Dimon (CEO of JP Morgan Chase) to recently portend that he would fire anyone who trades in bitcoin or similar currencies.

In South Africa, we have witnessed a proliferation of Ponzi schemes with the latest MMM scheme being another high profile example of the old adage that if it’s too good to be true…it probably is. Nearly all Ponzi schemes have the same modus operandi: investors are promised eye-watering returns over short periods of time. 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 pay-outs to investors inevitably exceed the new investment proceeds, preventing the scheme from robbing Peter to pay Paul.

The first question is why so many of us believe in ‘get rich quick’ 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 over-indulgences 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 3 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, effortlessly? Sign me up!

In the financial world, bubbles are always based on some shred of truth. Yes in a digital world, crypto currencies have a place. A medium of exchange, a currency accepted by major nations which 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 the fact that a pilot project had been on trial at its canteen store at its head office!  In a world where Central Banks have printed over $10 trillion since the global financial crisis, there has been a growing distrust in fiat currencies. Well instead of trusting central bankers and governments who 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 crypto currencies – 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 crypto currencies are not regulated and are not legal tender per se in South Africa. Hence if you pay for a transaction using a crypto currency and the goods are never delivered, it is next to impossible to get the transaction reversed and 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 crypto currencies – 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 current bitcoin bubble is in fact one of the most extreme examples witnessed in current time. Over the past few decades, globally we’ve seen a number of bubbles:  the global property bubble in the mid-90s, the dot com bubble, the silver bubble of 2001, etc. In nearly all of these cases, asset prices increased 1000% or more  – the common trait is that it took at least a decade to inflate.  In the case of Bitcoin, prices went up by over 1000% within a mere two years!

Source: Morningstar, August 2017

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 their Ponzi scheme in South Africa and elsewhere with bitcoin as its currency of choice! So while block chain 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 crypto currencies 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 gold 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 crypto currencies as the easy way to accumulate wealth.  My first consultation is, by the way, free.