What you need to know:
- Many innovations come as opportunities but people often do not give them chance for lack of knowledge about them. James Abola explores cryptocurrency, saying why it is a good innovation.
Last week, the Governor Bank of Uganda (BoU) Tumusiime-Mutebile issued a statement warning the public about the practice of ‘One Coin Digital’ which claims to deal in a digital currency known as ‘One Coin’.
Once Three weeks before the BoU warning, I met a worried priest who told me that a member of his flock had sold a valuable asset to raise cash to invest in digital currency. The investor told his pastor that he was looking for more money to invest in this once in a lifetime opportunity.
Where the investor saw the opportunity of a lifetime, his pastor foresaw danger, grave danger.
Faced with excited investors, worried people and warnings from the Central Bank, one is right to ask the question: Is digital or cryptocurrency an opportunity or a scam?
What is cryptocurrency?
Most of the money in a modern monetary system is what’s called fiat money.
Fiat money is money that has no intrinsic value but is used as a medium of exchange because a specific government deems it so.
The Uganda Shilling, the Euro, the US dollar are all examples of fiat money.
Cryptocurrency is another form of money which is a medium of exchange like fiat currencies, but designed for the purpose of exchanging digital information through a process made possible by certain principles of cryptography.
Cryptography is used to secure the transactions and to control the creation of new coins.
The first cryptocurrency to be created was Bitcoin in 2009. Today there are hundreds of other cryptocurrencies, often referred to as Altcoins.
One has to understand that digital currencies represent two things in one: Innovations in payment systems and a new form of currency.
The supply of digital coins is regulated by software and the agreement of users of the system and cannot be manipulated by any government, bank, organisation or individual.
There are five key requirements for creating a cryptocurrency, namely: All transactions should be made over the Internet; there should be no central authority that will process
transactions; users should be anonymous and identified only by their virtual identity; a single user can have as many virtual identities as he or she likes; value supply (new virtual bills) must be added in a controlled way.
One feature of digital currency, the blockchain, is worth explaining in more detail. This is a distributed ledger which allows a digital currency to be used in a decentralised payment system. This ledger contains the record of all transactions by all users and is publicly available to all.
Much as cryptocurrencies are legal in most countries of the world, they are subject to restrictions and regulations. In some countries, licensed financial institutions are banned from handling cryptocurrencies.
In the USA, Bitcoin which is the most popular cryptocurrency is treated as property for tax purposes.
Using, buying and selling cryptocurrency
There are businesses which allow people to pay for goods or services in cryptocurrency through three main ways:
Direct trades. This is done through websites where the person registers as a seller and posts an offer and the web site alerts when a buyer wants to trade. In a direct trade both the seller and buyer have to actively engage in negotiation and fulfilling the transaction if a deal is agreed.
Exchange trades. Similar to a stock market, both the seller and buyer register with an online exchange. The exchanges act as an intermediary who holds everyone’s funds. You place a ‘sell order’ (just as you would place a buy order), stating the volume (amount) and type of currency you wish to sell, and the price per unit you wish to sell for.
As soon as someone places a matching buy order, the exchange will complete the transaction. The currency will then be credited to your account. In the past some exchanges have had liquidity challenges when sellers want to sell digital currency for fiat money. In such a case the seller has to wait for a long-time before the fiat currency is available.
Digital currency scams
Just like with fiat money, there is also fake cryptocurrency. Since the majority of people do not know the genuine cryptocurrencies and are either too lazy or too greedy, they are very easily conned.
When people buy into a scam it is even much harder to convince them that they have been conned. The main features of digital currency scams are:
a) They operate as pyramid schemes where those who join early earn fees or commissions from those joining later; b) Because of the pyramid scheme set up, investors are promised high returns that are based on the aggressiveness of recruiting new investors; c) The currency is centralised and buying or selling is controlled through a central web site or a series of websites which are in effect clones of a parent website while genuine cryptocurrencies are decentralised; d) Does not have a wallet address; e) Does not have a blockchain; f) Does not have exchange where people can freely sell or buy e-coins.
Way forward for cryptocurrency
Cryptocurrencies have become so important that some countries are now considering retiring their fiat currencies in order to introduce national digital currency.
Ignoring cryptocurrencies is not a wise course of action. A country that shuns cryptocurrencies may soon find it costly to participate in international trade. Such a country will also shut itself out of opportunities such as cryptocurrency websites and cryptocurrency mining.
Uganda, therefore, needs to invest in learning about cryptocurrency and introducing laws that enable genuine cryptocurrencies to transact in the country.
Such laws would also enable the country to earn capital gains tax from people who invest or deal in cryptocurrencies.
James Abola is a business/finance consultant and Team Leader of Akamai Global. Email: [email protected]