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Investing in bitcoin: What you need to know

How cryptocurrencies work, and things to consider before investing.

WARREN THOMPSON:  Now we are going to turn our attention to a very interesting subject for those of you who have been tracking developments in the cryptocurrency space. We are going to be talking about all you need to know about investing in bitcoin with my in-studio guest tonight, Farzam Ehsani. He is the leader of Blockchain Initiative at Rand Merchant Bank. Good evening, Farzam.

FARZAM EHSANI:  Good evening, Warren. Good to be here.

WARREN THOMPSON:  Great to have you here. I think it’s piqued so much interest. We’ve seen how our articles about bitcoin have flown off the shelves on the Moneyweb website. People are wanting to understand more about these cryptocurrencies – what are these things, how do they work, what are the wider applications? And so I think while we’ve got the time now we are going to have a bit of a chat around how they work. We’ll get your impression and understanding of what these things are, and then obviously what the applications and the uses can be.

So, just to kick things off, bitcoin is one of I think hundreds–

FARZAM EHSANI:  Thousands.

WARREN THOMPSON:  Thousands? Thousands of cryptocurrencies. But let’s start with bitcoin, because it’s the most well known.

The underlying architecture around the idea of this cryptocurrency is something called blockchain. Lead us out there with your definition of blockchain.

FARZAM EHSANI:  Sure. I think it’s important to take a step back and try to understand what this is all about before we start talking about prices and why it’s gone up so much over the past few weeks, months and years. One thing that’s important to note is that it’s digital. We are talking about digital assets. And one thing to ask your listeners and yourself, Warren – because we all have computers and on our computers we have folders for our music, our videos and our documents – why don’t we have folders for our own money? Very few people stop and ask themselves that. Whenever we have digital money, that digital money resides in a bank today and any money we have full control over in our pocket is physical money.

So, up until about 2009, every time there was anything digital of value, it needed to be managed by a central, trusted intermediary – we call these things generally banks or financial institutions. And whenever that value had to be transferred from one account to another, it was that central institution that did the debit and credit to make sure that there was a transfer of value.

So this new technology called blockchain technology – and bitcoin was the first manifestation of this technology – is the first time that we can have digital value that doesn’t require a trust intermediary to do the processing between one individual and another. That is absolutely huge, because bitcoin doesn’t have a CEO, it doesn’t have a owner of the network. It’s a completely decentralised system that really functions on the activities of participants who are incentivised to make this system work. So it’s a really phenomenal system that we are talking about.

WARREN THOMPSON:  Just taking that a step further, it is this concept of what we call “open ledgers” as far as I understand.

FARZAM EHSANI:  Yes, “shared ledger”.

WARREN THOMPSON:  So I kind of brought it back to the experience I had studying the Sassa cards this year, where you have these cars that don’t connect to the national payment system. Basically someone like the government puts value onto the card, so you have the R1 000 social grant that gets paid into the card at one point. That card then is not the grid, but it can go to various merchants and keep a record of its own transactions. And when it connects to the grid it can also keep transactions of other cards.

So you have this thing where you have different people keeping a record of what’s happening and what’s been transferred between other parties, even though they are not the immediate parties involved in that transaction. And that is the basis of verifying multiple transactions taking place all over the show without needing that trusted intermediary that you talk about.

FARZAM EHSANI:  Let’s talk a little about that. The beauty about this world is that it brings together a lot of different disciplines. One of those disciplines is cryptography. The way that works at a high level is that there are these things called private keys and public keys. The public key is kind of just like your address, your account number. Think of it just like your email address, if you want to. It’s a series of numbers and letters and nobody knows that you are the one that has that public address.

And that public address is then associated with a balance, if you want to think of it like that. Now the entire network knows the particular public address has a particular amount of bitcoin on it. What allows people to spend their bitcoin is via this private key that they have. Kind of think of it like a password, and with that password you can create a digital signature and send that digital signature to the entire network to prove that the balance of the public key is actually yours, and you can then send it to anybody else that you want. So it’s a beautiful system of cryptography, computer science, economic incentives, and game theory that come together to create a system that’s really based on incentivising people to come into a decentralised system and do their part.

WARREN THOMPSON:  Okay. Farzam, we’ve got some questions coming in here. Phindi in Soweto asks: “Is bitcoin not a scam?”

FARZAM EHSANI:  It’s a great question and actually I thought it was a scam when I first heard about it, because what is bitcoin and the price is going up like crazy.

It’s not a scam, but it takes some thinking to see why that’s the case. A scam generally is when people are trying to do you in, take your money and run away with it, effectively. Bitcoin is not that. If you think about gold, for example, and ask yourself is gold a scam, a little ounce of gold today, as we talked about a little earlier, is worth US$1 290. Now, is that a scam or not?

What happens is that the world sees a particular scarcity in a particular asset as well as some utility. Gold for many, many years has held its value. It doesn’t rust, and so people have seen it as a durable store of value. So with bitcoin, nobody is just trying to promise you anything with it. It’s a very scarce digital asset. There are 16.5 million bitcoins in existence. There will only ever be 21 million bitcoins, so it’s scarce. And there is also a great utility.

So right now, if I wanted to send my bitcoins to anyone in the world, I could do that in a matter of minutes, and it would cost me less than US$1 to send that value. So if I wanted to, say, send R10 000 to someone in China right now, if I went through the traditional means of sending that money, some of those channels cost a lot of money. Sometimes 10%, 12% of remittances actually go to the intermediaries along the way, they get captured.

Now if you compare that to bitcoin that has a value today that you can transfer across borders, that costs me less than US$1 to do so, and arrives there in a matter of minutes. There is actually utility there.

So what I would encourage the listeners to think about is No 1, don’t get too attracted by the price at the moment. Right now one single bitcoin stands at about R63 000, but obviously you can buy less than one bitcoin. You can buy fractions of a bitcoin. But it’s a very, very volatile asset. So a lot of people have heard about this volatility. To give you an idea, about a year ago the price was R8 500. So from R8 500 all the way up to R63 000, we are talking about over 600% appreciation in a single year. That’s kind of unheard of in the financial markets.

So that comes about with a lot of volatility. It has gone up a lot, it could potentially come down a quite lot, back up again. So ultimately as more and more people come into it, that volatility will reduce. The price will likely go up. There are issues with the bitcoin ecosystem because it’s decentralised; it is difficult to make updates to the protocol. Just imagine that you’ve got a group of friends and you are put onto a project at school together, and nobody’s kind of the leader. It often takes some kind of manoeuvring to get the group together to move in a certain direction – right? It’s no different with the bitcoin protocol.

So I think it’s important not to get so attracted by the financial returns right now. But if you were thinking of buying some bitcoin, put in as much as you are willing to lose. Read about it, learn about it. There is a lot on YouTube on the internet, so that you can satisfy yourself that it’s not a scam. Nobody can convince you that except yourself.

WARREN THOMPSON:  Joy from Pretoria is asking how one gets started. This is a fairly practical question. Listeners want you to leave your details, but you are not in the business of trading bitcoins, right? So just give people a very quick idea as to how this actually works. Get an account with a bitcoin platform…

FARZAM EHSANI:  One thing that’s important to note is that, because it’s such a new asset class, the regulation around it as to what institutions can and cannot do – the verdict is still out. There are certain bitcoin exchanges. You can Google them and decide which one you want to kind of use for yourself. I would do a lot of research, because some of those bitcoin exchanges have had problems in the past internationally. So be very careful. Start with small amounts if you want to.

And there are many bitcoin exchanges internationally as I said, in Hong Kong, in the US, denominated in dollars, in euros, locally in rands. So you can Google bitcoin exchange and find one that you like. You will obviously have to deposit some rands onto that platform. Once you deposit some rands you can buy some bitcoin. And then, once you have your bitcoin, you see that centralised exchange platform that’s not different to a financial institution, because you are trusting them with bitcoins on their own ledger. So you can look up bitcoin wallets. These bitcoin wallets are basically pieces of software that you can have on your phone or your computer where you take possession of that private key that I was talking about earlier, which is kind of like your own password. So you have full control over your bitcoin.

So that’s a little bit. It does get technical, but that’s why I say if you want to get started, find an exchange, do some research, transfer a little money there, buy a little bit of bitcoin and start reading and learning about it.

WARREN THOMPSON:  If I’ve understood you correctly, there are a couple of things that in summary you need to bear in mind. No 1 is that bitcoin can be used like money, to pay for things. And because of that very low cost of transferring bitcoins it’s of particular interest to retailers, who typically pay out 2 to 3% of the sales price of goods for the transaction cost – the pleasure of having someone pay you over the internet with a credit card, for instance.

But on the other hand you’ve got people buying bitcoin thinking that it’s going to rise in value, so it’s being treated like an investment. Are those the two general ways to think about using bitcoin?

FARZAM EHSANI:  Bitcoin, because it’s not regulated or it’s not owned or governed by any government, institution or person, it really kind of lives outside the system in a sense. So it can be used as kind of a hedge, if you want to think about it like that, against geopolitical disturbances that we talked about earlier. It can be used as a payment mechanism. There are companies like Dell, Microsoft, Expedia – they all accept bitcoin. There are several institutions in South Africa that accept bitcoin. So there are many different use cases for it. But I think right now it’s still very early, and people are learning more and more about it. So education is scarce; educate yourself, understand it. This is going to be a big phenomenon.

WARREN THOMPSON:  Great. We’ll have to leave it there. Farzam Ehsani, thank you very much for your time.

Of course you can learn more about bitcoin on our Moneyweb platform and our Moneyweb radio shows. But that is all for tonight and we trust you have a good weekend.

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Tulips anyone?

The reason why Bitcoin and cryptocurrencies are the future of money is simple. They can change.

They are not static. They are not a tulip during the tulip bubble. Or a house during the housing bubble. Or even a dot-com during the dot-com bubble.

Bitcoin and Ethereum and most cryptocurrencies are dynamic. They grow, scale, and improve — almost on a monthly basis. They are led by teams of incredibly intelligent people who are motivated both by the lofty goal of decentralizing money AND by the practical ambition of making money. That is a winning combination right there.

They’re an incredible innovation. That doesn’t mean they’re an incredible “investment”. I stand by my analogy. Time will tell.

Where did I say they are an incredible investment?

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