Demystifying Virtual Currencies

Over the past year, there has been a great deal of media hype and discussion around virtual and crypto currencies. For investors, it is worth understanding this emerging trend that sees financial and technology innovation combining in new and fascinating ways…

So, what are virtual currencies and how do they work?

A virtual currency (e.g. Bitcoin) is a unit of account that is digitally or electronically created and stored. Members of the virtual community agree to accept these units as a representation of value in the same way that a currency is accepted.

In contrast to traditional currencies, virtual currencies operate without the authority of Central Banks and are therefore not regulated. (For many, this makes such currencies particularly exciting and ripe for further innovation.)

Notably, Bitcoins can be exchanged or purchased with real currency (e.g. ZAR, USD and Euro) and Bitcoins purchased are deposited into a digital wallet. They can also be converted back to real currency as and when required, provided there is a willing buyer. Many local e-commerce stores are accepting Bitcoin, with major retailer Pick n Pay recently following suit.

Virtual currencies are unregulated in South Africa

Currently, there are no specific laws or regulations that address the use of virtual currencies in SA. As a result, no legal protection or recourse is afforded to users of virtual currencies.

Due to their unregulated status, virtual currencies cannot be classified as legal tender and any merchant may refuse them as a payment instrument without being in breach of the law. Importantly, the use of virtual currencies depends on the other participant’s willingness to accept them.

There is no investor protection and no recourse!

Because virtual currencies are not regulated, users are not protected and are at risk of losing money. It must be emphasized that transactions are irreversible.

The price of virtual currencies is based on investor sentiment and can be very volatile. Prices can rise rapidly and in turn, drop very quickly. Just taking a brief look at what Bitcoin has done over the past several months can raise blood pressures!

Virtual platforms are vulnerable to attacks

Highly sophisticated cyber-attacks, resulting in the theft of virtual currencies, are becoming increasingly common.

Digital wallets can be hacked – and the virtual currencies stolen – since they are stored on electronic devices or platforms, which themselves are susceptible to damage, theft or disruption. In such cases, there are no prospects of the retrieval or recovery of the virtual currency (or the restoration of the hacked electronic device). Also, there is no possible cancellation or reversal of the transaction once the virtual currency has been transferred.

Virtual currencies are susceptible to misuse

By design, these transactions are difficult to trace and provide users with a high degree of anonymity, contributing to their attractiveness to criminals, fraudsters and money launderers.

In short, for curious investors, this is still a very new and volatile space; so proceed with caution (and at your own risk!)….

SOURCE: National Treasury, South Africa