By Francis Mwangi and Phillip Njoroge
On Thursday 15 April 2021 at 8:59:03 AM UTC, Bitcoin prices soared to US $ 63,216.44 per coin. This was the culmination of a series of events that elevated Bitcoin to being the fastest ever asset to hit US $1 Trillion (US $ 1,000,000,000,000.00).
In today’s capitalist society, success is measured in monetary value, and the same is best encapsulated by the market capitalization (market cap) concept. This concept is dictated by the total value of a corporation within the stock market.
Successful enterprises within this setting have a market cap range in the hundreds of millions of dollars. Global business conglomerates such as JP Morgan Chase, Walmart, Alibaba, Tencent and Facebook are within the range of hundreds of billions of dollars. However, only a handful of mega-corporations (megacorps) stand at the peak with their market cap going above the trillion-dollar market cap range. These are:
- Saudi Arabian Oil Company (Saudi Aramco) – $2.6 Trillion
- Apple Inc. – $2.2 Trillion
- Microsoft Corporation – $1.90 Trillion
- Amazon.com, Inc. – $1.64 Trillion
- Alphabet Inc. (Google and other Subsidiaries) – $1.60 Trillion
It took these megacorps, the richest in modern times, several decades (an average of 33 years) to climb up the rungs of success. However, what took the megacorps such a considerable amount of time to achieve only took Bitcoin – the leading cryptocurrency with a market cap of US $ 1.74 Trillion – a meagre 12 years. The scale of this success has baffled the public and left many to wonder:
- What exactly are cryptocurrencies and how do they operate?
- What is the rationale behind the ‘crypto-frenzy’ of this age and why are cryptocurrencies so extraordinarily profitable?
- Can one legally invest in cryptocurrencies in Kenya?
What are cryptocurrencies, and how do they work?
By definition, a cryptocurrency is a digital representation of value that functions as a medium of exchange, a unit of account, or a store of value. It can also be defined as a digital currency in which transactions are verified and records maintained by a decentralized system using cryptography as opposed to a centralized authority.
This process of collection, verification and maintenance is more commonly known as ‘cryptocurrency mining’ (crypto-mining). The concept behind crypto-mining is that all transactions (blocks) across the cryptocurrency network must be monitored and supervised. This is facilitated through the compilation of blockchains. The incentive behind this process is that once a blockchain is compiled, a new token is awarded by the creator of the cryptocurrency. In fact, this is the only way to release new tokens/coins into the market.
However, the process of crypto-mining is complex. Mining is an entirely automated process that must be conducted using high-capacity processing computers. For this reason, crypto-mining cannot be conducted using machines that perform regular desktop functions. The hardware and software needed to set up these machines is expensive and the electricity required to run them is costly, with these machines consuming electricity valued at up to Kshs. 2 million every 10 minutes (the amount of time it takes to mine one bitcoin, for example). One can then sell these coins, if history is anything to go by, for as much as Kshs. 7 million.
The primary value that blockchain brings is that, as an open-source database, it is decentralized and the data which is inputted is almost impossible to steal, hack or corrupt. Blockchain technology stores the data in millions of computers worldwide, and before it is saved as a block, it must be verified by a network of nodes (computers). Block chaining is thus a global, safe, scalable, trustworthy database with the potential to serve inexhaustible purposes.
What is the rationale behind the ‘crypto-frenzy’ and why are cryptocurrencies so extraordinarily profitable?
Cryptocurrency trading is profitable if one plays their cards well. For example, during the Bitcoin boom of April 2021, traders who had been in the market since 2014 (when one Bitcoin cost about $500) experienced returns of about 12,800%. Simply put, these profits cannot be experienced elsewhere in the world and are the reason for the ‘crypto-craze’.
However, cryptocurrency trading is extremely volatile and may not be generally appropriate, particularly with funds drawn from retirement savings, student loans, mortgages, emergency funds, or funds set aside for other purposes. Cryptocurrency markets have been continually shrouded in doubt and uncertainty, with unusually high-risk factors and expensive running costs.
Can one legitimately invest in cryptocurrencies in Kenya?
It should be noted that the risks that accompany the use of virtual currencies are generic in nature; the negative implications that apply to foreign markets apply to the Kenyan market as well. Those risks include the ones mentioned below which have led the Central Bank of Kenya to curtail the trading of cryptocurrency in Kenya by its licensees thereby pushing the bulk of cryptocurrency trading activity to offshore entities operating online.
a. Cryptocurrencies are unregulated currencies
Regulation of money supply is a crucial and important element in control of money markets as it is responsible for maintaining economic stability, controlling inflation, and informing monetary policy. For example, having more money supplied and circulating in an economy can lead to demand-pull inflation where an economy has too much money chasing few goods. For this reason, supply of money in any economy is a highly regulated affair with central banks being at the heart of any money issued in any economy.
In Kenya, the Central Bank of Kenya Act (the CBK Act) vests the sole right to issue notes and coins to the Central Bank of Kenya (the CBK) and only the CBK-issued notes and coins are recognized as legal tender. In addition, Section 19 of the CBK Act provides that all monetary obligations or transactions entered or made in Kenya shall be deemed to be expressed, recorded, and settled in Kenyan currency unless otherwise provided for by law or agreed upon between the parties. This means that unless a note or coin is issued by the CBK, it is not effective as a medium of exchange in Kenya.
As cryptocurrencies are not issued by central banks, they lack recognition as legal tender and do not fall within the regulatory ambit of the CBK: a fact which the CBK has repeatedly publicised.
b. Transactions and dealings that involve virtual currencies are untraceable and anonymous
As cryptocurrency transactions are blockchain transactions done through a decentralized network of nodes, it is not possible to oversee the entire network and as such cryptocurrency transactions are generally untraceable and anonymous. This makes cryptocurrency transactions susceptible to use by criminals in illegal transactions such as money laundering and financing of terrorism.
It is therefore possible for cryptocurrency transactions to pose a risk to the country’s internal security and undermine the process of holding accountable the persons involved in these criminal activities.
c. Cryptocurrencies are usually traded on unregulated platforms
As we pointed out earlier, the CBK has as its primary object the formulation and implementation of monetary policy directed to achieving and maintaining stability in the economy. Therefore, the CBK is mandated under the CBK Act as well as the National Payment Systems Act to license all persons responsible for monetary transactions to achieve its overall mandate of acting as the body responsible for formulating monetary policy that maintains the price stability of the issuing currency. To this end, the CBK licenses all banks, forex bureaux, mortgage finance companies, money remittance providers, microfinance banks and payment service providers.
The CBK is not alone in this endeavour. Its role is supported by other regulators such as the Capital Markets Authority (the CMA), the Insurance Regulatory Authority (the IRA) and the Retirement Benefits Authority (the RBA) who license many of the participants in the securities markets and dictate their role. In particular, the CMA licenses the platform where investments are traded, and it would not be possible for a cryptocurrency exchange to be set up without their approval.
The oversight by the regulators is not done solely for purposes of macroeconomic management. This oversight is extremely important to ensure the sanctity of financial transactions by the public is not violated thereby giving confidence to the investing public. It is indeed a key cog in ensuring that the financial sector remains vibrant, and the public is not defrauded or exploited through monetary transaction schemes.
However, as the regulation of cryptocurrencies is not within its ambit, the CBK does not issue licenses for cryptocurrency trading. Further, the CMA has not classified cryptocurrencies as investment assets and therefore participants in the investment markets are yet to fully embrace cryptocurrencies as a necessary part of their investment portfolio. As such, though it is not illegal to hold cryptocurrency as an investment asset, many of the platforms which process cryptocurrency transactions on behalf of the public can easily find themselves operating illegally if it is deemed by the CBK that their exchange of regular currency for cryptocurrency is an unlicensed foreign exchange transaction. This leaves the investing public with no recourse if an issue arises regarding a cryptocurrency transaction.
It is with the above in mind that the CBK, in its Banking Circular No. 14 of 2015 dated 18 December 2015 addressed to all Chief Executives of commercial banks, mortgage finance companies and microfinance banks, cautioned all financial institutions against dealing in cryptocurrencies or transacting with entities that deal in cryptocurrencies. Additionally, financial institutions were cautioned against opening accounts for any person dealing in cryptocurrencies.
d. Cryptocurrencies are not backed by any underlying assets and their value is purely speculative
Centralized financial institutions play a major role in regulating the economy; if the economy seems to be growing too quickly and causing prices for goods and services to become unaffordable, a central bank can increase interest rates to make it more expensive for borrowers to access money.
Conversely, if an economy is not growing quickly enough, central banks can reduce interest rates or create money to lower the cost of living and therefore make it easier for consumers to borrow money.
The ability of central banks to play this role is underpinned by the fact that licensed currencies are backed by assets such as foreign exchange holdings or gold which contribute to the value of the currency. This is not the case with cryptocurrencies.
Cryptocurrency trading is decentralized and the currencies themselves are not backed by any assets. Their value is dictated purely by the market forces of supply and demand. Due to this, cryptocurrencies experience high volatility in their values and investors in the same have repeatedly suffered losses due to the wild swings in the values of the cryptocurrencies.
The volatile, rogue and even loutish nature of cryptocurrency trading is the main pitfall of this venture. The absence of regulation as well as its attendant remedies makes the plunge into cryptocurrency trading even more daunting. Ironically, it is the discreet and unregulated nature of this market that has caused it to thrive. Considering the above, it is understandable that some countries like China, the former leading hub of this market, have banned the trade altogether.
From a Kenyan standpoint, trading in cryptocurrency is an unregulated venture which is currently not addressed in Kenyan statutes. The regulatory uncertainty increases risk tremendously given that while there is no express ban in holding cryptocurrency as an asset for investment purposes, it can be deemed illegal to use the same as a medium of exchange and one can easily find themselves on the wrong side of the law. Cryptocurrency trading should therefore be undertaken with extreme caution.
Be that as it may, central banks have begun realizing the potential of a well-regulated cryptocurrency market and some have started to create their own cryptocurrencies to facilitate this. China is known to be developing a digital currency, while Venezuela has issued one supported by its oil reserves. Acceptance and regulation of cryptocurrencies is taking hold globally, and this may well lead to a reduction in the volatility of the cryptocurrencies.
With these developments, Kenya cannot afford to be left behind. While the CBK has reasons to be concerned regarding the use of cryptocurrencies as monetary instruments, it cannot discount their value as investments. As such, if the CBK can collaborate with the CMA to recognise cryptocurrencies as investment assets and to establish guidelines on the holding and trading of the same, cryptocurrencies can end up creating wealth for the public without posing a risk to monetary stability. This has been done in Japan, and the approach is gaining popularity worldwide.