Crypto currencies as an investment vehicle
Cryptocurrencies – the bubble that everyone invested in and no one knows what it is! Yes, it’s that thing that everyone invested in and lost all their money!
Crypto is what this article is about and if you have no clue what this is this article is for you. If you do not want to invest in crypto – this article is also for you! In this article, I will explore a bit about how it works (on a high level) and how you can invest in it – if you want to!
What is crypto and blockchain?
Blockchain and wallets
Crypto and blockchain technologies are revolutionary, as it has solved a fundamental problem in digital currencies. Think of it like this: You have an image of a R 200 note on your phone that is seen as currency. How do you know someone did not copy and paste a new copy of your R 200 note? Crypto solves this by blockchain technology. This is achieved by something like this:
Do you know about pi (π)? Well, blockchain works like pi – it’s an almost endless amount of characters (except this is encrypted and hashed and other big words which you shouldn’t care about):
3.14159265358979323846264338327950288419716939937510… … … .. and so on.
If you own crypto, you own a piece of this – somewhere in this long list of ‘blockchain’. In this example, I own this piece: 832795. This is kept safe in my ‘wallet’ which is a fancy term for something like a postbox with a unique number like ‘sd65fs5d6s4df546sfb64y’.
Mining, transacting and wallets
If you want to spend the cryptocurrency, you transfer money from your wallet to someone else’s wallet. This is done via miners. The miners will try and see if you are somewhere in the presumingly endless list – if you are, the transaction will go through.
Miners get paid the transaction fee which you, the sender pays.
Some of the biggest cryptocurrencies are Bitcoin, Etherium, Bitcoin Cash, Monero and Dash.
Exchanges is like the stock market – you are able to buy, sell and trade. You are able to keep your crypto in an exchange for the long run or keep them in a wallet.
Types of cryptocurrency investment strategies
As with the stock market, you can follow a passive and active investment strategy. There are also other opportunities that you could leverage to make this an interesting investment:
- Passive, or “buy and hold” – Once you have your cryptocurrencies, you hold on to them and don’t sell them. This is often referred to as ‘HODL’.
- Active trading – If you know what you’re doing, you could actively buy and sell crypto – exchanging one for the other. Note that there are fees involved in this.
- Crypto ETFs – You can invest in an index fund that tracks the top cryptocurrencies. This can help with diversification.
- Mining – though most of the time not profitable anymore, many people buy hardware and mine crypto. This strategy needs careful calculation of costs of electricity, internet and hardware and returns.
The pros and cons
As with all asset classes, cryptocurrencies have some interesting pros and cons.
- Liquidity! If you’ve ever wanted to get rid of your asset to get money, this is the thing! You might not get what you paid for it, but it’s liquid!
- You can start with as little as R 10. Many exchanges and companies make the entry-level low
- You can use this as payment with some companies in South Africa and internationally.
- Crypto can be anonymous if you use the right wallets – If you are concerned about the government knowing what you are spending money on 😉
- Crypto is exceptionally volatile. This means that you could lose half your money the one day and double it the next.
- Due to crypto not being well regulated, it causes much of grey areas for tax, legality and use as a payment method.
- Crypto is software-based – meaning it can be hacked by experienced hackers
- If you lose the key to your wallet, the coins are gone. Forever.
Memes as explanation of volatility
Quick tax overview
For this section, I would like to give a special thank you to Andre Bothma (Twitter here) for his help and contribution.
What is your intent with buying crypto?
You can have one of two reasons for buying crypto: buy to invest or buy to trade. These are taxed differently.
As you will see below, it’s more tax-efficient to not day trade.
Intention to buy and hold (Capital)
If your intention is to buy and hold, If this spans over years, that can be classified as capital intention – and you will be eligible fo pay capital gains tax only.
The first R 40 000 is free from CGT.
From your capital gain (your profits), you get taxed on 40% of that money on your normal day-to-day tax rate.
If you bought R 100 000 worth of bitcoin in 2013 and sold it for R 500 000 in 2019, and you are in the 25% tax bracket, the calculation will look like this:
R 500 000 – R 100 000
= R 400 000 Capital gain
R 400 000 – R 40 000 (minus annual exclusion)
= R 360 000
R 360 000 x (40/100) (only 40% is taxable)
= R 144 000
R 360 000 x (25/100) (25% tax bracket)
= R 36 000 to pay to SARS
Intention to trade / buy and sell often (Revenue)
If your intention is to buy and sell often to make a profit, you will be taxed on your normal income tax rate.
If you are earning more money than you could hope or dream for, you will be in the 45 % tax bracket.
You bought R 450 000 in 2019. You sold it for R 500 000 in 2019. You are in the 25 % tax bracket.
R 500 000 – R 450 000
= R 50 000 (Profit)
R 50 000 x (25/100)
= R 12 500 to pay to SARS
Ways to invest
Crypto is everywhere – and you don’t have to look very far to invest. Make sure you know what you are getting yourself into!
South Africa has a few exchanges that you can buy the basic cryptocurrencies from. I suggest using a reputable one like Luno which has an international footprint.
These exchanges allow you to exchange Rands to Bitcoin, Etherium and Bitcoin Cash. You could keep the money with them or move it across to another exchange to buy other cryptocurrencies like Ripple, Etherium Classic or DogeCoin.
Other international exchanges include Poloniex and Binance.
You can actively trade on these platforms.
EasyEquities does offer a cryptocurrency ETF. They do a great job in setting out the fees so that you know exactly what you will be paying. Clarity is one of the most important things when it comes to fees.
The bottom line
Crypto is awesome if you know what you’re doing.
It’s also great if you want a place to waste your fun money.
It’s even greater when you can retire a week after you invested, only to lose your life savings the week after.