Will it be tears or tosses for bitcoin investors?

Ann Wambui lives in a two-story townhouse in Matumbato Estate, Upperhill, Nairobi. It is one of the few residential places in the area that are yet to be drowned by the strong tide of commercial development that has seen bungalows give way to skyscrapers.

Maybe, Ms Wambui and the other tenants have offered the landowner a better deal in monthly rents. After all, Wambui deals in bitcoins, the newest investment craze that is making people millionaires overnight.

Ms Wambui says she is retired and lives off bitcoins and other cryptocurrencies. Bitcoin is loathed or loved for being a digital currency that is unregulated, not backed by any asset but whose price is determined, technically, by the forces of demand and supply.

Wambui is madly in love with Bitcoin, so much that she has used the logo of the cryptocurrency as her Whatsapp profile. She also seems to appreciate the latest technological developments such as the Internet-of-things, perhaps as a means to better understand the complexity of this new technology that some people have declared the best thing since the invention of the Internet.

She has wirelessly interfaced her laptop to her 42 inches smart TV on which she navigates the Internet using a wireless remote mouse voice keyboard from the comfort of her seat, her three-month baby in her arms. On a table on the right of her seat is a speaker which amplifies any of the baby’s activity in the bedroom. Wambui is more of a collector of cryptocurrencies.

Ponzi Scheme

Her latest obsession is DASH, a cryptocurrency she says is backed by technology giant Apple but which has not yet reached the market.

She is also waiting patiently for the unveiling of another one that is reportedly backed by yet another Silicon Vally giant Microsoft. In fact, while most people have stuck with bitcoin, she has moved on to Ethereum, bitcoin’s arch-rival. 

Today, she has acquired yet another accessory to shore up her business – a ledger wallet. This is a storage device, like an external hard disk, on which she can save all her cryptocurrencies offline.

The ledger, which she has encrypted, will keep her cryptocurrencies away from the reach of marauding hackers who prowl the World Wide Web in search of loosely secured digital wallets. It cost her Sh13,000.

This is critical for Wambui. Ever since she discovered the lucrativeness of this trade three years ago, she has converted most of her money into bitcoins and other cryptocurrencies.

The cryptocurrencies are then stored in digital wallets, provided by different websites, including Blockchain.com. “Now, even if you got this,” she says, showing me the device, “There is nothing you would do with it.”

However, if she misplaced it, she would lose all her wealth, I remind her. “That is why you need to lock it up in a safe in your home or in a safety deposit box in a bank,” says Wambui.

And yet, if the fatalistic talk doing rounds is anything to go by, no security measure will protect Wambui from an inevitable financial Armageddon that could soon visit the Bitcoin market.

The blistering rate at which the value of Bitcoin has been rising has given skeptics reason to believe that the value of the currency is being driven by speculation rather than fundamentals and that it is only a matter of time before the Bitcoin market tumbles like a house of cards, leaving behind millions of wrecked families.

In 2009 when the cryptocurrency started trading, it was a worthless digital currency that exchanged at $0.0007.

On May 22, 2010, one Bitcoin enthusiast named Laszlo, offered a bounty of 10,000 BTC (an abbreviation for bitcoin) for two pizzas. A pizza then was going for $41 (about Sh3,500). 

Today, the value of Bitcoin has surged over a billion times to trade at $9,571.14 (sh1 million). What was only enough to buy two pizzas from a Dominos store, can today afford Kenya another Outering Road which cost the taxpayer over Sh8 billion.

Dr Irungu Macharia, an investment banker, did a paper on cryptocurrencies. After a careful study of this business, he is convinced that the Bitcoin “model” which operates like a “club” has all the markings of a Ponzi scheme and as such will certainly crash.

This is because the owners (miners) create “hype on the value and demand of the currency,” riding on the theory of demand and supply. “Few bitcoins are issued, a hype on demand side is created by the ledger owners (miners) pushing the prices up,” says Macharia. 

“This is how Bitcoin will end up like a Ponzi scheme that benefits some while crushing others, leading to humongous losses to the uninformed and unprotected Kenyans,” adds Macharia.

Dr Macharia’s sentiments are shared by the Central Bank of Kenya (CBK) Governor Dr Patrick Njoroge who recently took his attacks against cryptocurrencies a notch higher by labeling Bitcoin as a Ponzi scheme.

Dr Njoroge joins a small but powerful club of Bitcoin-bashers who include JP Morgan CEO Jamie Dimon who said bitcoin is a ‘fraud,’ predicting its eventual implosion.  Earlier in 2015, CBK had warned the public against trading in bitcoins and other cryptocurrencies which are unregulated and susceptible to being used by criminals due to their anonymity.

The regulator also noted that bitcoin’s high volatility exposed investors to potential loss. To most Bitcoin enthusiasts, and most likely its inventor, a man who went by the pseudonym Satoshi Nakomoto, revulsion against Bitcoin technology by financial sector players was expected.

Dr Bitange Ndemo, the former Information and Communication Technology Permanent Secretary and now an unapologetic believer in cryptocurrency, says those who stand to lose are the ones afraid of Bitcoin technology.

Financial transactions

Bitcoin is a trustless system in which individuals do not have to entrust their financial transactions to intermediaries (banks) under the supervision of a central authority (Central banks).

“Bitcoin — or more precisely, the underlying technology that allows it to function, called distributed ledgers, or blockchain — could allow what many see as radical rewiring of the financial sector,” said the international monetary fund (IMF) in its June 2016 of its magazine Finance and Development.

Bitcoin, said IMF, “is a technology for verifying and recording transactions on a peer-to-peer basis without a central authority.”

“It upends a very basic tenet of payment systems: having one central, independent, and trusted bookkeeper that stores and validates all transactions — a role often played by central banks,” said IMF in the article, The Internet of Trust.

Unlike in a centralised ledger where the Central Bank can turn on the printing machine, the number of Bitcoins in circulation has already been capped at 21 million by 2140.

The topic of Bitcoin, says Franco Pedro, goes beyond the purview of Central Banks, which are normally staffed with economists and financial experts. Bitcoin, he says, is a complex topic that traverses the fields of economics, cryptography and software engineering.

Ponzi Scheme

Franco is a consultant with management firm McKinsey and Boston Consulting Group. He holds a Master of Science in Electrical Engineering, a Bachelor of Science in Economics and an MBA.

And, in his 2015 book, Understanding Bitcoin: Cryptography, Engineering and Economics, Franco disagrees that Bitcoin technology, is a Ponzi scheme. He says that as a currency, it can be a bubble which can bust.

“In a Ponzi scheme, there is a central operator who pays returns to current investors from new capital inflows,” he says, adding there is a central operator who can profit from the relocation of funds in Bitcoin technology.

Moreover, there is no mechanism to deflect funds from new investments to pay returns. “The only funds recognised in the Bitcoin protocol are bitcoins, the currency,” says Franco, noting that transfers of bitcoins are initiated by the users at their will, not the protocol.

“Third, a new investment in Bitcoin is always matched with a disinvestment.” “There is simply no new investment flowing into bitcoins: the amount of sovereign currency that has flown into bitcoins exactly matches the amount that has flown out of bitcoins,” he adds.

Bitcoin can be a bubble that can bust when used as a medium of exchange or store of wealth. Nonetheless, Johnson Nderi, a corporate finance manager at ABC Capital, does not believe Bitcoin is going to bust because the rally is “legitimately” being driven by adoption of the digital currency.

“There will be corrections, but that is allowed,” Nderi told Financial Standard. 

Nderi contends that because there will be a maximum of 21 million bitcoins in circulation by 2140 against the current global population of seven billion people, it is almost impossible for the demand of this cryptocurrency to be depressed.

A few online and offline stores accept bitcoins for payment, revving up demand for the currency. Audit firm PWC is the latest to announce that it would accept bitcoins as payment for its advisory services.    You can buy any Microsoft software online using Bitcoin, buy your air ticket on the largest online travel agency Expedia.com using the crypto currency.

You can also pay for a Pizza from Helen’s Pizza in downtown New Jersey using bitcoins. In Buenos Aires, you could grab a humbugger from a Subway franchise using the digital currency.

Moreover, through eGifter, shoppers are buying stuff from such brick-and-mortar stores as Home Depot, CVS, Kmart and Sears using the controversial peer-to-peer digital system, the Forbes magazine reported.

South Africa’s online retailer Pick n Pay is also accepting Bitcoin.

As a payment system, bitcoin is cheaper, faster than forms of payment. Bitcoin can find a thriving market in remittances, according to the IMF, by sending senders billions of shillings in transaction and exchange fees.  The time spent on clearing would also be reduced. The Bitcoin market has also received a dose of confidence from the latest attempts to address its biggest flaw- volatility.

The price of bitcoins soared after the Commodity Futures Trading Commission, the main US markets regulator, gave JP Morgan’s CBOE Global Markets the green light to list bitcoin futures.

The derivative market would go a long way in hedging the bitcoin price, and shield miners and bitcoin owners from potential loss.

But Bitcoin’s biggest problem is hoarding, one which, Ndemo says regulators have to figure out a way to address it. While the mining of bitcoin is programmed to occur after every 10 minutes, Bitcoin miners can indeed hoard the currency to hype demand.

Perhaps the biggest fear, especially in Kenya, is that the Bitcoin craze has spawned the dreaded pyramid schemes.

Wambui is a member of BitClub Network, a global network of people who pool money together to buy machines for mining. Mining is the process by which transactions are verified and added to the public ledger, known as the block chain, to generate bitcoins.

Mining of bitcoin is a multi-billion dollar investment which, according to Wambui, cannot be easily undertaken by a single investor, thus the need for ‘crowdfunding.’   Mining consumes a lot of electricity, thus its prohibitive cost. Besides the need for a place where the cost of electricity is low, mining is also better done in cold climates such as in Iceland and Russia.  

Wambui projects on the TV screen a short video showing stacks of servers. “This is our mining plant in Iceland,” she says. She has a number of machines under her name that she has bequeathed one to her three-month daughter.

She will not tell me how many, fearing that I might calculate her net worth once I get the number of bitcoins they mine in a day.  One machine costs about $500 (Sh51,500), plus a lifetime membership fee of $99 (10,197).

These fees have to be paid in bitcoins. She gets a commission from the fees paid by a new member that she recruits and subsequently earns from the bitcoins generated by her recruit’s machines. People, she says, have seen BitClub Network’s aggressive recruitment and concluded that it is a Ponzi scheme.  “But in a Ponzi scheme, there is nothing that is being done.

But with this, whether I recruit or not, my machine continues mining and I continue earning,” she says noting that there are people who, rather than going through the hassle of recruiting, have just bought their own machines.

There is a fine line between multilevel marketing, like the one being used by BitClub, and a pyramid scheme.  Nderi, in a previous interview with this writer, multilevel marketing relies on the use of networks to push products.

“Instead of paying media to market you, you rely on word of mouth and the seller/advertiser is rewarded for that effort instead of an advertiser,” explained Nderi, noting that a pyramid scheme was a “money shuffling exercise.”

Is it possible that aggressive recruitment of members, who are required to pay for their membership and machines in bitcoins, is meant to increase the demand for the cryptocurrency and thus drive up its price?

There are so many clubs as BitClub Network, all requiring their members to pay their fees in bitcoins.

The other thing that has pushed up the price of bitcoins is what has come to be known as initial coin offerings (ICO), in which start-ups raise money, normally in bitcoins, to start their own cryptocurrency- from Bitcoin, which is an open source code.

And that is why a number of countries, led by China, have been cracking down on these ICOs, warning that their rise has offered little value to investors.

Instead, most investors in these ICOs have been left with worthless cryptocurrencies. Dr Njoroge, while against bitcoins, agreed that the technology behind it, Blockchain, can be put to some good use.

In, there is a growing consensus that blockchain’s first landing should be at the Ministry of Lands where keeping the registry of title deeds has been messy.

Dr Ndemo says they have agreed to put up a public register of everybody who has owned land through the years. Every transaction is transparent and securitised. And because blockchain abhors double-spending, it is not possible for one title deed to be owned by more than one person. 

Poll-rigging claims

Blockchain might also be the antithesis to the frequent poll-rigging claims which in 2007 almost drove this country down the cliff.

According to PWC, using a blockchain code, constituents could cast votes via smartphone, tablet or computer resulting in immediately verifiable results.

Unfortunately, blockchain is for the future, Kenyans are presently on bitcoins. To some observers, things will get worse before they can get better. “The bust will most probably lead to better focus by regulators on fundamental pillars supporting the cryptocurrency given its unstoppable global wave,” says Dr Macharia.

Yet some regulators, tired of giving warnings, have decided to stop taking chances.  Even before a bust happens, Japan has put in place regulations to forestall exactly what Bitcoin-bashers such as Dr Njoroge hate it for the possibility of it being used for money laundering, drug trafficking, tax evasion and other illegal activities.

The Asian economy has already put in place regulation for digital currency exchanges. Australia has announced that it will follow suit.

The US has agreed that a derivative market is put up to hedge miners against fluctuation of the digital currency.  Its Department of Financial Services has already come up with BitLicense, a set of regulations for digital currency companies.

US’ taxman, Internal Revenue Service (IRS), also released regulatory guidelines over bitcoin and taxes.The U.K Treasury also came out with a report about the need to regulate bitcoin, with the objective of applying anti-money laundering rules to bitcoin exchanges.

In Kenya, media reports indicated that the Capital Markets Authority was exploring ways to regulate cryptocurrency trading. Some of the bitcoin exchanges in the country include Belfrics and Remitano.

But they have gone silent since then. Perhaps Bitcoin will follow the Internet’s trajectory, where the Dot.com bust went down with all the speculators, leaving behind only the real traders.

Perhaps, as Ndemo puts, only the brave ones as Wambui, will survive.