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Crypto Assets: How to invest wisely

11 June 2021 Tino Mombo, Actuarial Analyst at Novare Actuaries and Consultants

As at the first quarter of 2021, the global market capitalisation of crypto assets was in excess of $1.3T, which naturally attracted the attention of a league of investors with different risk appetites, with some seasoned investors leveraging the opportunity for promising long-term investments and some newcomers seeking to make quick profits on price movements.

As a result, this market has exhibited high volatility, with some investors experiencing major financial losses over short periods. We look into this reasonably new market, with the aim to achieve a greater understanding of it, and gain insights into some basic investment principles that should be considered when investing on the crypto market.

What are crypto assets exactly?

Before diving into how to invest on the crypto market, it makes sense to first understand the fundamentals. For simplicity, crypto assets are shares or equity in virtual projects, which are typically traded on a crypto exchange.

When you buy shares in a virtual project, you are issued with tokens, the value of which is equal to the size of your investment. Some of these tokens can be used both as securities, e.g. shares in the project, and as a currency (crypto-currency) to exchange goods or services with. The monetary worth of these tokens in turn, are determined by the usefulness, adoption, and viability of the virtual projects in question. One example of such a virtual project is the HealthNexus protocol, which issues the HLTH token. The project provides the canvas on which many health applications can be built to assist in patient care - from initial contact to finish.

A key difference between crypto currencies and fiat money (traditional money), is that any transaction in fiat money has to be validated by a “trusted” third party such as a bank. Crypto currencies however, are powered by blockchain technology (a distributed digital ledger of transactional records), which works to eliminate the need for a third-party validator.

Crypto assets versus fiat money

Because crypto assets are becoming increasingly popular as mediums of exchange, it automatically raises the question of how they compare to fiat money:

i. Universal usage
Crypto currencies can be used to transact anywhere in the world, without restriction. Entities who trade in crypto, simply need to find sellers of goods and services who are willing to accept their chosen crypto currencies as a means of payment on a long-term basis.

ii. Security
Crypto currency transactions are recorded in a decentralised and transparent ledger (AKA blockchain). By design, a blockchain ledger is immutable and hacking it has proven to be more costly than the potential gains from it. It is furthermore in the best interest of those who validate transactions (miners or validators), to ensure the network is ultra-secure. The greatest point of risk for users typically lies in where and how they store their digital assets i.e. crypto wallets.

iii. Protection against inflation
The value of any currency is predominantly dependent on its supply and demand dynamics. It can be argued that the value of fiat money is mostly subject to government’s responsible application of monetary and fiscal policies. The lack of which could of course lead to an imbalance between money supply and economic growth, and pose risks such as excessive inflation or deflation. Some innovative projects have launched crypto currencies whose supply dynamics can expand and contract much like fiat money but are able to do so in a transparent and non-dilutive manner. In practise, this means (if widely adopted) they should be a better “store of value” than fiat money.

iv. Freedom and privacy of money
Should crypto currency become the currency of the future, it will in all likelihood lead to greater freedom and privacy in transacting and trading than that of the current monetary system. However, because crypto currencies and their flows cannot yet effectively be controlled and monitored by authorities, they are still open to abuse such as money laundering and terror financing.

Factors to consider when investing

• Beware of opportunistic projects

The allure of some quick profits that have been observed on this market, has paved the way for opportunistic developers who have been raising money and issuing tokens without actually executing any bona fide projects. It is critical to gain as much objective information as possible, before investing. This is where that old adage applies: ‘When it sounds too good to be true, it probably is.’

• Utilise valid crypto exchanges

On traditional stock exchanges, listed companies have to comply with specific requirements, all of which serve to minimise risks for investors. As crypto exchanges are being developed with similar objectives in mind, investors are now in a better position to differentiate between legitimate and illegitimate projects. It is therefore best to trade on these exchanges instead. That being said, never lose sight of the fact that no project is ever bulletproof.

• Formulate an extensive view

Investors should ideally formulate an extensive view of a variety of projects (for diversity), and decide which are best to invest in, based on their value and potential. Whilst this approach has proven to unlock optimal value in more mature markets, applying the same principles on the new crypto market, will at least reduce the risk of permanent capital loss.

• Do not invest it, if you are not prepared to lose it

Considering the crypto market is still marked with uncertainty and speculation, it is best to not invest what you cannot afford to lose. Finally, it is critical to note that past performance is not necessarily indicative of future returns, even with crypto assets.

For more comprehensive information on all things crypto, go to: https://www.novare.com/docs/gen/Novare-NIS-Crypto-Assets.pdf

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