Introduction to Cryptocurrency and NFTs: Are they suitable for retail investors?

Date: April 14, 2023

The dean of the London School of Economics and Political Science Andres Velasco in a Nov 2022 article titled “The unbearable uselessness of crypto’’ said that “thanks to (the collapse of crypto exchange) FTX, the world may have woken up to the grim reality that crypto is a get-rich-quick lie, wrapped in hype, bobbing on an ocean of libertarian technobabble’’.

He was writing about FTX’s crash which sent shockwaves throughout financial markets and sent the price of the leading cryptocurrency Bitcoin plunging from an all-time high of US$69,000 to below US$20,000 towards the end of 2022.

Since then however, Bitcoin’s price has rebounded and now trades around US$37,000. So what is driving this rebound? Or for that matter, why invest in cryptos?

What are cryptocurrencies?

The “technobabble’’ Mr Velasco was referring to is blockchain, the technology that underpins the creation of cryptocurrencies or cryptos for short. When trying to explain what digital assets, blockchains and cryptos are, we can do no better than use the explanations given by the Monetary Authority of Singapore (MAS):

“A digital asset is anything of value whose ownership is represented in a digital or computerised form. This is done through a process called tokenisation – which involves using a software programme to convert ownership rights over an asset into a digital token’’.

“Many items can potentially be tokenised: financial assets like cash and bonds, real assets like artwork and property, even intangible items like carbon credits and computing resources’’.

“In other words, anything that has value, when tokenised, becomes a digital asset.  Digital assets are typically deployed on distributed ledgers that record the ownership and transfer of ownership of these assets’’.

“A blockchain is a type of distributed ledger that organises transaction records into blocks of data which are cryptographically linked together. When deployed on distributed ledgers, digital assets are referred to as crypto assets’’.

“A cryptocurrency is the digital asset issued directly by the distributed ledger protocol’’.

From the above, we see that cryptos can be taken as the distributed ledger’s native currency and are used as a medium of exchange and store of value within the network, for example to pay transaction fees or incentivise users to keep the network secure.

Have cryptos gained widespread acceptance?

Stated differently, if everyone were to accept that cryptos can be used as a means of payment via the distributed ledger, then transactions can bypass the traditional banking system and could be settled much faster.

For instance, MAS has highlighted that wholesale settlement networks using distributed ledger technologies such as Partior – a joint venture among DBS, JP Morgan and Temasek – are achieving reductions in settlement time from days to mere minutes.

At this point though, it’s worth noting that the Nobel-prize winning economist Paul Krugman has many times pointed out that the leading cryptocurrency Bitcoin has been around since 2009, which makes it “ancient by tech standards’’ yet it has yet to gain widespread acceptance as a medium of exchange.

“If crypto was going to replace conventional money as a medium of exchange – a means of payment – surely, we should have seen some signs of that happening now. Just try paying for your groceries or other everyday goods using Bitcoin. It is nearly impossible’’ wrote Prof Krugman.

He also pointed out that the first country to make Bitcoin legal tender is El Salvador but all indications are that the experiment there has been an abject failure.

What are Non-Fungible Tokens (NFTs)?

Another form of a digital asset is a Non-Fungible Token or NFT, which is a cryptocurrency chit that proves a buyer owns an intangible marker connected to a unique piece of digital art, music or other item.

Unlike other types of tokens, such as Bitcoin or Ether which are interchangeable and can be traded for other cryptocurrencies, NFTs are unique and cannot be replicated or exchanged for other tokens.

This makes them ideal for representing ownership of digital assets, such as art, collectibles, or even virtual real estate.

One of the key benefits of NFTs is that they provide a way to verify the ownership and authenticity of digital assets. Because they are built on top of a blockchain, NFTs are immutable and can be easily tracked and traced. This makes it much easier to prove ownership and prevent fraud, which is a major concern in the world of digital art and collectibles.

Are cryptos and NFTs suitable for retail investors?

The fourth edition of the OCBC Financial Wellness Index reported in Nov 2022 that two in five Gen Z and young millennial Singapore investors in their 20s still plan to invest in cryptocurrencies within the next 12 months despite the crash the crashes suffered by cryptos last year. On average, Gen Z and young millennial crypto investors who made losses lost 40% from their crypto investments.

You have to wonder – why the eagerness to put money in cryptos despite all the warnings signs and even after the Monetary Authority of Singapore (MAS) has said trading in these assets is highly risky and not suitable for the general public, and after the Government has advised retail investors to “steer clear of cryptocurrencies’’?

As for NFTs, MAS has said investing in these tokens is not suitable for retail investors as their perceived uniqueness combined with speculative demand has led to inflated prices.

“This potentially puts investors at risk of outsized losses should speculative fervour abate. Further, there are significant legal complexities and risks involved in NFTs. For example, a holder of an NFT with an underlying asset of a digital image should clarify his right of ownership and the legal framework that governs his rights’’ said MAS.

However, MAS did say that although it does not regulate NFTs, should an NFT have the characteristics of a capital markets product under the Securities and Futures Act (SFA), it will be subject to MAS’ regulatory requirements.

“For example, should an NFT be structured to represent rights to a portfolio of listed shares, it will like other collective investment schemes be subject to prospectus requirements, licensing and business conduct requirements’’ said MAS.

So why are people still keen on cryptos and NFTs?

From all of the above, it can be concluded that the price of digital assets depends almost entirely on demand and supply, and how much the next person is willing to pay. There is no fundamental basis for valuation so prices can be wholly driven by speculative fever and momentum.

To be clear, traditional currencies like the US dollar also lack intrinsic value, but they are backed by the full faith and credit of the institutions that issue them, like the US government. Cryptos on the other hand, are backed by a decentralized network of computers and secured by blockchain technology.

As a result, prices can undergo very large swings – as noted earlier, Bitcoin reached a high just under US$70,000. It is the hope of making a lot of money in a short space of time that is driving crypto prices at the moment, together with FOMO, which stands for fear of missing out.

Of course, prices can also crash very quickly, which is why the authorities have repeatedly cautioned retail investors not to dabble in cryptos.

In short, crypto is an emerging technology and investment that isn’t for everyone — not yet at least. For now, crypto is a pure momentum and speculative play — and not one for the faint of heart.