A recent conversation about an acquaintance's case against cryptocurrency gave me cause to write up this not-so-brief blurb. Given that there's been a recent down-trend in the dollar-valuation of most cryptocurrency - especially Bitcoin - there are those who argue that cryptos are, or were, a "bubble", that they're not real, that it's all a bunch of garbage, that it's not an investment, and so on.
Let's ruminate!
Note: this is a very low-level primer/discussion. Any mistakes in how stuff works in reality are entirely my own. Not all blockchains operate identically, but for sake of brevity I have omitted these obtuse details. If you want to learn about blockchains in greater detail, seek out their documentation.
What Cryptos Are Not
Cryptocurrencies - or cryptos, as everyone is calling them these days - are not intended to be an investment. If you would invest in the currencies market, or the futures market, then yes perhaps you could consider cryptos yet another investment opportunity. After all, an investment is anything anyone believes will be more valuable in the future than it is today.
Cryptos are also not tangible items. You can't hold them in your hand like a gold coin, no matter how awesome the pictures on everyone's news articles look (and the coins they draw do look really great!). Some consider cryptos as being non-fungible, in that with most currencies you can track the motion of coins from wallet to wallet. Rarely currencies, such as Monero (which I have only recently been playing around with), are build with total anonymity from the start, such that you can trade them as you would any paper or metal money and no one outside of the transaction would be the wiser for it. I don't think "non-fungible" is quite the right term to apply, when the lack of privacy in Bitcoin is considered, but we won't split hairs here.
Cryptos are not, in fact, independent of the algorithms that represent them. The blockchain is the underlying mechanism for the storage and transference of value, the coin in question being simply a unit or a value component within the blockchain.
So What is the Blockchain, and Why Do I Care?
When you write a check - assuming you're old enough to be familiar with such a task - you typically record the amount you spent in the check register. Likewise, in the accounting field, every income and expenditure is entered into some bookkeeping system. The bank keeps a record of every transaction it processes, as do your credit cards. Every statement is a list of transactions, all recorded and curated for your informational benefit (and many other reasons, legal and otherwise, as well).
A blockchain is a record of transaction that is designed to be immutable, and indisputable. It is immutable because each record you add to the blockchain is cryptographically tied to the previous record. The only record not tied to anything is the "genesis block" - the first record. If you change any previous record in the chain, every record that follows would be affected.
Without going into gross detail, but we'll talk about it because it's cool, this all works because of a special cryptographic function called a "hash". The hash is a simple tool: it's a little algorithm, and you put some data into it, and you get a big number out of it. You can put as much or as little data as you want through it, and it will always output a number. This number is the hash.
The thing that makes hashes special is that when you change the input by even the smallest possible amount, the output changes dramatically. Now, each record we add to the chain takes the hash of the previous record, and adds it together with the contents of the new record and then hashes the whole thing together. After all, it's all just data. We take the hash output and store it with the record. The next record will use this hash as part of its input. In this way, we can start at the genesis block and generate hashes for it and every block that follows - in order - until we get to the end, and validate the whole chain. If someone mucks with the middle, the hashes will change from there down, and we can detect the change.
So Just Rewrite All the Rest of the Hashes!
This is where Bitcoin made its mark. When you make a hash, it looks like a giant random number. But the number is always the same length when the algorithm outputs it. Remember, computers store numbers in bytes, a byte is eight bits, and we put multiple bytes together to make really big numbers. The SHA-256 hash algorithm outputs 256 bits for it's hash when it's done hashing your input. That's 32 bytes. Even if the first 3 bytes (or 24 bits) are all zeros, it's still considered a 256-bit number.
And that's where things get interesting: if hashes are so random, is it possible to find a hash that starts with the first 10 bits as zero? This is how proof-of-work basically functions.
To make it work, in addition to the record data, and the hash from the previous record, we have to add a special value into the mix. We get to choose this special value. When we hash this special value with the record and previous hash, we want the resulting hash to have the first 10 bits as zero. Any hash with the first 10 bits as zero will do. This is, in fact, a very hard problem because you can't predict hashes and if you change even one bit, you'll wind up with some completely different hash, so at best you can only guess at this special value for a long time.
Thousands and thousands of miners do this, until one finds a special value - and a hash - that works.
Because this is so compute-intensive, in order to rewrite the blockchain from some prior point AND catch up to the newest blocks (records) being added, you'd have to have more computing power than all the miners currently participating in Bitcoin, combined. If you can't catch up, your EvilChain will never be adopted by the rest of the Bitcoin community. This is known as the 51% attack, because your computing resources would have to account for 51% of the overall participating community.
It's possible someone could do this someday, but there are a few other tricks up Bitcoin's sleeves to ensure that the blockchain integrity remains intact. We're not going to cover those here.
A Brief Note on Keys
Modern cryptography often relies on something called asymmetric keys: a private key, and a public key. If you encrypt something or digitally "sign" something with one of these keys, you can decrypt or "verify the signature" with the other key. In this way, there is no difference really between the private and the public key.
But we need to keep one of them secret, so that anything we sign can only come from us, and anything encrypted to us can only be decrypted by us. So we call one the "private key" and never share it, and the other the "public key" and everyone knows about it.
Cryptocurrency wallets require these keys. Your private key lets you send your funds to other people, because when you add a record to the blockchain, you need to digitally "sign" it with your private key. Your public key lets the blockchain and everyone else verify that it came from you. Your public key might also represent your wallet online, for technological convenience. What this means is that if you have your own wallet, you should have your own private keys. If you use an exchange, however, the exchange runs the wallet and the exchange has the private keys.
ANALOGY: Back when banks used to store your cash (or gold) on-site, a bank robbery would mean your money went bye-bye, along with everyone else's. An exchange is a glorified bank-of-olde. If you kept your gold under your mattress or in a safe in your house, and your house got burgled, then sure you'd probably lose it all the same. But, with a sufficiently mean safe or a sufficiently good hiding place, there's a chance the thief will be thwarted in this regard.
Your wallet private key is this special hiding place, this mean safe. It's up to you to keep it well-secured so that someone can't just walk away with it.
OK, So What ARE Cryptos?
Now that we have a good idea why they work - or mainly why the blockchain works - how do they become considered currency?
Consider a gold coin in your possession. No one else can possess it. It's yours, until you give it away (or it stolen). Each record in the blockchain records your possession of the coin. If you send some of your coin away, this is recorded also. If you receive some, it's recorded. In every instance, the record becomes a fixed (immutable) part of the blockchain. It's the digital analogue of handing a fistful of gold atoms over to someone else: the Universe knows you did it, and you can't suddenly wish those gold atoms back into your hand. We assume magic does not exist.
When people trade gold atoms - I mean, gold coins - they do so usually in exchange for something else. In times long past, you could buy food, supplies, houses, wagons, horses, and so on. You could sell all this stuff in exchange for the gold as well. Anything that becomes a medium of exchange has the potential to become currency.
The special/important thing about currency is that it doesn't disappear on you. Flowers make a poor currency because they wilt. Food makes a poor currency because it generally goes bad (unless it's canned food, in which in the zombie apocalypse you might be very rich if you're well prepared). Water is poor currency because it falls from the sky, and evaporates. In the right situations, any of these might become currencies, but generally we're not anywhere near those situations.
Bitcoin and other cryptos can act as currencies because once you receive your coin, it stays with you. Only you can throw it away. Even if you do, there's a chance you could get it back if you manage to recover your wallet keys. But as far as the blockchain is concerned, the coins that are there will always be there. You can't burn it, you can't bury it. Sure, people have lost their private keys or tossed hard drives into the garage that contained the only access records for thousands of Bitcoins, but the blockchain still remembers them all.
In this way, Bitcoin is unlike gold in that gold can wind up at the bottom of the landfill and no one would know how much is there. Bitcoin, on the other hand, never forgets, so someday we might look for accounts that haven't been accessed in the last lifetime and then we'll know exactly how much Bitcoin was "lost".
Because it's yours, and it doesn't deteriorate, and you can trade with it, and you are guaranteed that the record will be both honest and intact from the moment it's added to the end of, well, Bitcoin, it is pretty darn close to being currency.
So What is Missing?
What's missing is common adoption. That's changing, and with actual point-of-sale appliances now integrating crypto payments, this last hurdle will soon be cleared. The important thing to realize is that the only reason we conduct our business in USD (here in the US) is because everyone here conducts their business in USD. We could conduct our business in CAD, or Euros, or yen, and demand payment from our customers in kind. We'd have a hard time doing business that way, since most people don't have CAD or yen in their wallets - and they prefer to use USD-based credit cards anyway. But that reality aside, there is nothing physically stopping us.
The catch, of course, is that we'd have to report our income in USD for taxes and whatnot. Our government does its business in USD, so we have to eventually exchange to it and ante up. This is not a terrible problem, however, and crypto exchanges make it remarkably easy to deal with.
One argument I've heard against cryptos is volatility. I consider this as a strawman, however, and here's why. If your only goal in life is to accept cryptos as a form of payment, only to turn them into USD then and there, then sure volatility is going to be unwelcome (when the value is low) or awesome (when the value is sky-high). But if you're conducting your business in crypto, and paying your people in crypto, and buying your supplies with crypto, the only volatility you have to worry about is the volatility of your suppliers' prices (and your workers' wage demands).
We've watched the value of the USD go crazy, with inflation rocketing to the moon. Another way to look at it is that the value of USD relative to goods has plummeted. Decades ago you could buy a loaf of bread for, say, 5 cents. Now it's 5 dollars. We say the price of bread went up. Or did the value of the currency go down? Either way you slice it, you need more money for the same item.
The volatility of crypto is measured against USD. However, crypto-against-crypto they are remarkably stable. If you watch the trends of Bitcoin, Etherium, Monero, Solana, and others, you see them all rise and dip generally together. They are rising and dipping with respect to USD, but not necessarily to each other. So, if 1,000 Solana is worth one Bitcoin today, and tomorrow the value of Bitcoin in USD drops by half, what is the cost in Solana of one Bitcoin tomorrow? Very likely still at or near 1,000 Solana.
Therefore, if we consider cryptos as their own currency system, then it makes no sense to judge them based on their value relative to a different fiat currency. They are either a medium of exchange and a store of value on their own accord, or they're not.
ANALOGY: Let's say that some foreign country's government-issued fiat currency - we'll call it the Foo, in the country of Fooland - undergoes wild swings one day in comparison to the USD. If the USD doesn't change with respect to the Euro, yen, or yuan, and the Foo changes wildly with respect to them all, we would consider Foo as being highly volatile. Does this mean it ceases to be a currency? Not to the people who live in the Fooland. They're still doing business in Foo, they have Foo stuffed under the mattress and stored in their local banks. They expect to be paid in Foo. It's a currency in spite of its volatility, to those who wish to continue using it.
I Want to Put My Life-Savings into Crypto!
Would you convert your life-savings to the ruble? How about the peso? Maybe some CAD, or Euro? I know, pounds! God Save the Queen!
If you wouldn't ordinarily do any of these things, you'd be a fool to do it with crypto. While I personally think speculating in currency markets is a fools-errand, no one can stop you. I just don't see the point: you can't guess the future value, no matter what the currency is. You can't be in tune with all the worlds events in real-time to see a crisis coming, nor can anyone process that much data fast enough to even recognize a crisis. If you are doing anything at all, you're playing roulette, and if that's the case you'd be better of running a bunch of statistics and hammering local casinos like one mathematician did.
If you are interested in conducting transactions in crypto, however, then converting some fiat to crypto isn't a bad idea. The worst that can happen is that your local government forbids people from doing this. But ironically, forbid as they may, your access to your crypto should be unfettered - assuming you have a private (also known as "offline") wallet. This is in deference to exchange-hosted or custodial wallets, where someone else has the private keys. In other words, they can forbid all they want, but as long as you have crypto to play with and can connect with the blockchain, you can move money and do business.
Crypto Isn't Backed by Anything! Neh!! I win!!
What is backing the US dollar? How about the CAD? Or the Euro? Recently Russia took the "unprecedented" step (ha ha) of backing their ruble with gold, in a way. It's not a gold standard, but it's also (apparently) no longer the free-floating fiat that it once was. The US dollar has no backing. Its value compared to other currencies is set by complex interactions between the Treasury's printing presses, the Fed's meddling, the various massive banks around the world, treaties, bond markets, wars, and so on. There is really nothing concrete underneath the dollar.
Some argue that the dollar is backed by debt - that each dollar in circulation is backed by actual labor yet to be done. But does this even make sense? While it may be ostensibly true, the reality is that if I ask you for a loan of $10,000, and I promise I'll either pay it back or work it off, who are you to make me do either? If I pack up and go, or suddenly become unable to work and unable to pay, your gamble that I would be able to pay or work fails completely. What's more, to say that I have $10,000 worth of work in me (because of my loan that you gave me), this is not collateral. This is a liability. I can't justifiably take this $10,000 and show it to someone else and demand more money be loaned to me. That $10,000 isn't really mine. Anyone foolish enough to consider a liability as legitimate collateral is wearing their ass for a hat: I can now fail on two loans, make off with twice as much money and compound the pain I deliver to these two fools (sorry, one of them was you).
Unfortunately, it seems our major financial institutions do this all the time. I suspect this is where derivatives get their name and calling, but I could be wrong. It makes sense, though. All debt comes with interest - in theory. The debt plus the interest is future value. If I request a loan based on future value of my returns (as the one who loaned the money), in theory I can pay it back once I get paid back. But again, this is a liability, not an asset. Future value is not guaranteed. Repayment is not guaranteed.
Anyone thinking that it's good having a currency founded in debt and the labor to work off that debt had better start learning Mandarin, because if you plan on paying off the country's debt to its debtors with your labor, one of our biggest debt-holders is China. I'd be astonished if the average American would take on this duty willingly, and for choices they didn't directly or even indirectly make. So much of modern fiat money looks like a shell-game, a play on words, a play on concepts, all designed to make things look stable and real and based on something tangible, but ultimately it's all a house of cards.
In this way, Bitcoin and other cryptos have the potential to be something quite different: while they are also not based on anything specifically tangible, well-build cryptos are also not things that can be counterfeit. They cannot be manipulated the way the Fed manipulates the USD. The coins - at least where Bitcoin is concerned - cannot currently be just printed off. Yes, a change to the whole system could enable this, but it would take an amazing amount of consensus. Right now, it takes only the Fed asking for more money to get the Treasure to print it.
So Are Cryptos the Future?
There is very likely going to be a digital currency soon. China has been working on theirs. The US is investigating their own. Most people already use their USD in a digital form anyway - when was the last time you transacted in honest-to-goodness dollars and cents? Credit and debit cards are easy. Checks are not far behind. Most bank transactions between banks are all digital. In a way, it's amazing nothing gets lost or corrupted - or maybe it does and we never hear about it.
A central bank digital currency (CBDC) will have huge implications for privacy, trust, security, fidelity, reliability, government manipulation, and so on. It's hard to say how long it will take to get there, but for what it's worth your bank account, being the digital record it is, is all but in the government's hands already. One interesting idea with CBDCs is that of expiring currency: when the Fed wants to make people spend money, give them money that will lose value over time, so that they have to spend it before it disappears. Can't do that with gold or even paper money.
The question becomes whom would you want in charge of your digital currency? If you're fine with the government, the Fed, the banks, maintaining that power over what you hold, how much of it you have, and where you can spend it, then CBDCs should be exciting and wonderful news for you. If you would prefer to manage your own money, buy and sell as you see fit, enjoy your privacy while doing so, and to be sure know that no one else can take your money unless you give them the power to do so, then cryptocurrencies are going to be the place to be.
I would envision a future where both CBDCs and cryptos exist. How one gets along transacting in either or both worlds, it's hard to imagine. But I think this is where things are going, and if I had to hedge my bets, holding a little crypto isn't a necessarily bad thing.
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