A Young Adult’s Guide to Cryptocurrency
What is Bitcoin?
What is blockchain?
Why do we need cryptocurrencies?
Why the explosion of new coins?
What are some of the other coins with potential?
What is the future of cryptocurrencies?
How does one get involved?
Do you know the average trade size for an amateur stock investor? Neither do I. Let’s say it’s $5,000. It’s probably lower, but whatever. $5,000 invested in the S&P 500 Index in 2010 would be worth over $11,000 today. Up almost 125%! In seven years, that’s a fantastic return. Of course, if you pick stocks like I do, and invested in a company that makes bottled water for dogs and cats, it would be worth $0 now. How about if you’d invested $5,000 in Bitcoins? It would be worth almost $400 MILLION. Yes, you read that right. Bitcoin, which currently trades close to $4,000, traded around 5 cents back in 2010, after its debut in 2009. There are now over 900 other digital coins out there, most trading for pennies. Think it might be time to start paying attention?
As you may have noticed, my blog is about whatever the hell I feel like writing about. This topic does tie in loosely with my upcoming young adult novel The Initiation, because cyberterrorism is one of the causes of the apocalypse in my story. Cryptocurrencies and cyberterrorism are sort of in the same genre.
Bitcoin is a fad, some sort of virtual currency for hackers and money launderers. As soon as someone hacks it, Bitcoin will go away forever. That’s what I thought a few years ago. Um yeah… I was wrong. You may not care to learn about cryptocurrencies, but eventually you’ll have to. Whether they ever garner global acceptance is anyone’s guess. But the technology that underpins it—blockchain—is here to stay and has many applications outside of money. That’s my opinion after doing the research. Might as well get it over with now.
I am not an expert on cryptocurrencies. In fact, I’m a relative beginner. So why am I writing a blog post to teach you about them? Well, imagine you tried to learn about Bitcoin from one of its core developers. That would probably not go so well. After 10 minutes, she would throw her hands in the air in frustration, call you an idiot, and give up. Sometimes it’s better to learn about a complex topic from someone who isn’t an expert, who won’t confuse you with jargon or make assumptions about your knowledge. Somebody who knows what the average person doesn’t “get.” You need a person who doesn’t know anything, who’s totally clueless. That’s where I come in.
Before becoming a writer, I was a professional trader, so I do have some qualifications here. News stories about Bitcoin hitting $5,000—having doubled in August alone—caught my attention. I decided I needed to finally learn about it. This post is the result of that research. I wanted to know what it is, why we need it, if it’s legit, if I should buy it, and how to buy it. I discovered many more things along the way. For just $297, you can have full access to—I kid! Jokes. I can sum up what you need to know to be Bitcoin literate, or BitLit, in one post.
I’ll be pulling some examples and explanations from sources which I’ve cited at the bottom. I’ll say up front, so I don’t have to mention it beside every description, that I’m simplifying how all this works. To describe it in depth would require major coding terminology, knowledge I lack, and a novel-length post. That would also force you to go fetal. I’m sure there will be some cryptocurrency gurus that troll my post, but I promise my simplifications will be largely correct. My goal is to cover Bitcoin and cryptocurrencies like I was explaining it to my daughter, who would lose interest 3.8 seconds after it became boring.
WTF is Bitcoin, anyway?
Unsurprisingly, this is not a simple answer. Most people get that it’s some kind of “digital” currency. But why all the hoopla and cryptography and such? What is the blockchain? And why does the world need a digital currency when we already have regular currency and credit cards?
*Takes deep breath* Let’s say I have a hundred-dollar bill, and I hand it to you. Now you have a hundred-dollar bill and I have nothing. You’re welcome. There’s little ambiguity in the transaction. We don’t need anyone to verify it, or facilitate it, because we experienced it and saw it with our own eyes.
What if you were in California while I was in New York? After forcing you to acknowledge the superiority of east coast rap, I’d probably do a wire transfer. I’d go to my bank, which possesses all my personal info, and give them your personal info. They’d send the money, journaling it over from my account to yours. After an entire day or more, my account balance would decrease by $100 and yours would rise by that amount.
The transaction has become more complex and less certain because we’ve involved a third party. How do we know the bank will do it right? Or honestly? What if they sent $10 by accident? What if we needed it done in the next 5 minutes when wire transfers can take days? What if a bank, who will go unnamed but rhymes with Crank of Schemerica, decides to honor the request of an identity thief who tried to withdraw $800,000 from my checking account by giving them ALL OF MY MONEY? Yup, that happened (no I did not have $800,000 in my checking acct). That request did not strike anyone at Crank of Schemerica as odd. But I digress.
Say we decide to do it ourselves, without the help of a bank. We opt to cut out the sketchy middle man, to whom we’ve had to reveal many personal details about ourselves. I email you a digital $100 bill that I say is worth $100.
Well, how do you know it’s worth $100? How do you know I didn’t make a copy of it first, or 50 copies? How do you know I didn’t send this same “bill” to all my friends? This is a well-known computer science dilemma called the double-spending problem. In the digital realm, ensuring money (or anything else) wasn’t forged, or created twice, is really difficult. But some very smart people came up with a brilliant solution. Shout out to Yuji Ijiri and Ian Grigg for triple-entry accounting, and to Satoshi Nakamoto, the mysterious creator of Bitcoin. The solution is called blockchain.
What in the world is blockchain?
It’s the technology underlying Bitcoin and the other cryptocurrencies. Many of these other coins, which are sometimes called “alt-coins,” aren’t even about currency. I’ll get to that later. Satoshi figured out that if every single transaction was recorded in a ledger, and every person had that ledger, and the ledgers were always synced, there could be no fraud. I can’t forge digital money because it wouldn’t sync up with everyone else’s ledger. Blockchain is this ledger, or database. Every transaction must be recorded and verified, everywhere in the world. The ledger is permanent and can never be changed.
I’m stealing this explanation from an article cited below, because it’s the best way to think about blockchain. Imagine 10 people sitting in a circle, each with a stack of blank papers and a folder sitting in front of them. When someone makes a transaction (#3 pays $100 to #7), it’s announced to the whole group. Everyone makes sure #3 has enough money to pay $100 and then they all record it on their first sheet of paper. They keep logging each new transaction on that page until it’s full, at which point something special happens.
Before dropping this first sheet of paper into their individual folders, they must
break dance fight “seal” the page. To do so, they write a special key at the bottom, on which they all agree. Once the paper is sealed and placed in the folder, it can never be changed. If everyone trusts the matching seals, they must trust that the information on the page is accurate and permanent. Instead of a bank person who we must trust, now the seal provides the trust. This process of sealing is called “mining” and is the basis for this entire method.
But wait, how do they come up with the seal? I’m glad you asked. Everyone must try to solve a complex mathematical puzzle. Yes, seriously. Doing so requires major computing power, and it’s intended to be difficult. The first person to solve it announces the result to everyone else. That person also gets rewarded with Bitcoin (or another coin on a different blockchain), providing the incentive to do the mining. Miners are also paid a fee for verifying transactions. This reward system for solving the puzzle is how new Bitcoins are created.
Since receiving Bitcoins as a prize is quite lucrative, Satoshi envisioned a growing flood of new miners. So as miners grow, the protocol calls for increasing difficulty of the mathematical problem. This stabilizes the production of new Bitcoins. It’s called mining because it’s not dissimilar to actual mining which requires great effort to produce new commodities, like gold. As per the original design of Bitcoin, only ~21 million Bitcoins can ever exist, and there are ~16 million today.
If you care to know a little about this cryptic mathematical puzzle, read this paragraph. Otherwise skip to the next one. (Oh just read it, it’s not scary). The problem involves feeding numbers into a special algorithm called a hash function, which spits out other numbers. Inputting a unique number will always produce a unique alphanumeric output. Given a particular output, however, it’s very difficult to go the other way to discover what the input was. In fact, the only way is by trial and error; basically trying every number out there. Feeding each into the hash function to see what pops out. This is what the miners do, and need supercomputers to do so. (Anyone can mine Bitcoins with a special program on your home computer, but it would take roughly 100 years to mine one Bitcoin). Once you find that unique input, you have your seal. Everyone writes the seal on their piece of paper and puts it inside the folder.
Bitcoin mining setup
The piece of paper is essentially a block of transactions (block) and the sequence of those papers inside the folder forms a chain (chain) ==> blockchain. The seal on the page is known as Proof of Work.
Here’s why blockchain is “unhackable.” Once a paper is inside the folder, it is sealed forever, and identical to everyone else’s. It’s an immutable record of every transaction that’s ever taken place. What happens if someone opens the folder, grabs a sheet of paper, and edits or forges a transaction in their favor? Well, they’d have to come up with a new seal via the mathematical puzzle, which wouldn’t match everyone else’s. And here’s the kicker about those seals: each one depends on the one that came before it. So this “hacker” would need to adjust the seals on every block after that. He’d have branched off with his own chain. But since thousands of transactions are always occurring, he could never possibly catch up to everyone else. His new chain would always be shorter. The longest chain is always the real one.
There is one vulnerability in blockchain: the 51% attack. In our example above, a lone cheater would simply be kicked out of the group, with his bogus blockchain. Later bro. But what if the majority of the group—six people in our example—colluded together to cheat? Yeah, the whole thing would fail. The concept of blockchain hinges on the assumption that the majority of a crowd will be honest. I’ll add that the current political climate would seem to put that assumption in doubt. There are, in fact, a few Bitcoin mining firms that have come close to controlling 50% of all mining. It’s a major concern for everyone else.
The few hacks in the cryptocurrency space have had nothing to do with hacking the underlying technology. They’ve targeted the ancillary functions of the crypto business. You can’t keep cryptocoins in your bank account. “Wallets,” where people must store these badboys, are often at risk because of weak code or human error. As in real life, someone can digitally steal your wallet. Several wallet options exist, such as hardware wallets (kind of like flash drives), or web-based wallets. Exchanges, where cryptocurrencies are traded, are also exposed because people store cash and coins there.
A hacker once stole $30 million of Ethereum from some wallets by exploiting a simple vulnerability in the wallet code. While that isn’t so crazy, what happened after that totally is! Some white-hats (good guy hackers) figured out what he was doing mid-hack. The only way to stop him was to hack every exposed Ethereum wallet in the world the same way, before he did. They saved (by stealing and then returning) around $150 million, limiting the losses to $30 million. Read about it here.
Okay, but why do we need cryptocoins?
Earlier I mentioned cutting a slow, possibly dishonest, middle man out of transactions. The allure of Bitcoin runs much deeper than an unreliable broker, though. Blockchain first appeared in Satoshi’s white paper around ten years ago. He pointed out that the internet doesn’t offer the freedom we think it does. Everything runs through servers owned by huge corporations. Money transferred through the internet must travel through those servers before reaching its destination.
He devised the blockchain which, like the internet, utilizes a network of computers. With blockchain, though, a log of the payment is recorded on all computers simultaneously. But only you and the recipient could access it, using a cryptographic key. It reveals no personal information about either of you. And it takes minutes not days. Of course, to use this system, you must use Bitcoins, not dollars or any other fiat currency. (Click here for an explanation of fiat currencies and a brief history of money). There’s no middle man, no corporation, no bank, no government. It’s decentralized.
Decentralization is a key element of blockchain. It takes the power and control away from corporations, and governments. It came around at just the right time, too, like a winning lottery ticket right after your house burned down. The 2008 global financial crisis left the world disillusioned with banks and multinational corporations. A common theme of protests was “people taking their country or economy back.” Blockchain literally gives the world back to the people, which is a huge reason why it’s so popular.
Central banks control the supply of money. In doing so, they control its price. For example, China devalues its currency to make its exports cheaper to consumers outside of China. But that sure doesn’t help people who live in China, because their buying power is lower. Using Bitcoin, or another cryptocurrency, removes government control (which is why governments don’t like it, and China is starting to ban aspects of cryptocurrencies).
Decentralization has other benefits as well. It eliminates single points of control or failure. It reduces the possibility of internal corruption or collusion, while also lowering the practicality of an external hack. Transactions are faster and more direct. They’re also more private—no need to set up accounts at banks, giving up personal information, which the Crank of Schemericas cannot or will not protect.
This perk leads to the presumption of total anonymity, which is actually not the case. A more suitable term is pseudonymity. While your personal details are not recorded on the blockchain, many details of your transactions are. Not only that, but every transaction is recorded for eternity. With some investigation, it is indeed possible to determine identities (just ask people on the dark web busted for illicit activity). Bitcoin has still been the currency of choice for criminals because it was better than the alternatives. It’s quite possible most didn’t know it wasn’t fully anonymous. These days newer coins have emerged whose defining characteristics are true anonymity (Dash, Monero, and Zcash to name three). Illegal businesses on the dark web often accept Monero as payment now. Not that I would know…
No group “owns” Bitcoin. There is a nebulous association of developers who manage it, but it has no ownership. Or, everyone owns it, looking at it another way. (Satoshi disappeared, from wherever he secretly lived, long ago. He mined the first few million Bitcoins himself, which today are worth billions of dollars. It’s possible he was several people, or was a she. Nobody knows, though rumors suggest the NSA identified him/her with some clever tactics. Read about it here.) The code is open source, meaning anyone can see how it works with full transparency AND can add to it, improve it. It’s kind of like how Wikipedia works. Bitcoin is a worldwide, virtual community of people all working together towards a common goal. Unfortunately, sometimes too many cooks in the kitchen can be problematic. It’s why a corporation has one CEO. There’s been plenty of infighting amongst the developers, to the point that Bitcoin took a “hard fork.” That means it actually split into separate currencies in August (Bitcoin Classic, and Bitcoin Cash). Kinda like Coca-Cola Classic and New Coke if anyone remembers the disaster that was New Coke. The division was due to disagreements about the future course of the coin. People followed the vision they believed in.
Explosion of other cryptocoins
Despite Bitcoin’s hype, high price, and dominant market capitalization, it’s not even the best cryptocurrency out there. (Market cap is the total number of coins multiplied by their price, which is ~$65 billion for Bitcoin, or roughly double the size of Deutsche Bank). While it had first mover advantage, everyone that came after it learned from its mistakes. Enter Ethereum.
Since Ethereum is the second largest cryptocurrency, it is often called Bitcoin’s main competitor. Its coin, or “token,” is actually called Ether—Ethereum is the platform. The market cap of Ethereum is currently $27 billion. But Ethereum is vastly different from Bitcoin, and I’d argue not even a competitor. It’s also better (more in a moment).
Bitcoin is a currency. That is its purpose. It’s a repository of monetary value, like gold. You can invest in it, you can buy things with it. It’s forced the world to think about money in a way it never has before—secure, decentralized, easily transferrable, and digital. But the real beauty of Bitcoin is blockchain.
Blockchain is the real reason everyone is all gaga about crypto. Blockchain is to Bitcoin what the internet was to email back in the mid 90’s. It has so many potential applications outside of money. Social media, gaming, finance, lending, insurance, payment systems, voting, real estate, among others. Any industry that exists today can be rebuilt using blockchain technology and in pretty much every case, drastically improved. That’s the reason for the surge of new coins. It’s not that they’re trying to replace Bitcoin (well, some are). They’re using blockchain to build decentralized versions of some existing service, activity, or business. Each of these new protocols happens to come with a native coin that must be used to pay for whatever service they offer. The coins also have a neat feature—they finance the project.
This is uncharted and as yet regulated territory, but they’re called ICO’s, or Initial Coin Offerings. ICO is monikered like IPO (Initial Public Offering). Companies use IPO’s to go public, raising money through stock sales rather than coin sales. In an ICO, the public buys the coin based on a white paper description of what the company will do. These investors hope the coin will appreciate in value if the company is successful. Demand for the service would create demand for the coin. The company in turn gets a lot of money to build the requisite technology. It’s not uncommon to see a new tech company that would historically be valued at $5 million in Silicon Valley easily raising $50 million in an ICO. Venture capitalists are eager to find the next Bitcoin. Scammers are launching fake coins, taking advantage of the hype, and succeeding with relative ease. Many aren’t scams, but are a stretch. PotCoin anyone? Yes, it’s what you think it is.
Back to Ethereum. Ethereum uses its own blockchain. But the purpose of Ethereum is to provide a platform on which others can build blockchain apps, via “smart contracts.” It provides the infrastructure to apply blockchain technology to the many other industries I mentioned earlier. While Bitcoin’s goal is digital currency, Ethereum’s is these smart contracts. The cool thing about Ethereum’s blockchain is it forms a huge decentralized computer spread all around the world. Thousands of individual computers run a protocol called Ethereum Virtual Machine, allowing each to be a node in this one massive computer. A smart contract is code, a program. When sent to the blockchain it’s executed by every node and added to the system.
A good way to think of smart contracts comes courtesy of this article. Imagine you and a friend had wanted to bet $100 on the big Mayweather/McGregor fight a few weeks ago. How would you do it? You could trust each other. But what if you picked Mayweather and your friend refused to pay up? Oh okay, well you could entrust a third, uninvolved friend instead. You each give him $100, and at the end he gives the winner the $200. Except that he snuck out and blew it all on tacos and pizza. A smart contract on Ethereum can act just like a person. You each send $100 (or in this case, Ether, the token for Ethereum) to the smart contract, and at the end the smart contract sends the winner the funds. No emotion, no binge eating.
If I wanted to send $100 to you in California, using my example from the beginning of this post, I could send it to you in Bitcoin. If I wanted to send you $100, only if I had more than $1000 and you had less than $200, I could do that with a smart contract on Ethereum. It’s like highly programmable digital money.
Most of the new startup coins are based on Ethereum’s blockchain. It’s superior to Bitcoin’s blockchain in other ways, but they are beyond the scope of this post. This is not to say that Ethereum is more valuable than Bitcoin, or will ever be priced similarly. Currently Bitcoin trades at $3,932 and Ether at $285. Keep in mind those prices are a function of the number of coins outstanding. Bitcoin only has ~16 million coins outstanding while Ethereum has ~90 million. Many people get excited when a new ICO prices at 10 cents, dreaming about being a billionaire if it should ever reach Bitcoin’s price. But they fail to notice the firm auctioned off a billion coins, meaning it’s unlikely it’ll ever trade over $1. Each $1 rise in price adds a billion dollars to its market capitalization. Market caps provide a better measure of the relevance of a coin than price.
Some of the other contender coins
Looking at market caps, after Bitcoin ($65 billion) and Ethereum ($27 billion), it falls off a cliff. But each coin utilizes blockchain, involves cryptography, and has a certain purpose.
#3: Bitcoin Cash – Symbol BHC. Mkt Cap = $8.4 billion. This is the “hard fork” of Bitcoin.
#4: Ripple – Symbol XRP. Mkt Cap = $7.0 billion. Ripple is a blockchain targeted at banks, rather than individuals (like Bitcoin). Instead of destroying the financial system like Bitcoin aspires to, it seeks to earn the financial system as customers.
#5: Litecoin – Symbol LTC. Mkt Cap = $2.8 billion. Litecoin is similar to Bitcoin but enjoys nearly costless transactions and is 4x faster.
#6: Dash – Symbol Dash. Mkt Cap = $2.4 billion. Dash is intended as a currency, like Bitcoin, but seeks to improve on transaction costs (like Litecoin) but also to improve on its anonymity. It achieves both.
#7: NEM – Symbol Nem. Mkt Cap = $1.8 billion. NEM is sort of a competitor to Ethereum in that it built an advanced blockchain capable of hosting apps on top of it. It also handles mining much differently than the others; rather than reward hoarding them, it encourages transacting.
#8: Monero – Symbol XMR. Mkt Cap = $1.4 billion. Monero cares most about anonymity, and has become a favorite currency on the dark web, accepted in transactions for illicit activity. It should be noted that people other than criminals may want to protect their privacy on the blockchain.
#9: IOTA – Symbol IOTA. Mkt Cap = $1.4 billion. The toughest to conceptualize. Its goal is to empower the machine economy and internet-of-things (IOT). Think, rather than having a smart phone, everything if your life is “smart” and all devices communicate with each other. Its underlying technology is called Tangle, which some people call a 3rd-generation blockchain but isn’t actually a blockchain. It has no mining, no transaction fees, is fast and scalable.
#10: NEO – symbol NEO. Mkt cap = $0.9 billion. A new blockchain from China that is a direct competitor to Ethereum but improves upon its blockchain technology.
What does the future look like?
The cryptocurrency market is only ten years old, still in its infancy. Using these cryptocoins to buy goods is impractical at this stage (though some vendors do accept Bitcoin today, and many businesses have contracts with Ethereum). It makes no sense to convert your dollars to Bitcoin just to spend Bitcoins, since the transaction requires some effort and costs money. Most people that own these coins are doing it for pure value speculation.
Some believe that while the technology is revolutionary, cryptocurrencies will only ever be useful in places where the currency is totally unreliable (North Korea, Venezuela, etc.). They could never eclipse the safety and worldwide acceptance of the US dollar. And if they ever began reaching those heights, governments would ban or heavily regulate them. That is possible. Even cryptocurrency bulls expect regulation.
Last week Jamie Dimon, the CEO of JP Morgan, ripped Bitcoin in the news, calling it a fraud. The obvious critique of his opinion is he’s speaking as a banker, and banking is the industry most threatened by Bitcoin. It’s like an Uber driver commenting on self-driving cars. It’s also worth noting that JP Morgan has reportedly created its own blockchain. Is it a fraud or not Jamie?
For the believers, the vision is unclear as well. Will one coin “win?” Can several or many co-exist? As we learned, Bitcoin and Ethereum are not exactly competitors. The shoe market, for example, has multiple heavyweights like Nike, Adidas, and Reebok, plus many other smaller brands.
There are over 900 cryptocoins out there, with many new ones born each day. It’s very likely that most of these will fail. It sure would be nice, however, to find the one that costs $0.01 today and is headed to $4000. Many Bitcoin bulls think the fair price for Bitcoin is more like $100,000. Some think it’s closer to $2 million per coin. It also might be regulated out of existence and be worth zero.
“Worth” is a tricky thing. A big hang up for many people is the lack of fundamental value. Why is it worth anything? It’s not backed by something of value. I’d direct you to my blog post on printing money, again here. Most currencies in the world today are fiat currencies. While once backed by gold, today’s money derives its value from the belief that it has some. Otherwise it’s just a slip of paper. People accept it as payment because they can, in turn, use it to buy other things. If people stopped believing in the value of money, it would cease to have any. Unlike fiat currency, Bitcoin is finite in number (21 million). As it grows in acceptance, and demand increases, it’s only natural for the price of each Bitcoin to rise.
How do you get involved?
As an investment, cryptocurrencies are about as risky and volatile as you can get. That’s a warning. They make the stock market look like a checking account by comparison. Nobody should ever invest money they aren’t willing to lose. Because you could very likely lose it all. Responsibly investing in these coins, particularly the new ones, requires significant computer science knowledge. The coins/platforms are only as good as the code that defines them. Many of the newer coins have rocketed straight down to zero when their code was either hacked or revealed to be vulnerable. This is less likely to be an issue if you stick with the top coins.
The above disclaimer notwithstanding, I own several of the above coins myself. I’ve bought a new coin in an ICO priced at $0.10. I’m a realistic believer. Cryptocurrencies are where the internet was in the mid 1990’s. Despite the overwhelming press that Bitcoin has enjoyed the past few weeks, very few people own it. Big institutional investors have yet to buy them. I forget the exact stat but something like 97% of people that own Bitcoin own less than one Bitcoin. (Yes, of course you can buy any fraction of Bitcoins. In fact the smallest unit is 1/100,000,000th, or 0.00000001 BTC, which is known as a Satoshi. Many of the new coins trade for 8,000 Satoshi’s for example). As more people get comfortable with the concept, all coins could get pushed to greater heights by a surge of investment. Just to be clear: I am not an investment advisor and am not giving investment advice. I’m sharing my opinion.
There’s a learning curve to playing. You can’t call your bank and buy Bitcoins. You must go to an exchange, kind of like an online stock exchange, or a service that sells them. The most popular and easiest is Coinbase (not without many user complaints). At Coinbase you can buy Bitcoin, Ether, and Litecoin. You create an account, and need to deposit money there, for which several methods exist. You can link up a credit card for an immediate purchase, or sync it with your bank account. You can also wire money from your bank account. These methods take time, and considering the risk of fraud, all the exchanges require personal information. (Some of them demand a lot, like a photo ID).
You also need to set up wallets to store your coins. The exchanges usually set up wallets for you, but it’s not recommended to keep your coins at the exchanges because you don’t control the coins, they do. Also, you’re at risk of the exchange being hacked. You need your own separate wallets.
This was a very long post, but still only a basic introduction to cryptocurrencies. If you’re interested, there’s a lot more info out there. But my advice is to proceed with caution. You are stepping into the world of hackers and computer experts, and if you make a mistake, someone will steal your money. Before you accidentally give your hard-earned cash away, educate yourself.
Bitcoin is a polarizing topic. Are you a believer or a hater?