Over the last week, I’ve seen the words bitcoin, blockchain, cryptocurrency so much, it was all I could think about. After reaching out to the wonderful women of Dreamers // Doers, Michelle Staton kindly offered to answer all my burning questions on this newfound obsession.
Let’s start with defining bitcoin, cryptocurrency and blockchain and what is actually the correct term?
Those are correct terms. Hold on, how much do you know about this?
I know nothing.
Okay, so in fall 2008, somebody with the screenname Satoshi Nakamoto developed Bitcoin and wrote a whitepaper called Bitcoin: A Peer-to-Peer Electronic Cash System. It was released in January 2009, shared on a web forum with a bunch of cryptographers called Cypherpunks. We don’t know who Satoshi is, or if it’s a group of people. But he, she, or they developed it in response to the banks having so much unchecked centralized power that it caused a massive financial crisis. Satoshi thought a decentralized digital currency was a good alternative.
Bitcoin is based on mathematical cryptography. It incorporates Merkle Tree logic, the Elliptic Curve Digital Signature Algorithm, and the SHA256, which is a secure hash algorithm. I’ve heard people who don’t understand Bitcoin dismiss it as “magical internet money,” but it’s actually based on highly complex math, which is why I believe in it. If it wasn’t mathematically and cryptographically sound, then I would say, “Okay, yeah. This is a stupid fad. It’s a scam.” But it is a mathematical store of value, which is revolutionary. It’s now being used less as a currency and more as an asset class, like a digital gold.
Bitcoin is the first working use case for blockchain technology. Blockchain technology allows transactions to be verified without requiring trust between parties. It’s a public, append-only ledger of transactions that requires mathematical consensus for transaction approval. That is the fundamental underlying technology that allows Bitcoin to work.
I have a presentation called Demystifying Bitcoin that explains Bitcoin further. One thing to note is it is pseudo-anonymous. Every transaction involves an address, which is a long string of numbers and letters, rather than a name. Because of that, people think it’s anonymous, but it isn’t really.
The technology and math involved verifies that person A has enough bitcoin to send to person B, and it tracks that bitcoin forever as it goes from address to address. This eliminates the possibility of double spending. Person A can never send person B bitcoin that she doesn’t already own. And person B can never claim he owns bitcoin without proof it was given to him. This is why bitcoin is as safer than standard credit transactions, which can easily be fraudulent. Most people don’t know this, but part of that process is called triple entry bookkeeping, or triple entry accounting, which is another revolutionary concept.
Bitcoin has gained a reputation for being used in hacks, but since there is a public record of every transaction, it is a really dumb thing to do. It’s like a stolen good that can be traced back to the thief. There are companies already working with the Department of Justice to link Bitcoin addresses with specific people. Cash is untraceable, and a much better form of payment if someone wants to transact off the record.
Since Bitcoin involves peer-to-peer transactions, it allows us to eliminate the middleman. If I want to give you $5.00 worth of bitcoin, I can just send you that, and there would be no intermediary involved. As in, there would be no large bank that my money would go to, which would in turn pay you. With Bitcoin, it can go directly from my wallet to yours.
Bitcoin has no central authority. There is no bank or company that owns it, although the code can be controlled by a group of core developers, which is important to note. Decentralization is a double-edged sword. It is a good thing because there is less chance for corruption, but there are also no repercussions if something goes wrong. If someone’s Bitcoin wallet is hacked, they’re out of luck.
So is blockchain essentially the idea, and then Bitcoin is the currency?
Yes, blockchain is the technology, and there are a lot of use cases for it. Bitcoin is just a monetary use case for it. Other use cases include supply chain tracking, identity verification, and proof of ownership.
What is mining?
Mining is the process through which nodes, or computers, verify transactions. Miners are rewarded in newly created bitcoin for doing the computations. By design, the mining reward halves every four years. This is to control the supply of bitcoin. When there is a consensus that a transaction is valid, the transaction data gets added to the blockchain.
Years ago, people could mine bitcoin from their living room. But because the equations have become so complicated, it requires too much computing strength and energy to be profitable. A lot of mining takes place at large mining farms in countries where energy is cheaper.
Cryptocurrency can be bought through exchanges. Coinbase and Gemini are popular ones in America. I prefer Gemini because of their ask-permission-not-forgiveness approach it has regarding regulation, but that’s just me.
Gemini is owned by the Winklevoss twins, who are actually the people who inspired me to get into Bitcoin. I first learned about Bitcoin in June 2011, when it was being affiliated with the dark web. I worked at the Senate at the time, and Senator Schumer released a letter condemning it along with the Silk Road, an online marketplace to buy drugs and other illegal things. So I wrote Bitcoin off completely.
Then in 2015, I heard the Winklevoss twins give a talk about Bitcoin, and it made me think, “Why would these people who could be doing anything choose to go all in on Bitcoin? There must be something to it.” Eventually I started studying how it works from a technical perspective, and I fell down the rabbit hole that I have yet to get out of.
How are you able to use bitcoin in the everyday world?
Japan actually declared Bitcoin an official currency this past May. Square is currently implementing support for bitcoin. Overstock.com has accepted bitcoin as payment for a couple of years now. But many people are not spending it in their everyday lives anymore because its value going up so dramatically. If I bought a coffee with bitcoin, what would have cost me the equivalent of $6.00 last week might be worth $8.00 this week, so I would have overspent for it.
The first known bitcoin transaction for a tangible good was the infamous Bitcoin Pizza. In May 2010, a Florida man offered to pay 10,000 bitcoin to anyone who would send him pizza. A London man called a Jacksonville Papa John’s and had two pizzas sent to the hungry guy’s house. It cost him about the equivalent of $40.00, and in return he received 10,000 bitcoin. Because of that, we say on May 22, 2010, 10,000 bitcoin was worth $40.00. Today (December 6th, 2017), 10,000 bitcoin is worth around $115,000,000.
What is the most common fear or misinformation put out about Bitcoin?
People still think bitcoin is being used for illegal things. It does have a rocky past with Silk Road. Ross Ulbricht, the creator of Silk Road, is serving a life sentence for money laundering, hacking, and conspiracy to traffic narcotics. I think it was right for him to get jail time for running a marketplace solely used for illegal activity, but I think a life sentence is too harsh. The court was trying to send a message though; they wanted to warn people that they will not put up with that type of activity.
Also, it is often said that bitcoin is a bubble. My senior thesis was on emerging economic bubbles, so I’m very keen to paying attention to bubbles. But a key to bubbles is problematic supply and demand ratios. With bitcoin, there will only ever be 21 million mined, which is important. That’s just one of several things that separates it from Tulip Mania.
Wait, tulip mania?
Yes, that’s one of the earliest known economic bubbles. One time in the 1600s, people in Holland started buying tulip bulbs in mass, and it became a bubble. When the bubble burst, a lot of people lost money. With tulips, there’s an unlimited amount of them and they’re easily destroyed, which throws off supply and demand. That’s where Bitcoin is different. There is a limited supply of bitcoin, so the market can react accordingly.
Bitcoin has definitely had a bubble-like rise in value and popularity this year. But I think, or I hope, its price volatility will stabilize as institutional investors start trading bitcoin-based derivatives, such as the upcoming futures contracts and potential ETF. An ETF is like tradable a stock, but its price is dependent on the daily value of its underlying asset. In this case, people will be able to trade a bitcoin-based ETF without actually purchasing bitcoin.
The futures contracts will allow investors to take a short or long position on bitcoin. If someone thinks bitcoin is going to go down in value, they can short it, meaning they can contractually sell it later on while locking in today’s purchase price. On the opposite side of that contract is a person who buys it in the future at today’s price. If bitcoin rises in value, the latter person gets a good deal. If bitcoin does down in value, the first person gets the good deal. Hopefully this will also help with price prediction.
The first futures contract is coming out on December 10th, and it’s through Gemini and the Chicago Board of Options Exchange (Cboe). The second one is through CME, and it hits the market on December 18th. Nasdaq is also considering one for 2018.
I feel as if it sounds like it’s one of these things that it’s best to become a part of it before they do.
Well, it does reward early investors. Regardless of price though, I believe Bitcoin is important because of how it can function as a digital store of value. Everything is becoming digitized – photos, music, media – I think the same will be true for assets. You can already see this with generational perspectives on bitcoin. Younger people get it instantly; they have no problem with the concept of a digitized asset as opposed to a physical one. Older generations seem to be less keen on the idea and they have a harder time understanding it, or wanting to believe in it. Obviously, I’m generalizing here, but there have been surveys to back this up.
I think that we used to live in a materialistic world in the sense that you had to have it in our hands to see it and believe it, and now we’re moving away from that.
Right, especially as cloud-based storage increases.
Are there other types of cryptocurrencies?
Yes, there are several. Ether is the second most common one right now. It is often called Ethereum, but Ethereum is the blockchain, ether is the currency. Other popular ones right now include Litecoin, Ripple, Monero, and Zcash.
What can you do with this currency? Is it real?
They’re tradeable, and they can be converted into U.S. dollars. Different currencies are used for different things. Bitcoin is accepted as payment at certain places. But some of the alternative coins are only used for specific applications.
Let’s say I’m on a website, and the options are like PayPal, regular credit card, and Bitcoin. If the shirt is $34.99, in bitcoin, how many would that be?
However much it’s worth exactly at that moment – its ratio to U.S. dollars.
That is insane. Like a legit currency!
It is a currency, but it’s also an asset. I don’t think it can be both forever, To survive, I think bitcoin is going to have to be one or the other, a cryptocurrency or a digital asset.
So where is cryptocurrency best suited?
Places where cryptocurrencies can be really helpful are in developing nations that have an inaccessible or unstable banking system, and/or a corrupt government. Through cryptocurrencies, people can pay each other directly, avoiding the banks and government all together. In developed countries, I think fiat currency will remain very relevant for a long time.
What is fiat currency?
Traditional money like U.S. dollars, yen, pounds.
So if I were to buy $1,000 of bitcoin right now, what would that do?
According to this price converter, you would get .08 bitcoin. Bitcoin can be broken down to eight decimal points, so you could even have 0.00000008 bitcoin.
What about the crypto market that has been getting a lot of attention lately?
Initial Coin Offerings, or ICOs, have exploded in popularity this year. Billions of dollars have been poured into them in a matter of months. I am a vocal critic of ICOs because many of them are illegitimate. The coin is going to be completely worthless because the company selling it doesn’t even have a viable product yet, and maybe never will. Some ICOs are intentional scams, and many others will fail due to any number of incompetency issues.
There are legitimate ICO projects, but unfortunately they are getting outnumbered by the illegitimate ones. There is too much noise and too much short-sighted greed in the marketplace right now. It’s a total distraction.
ICOs are also problematic because the SEC considers many of them securities, so some people are getting in trouble for securities fraud by doing an ICO. In the U.S., only accredited investors can invest in ICOs (though people don’t always abide by that). The SEC is trying to protect unsophisticated investors from losing all their money by buying what may be worthless tokens. They are told their investment will have astronomical returns, and many people fall for it because they have bitcoin FOMO.
Let’s say you want to be a part of this movement, how do you join?
If you want to get in now, you can join an exchange. It can take a while to get approved. The respectable exchanges abide by KYC [know your customer] and AML [anti-money laundering] laws. So you have to submit proof of identity to join those exchanges. Once you’re verified, you can link it to your bank account and start buying. You can export your cryptocurrency into a hot or cold storage wallet. Hot wallets are hosted online. and cold storage wallets are completely offline.
How do you know when bitcoin rises?
The prices updates in real time. It’s always visible.
There are people in the finance world saying, “Stats behind crypto are not proven!” Why are they saying that and what are some ways to fact-check them without being too rude?
A lot of people in the banking industry are not a fan of Bitcoin because they don’t understand it. Plus, it is a disruptor to their industry. The smart ones are finding ways to get in on the action and try to use the technology to their advantage.
Have you seen any people who are in the banking industry sort of slowly make that shift?
Oh yeah, that’s why derivatives are being developed. Institutional investors are interested. They can’t ignore cryptocurrency anymore; the market cap for cryptocurrency is upwards of $300 billion.
How does crypto affect your taxes?
You have to report it if you own bitcoin when filing, and you have to pay capital gains taxes.
So the IRS will take your gains from it, but a lot of institutions don’t even acknowledge it.
Yeah, but taxation requirements will probably change as the market develops.
Do you foresee any challenges?
ICOs are a challenge. The possible bubble is a challenge. At the beginning of this year, bitcoin was trading around $800. Now it’s over $11,000. It can’t continue on that path forever. The question is when will it stop increasing, and what will happen after that? Will it stably plateau or will it go down in value?
We also don’t know what the future holds regarding regulation, both worldwide and in the U.S. specifically. It is something that’s very important to pay attention to because even if people dislike regulation and government, they cannot escape being subject to laws. That’s why I started Digital Asset Affairs, to track and clarify what is going on in the crypto regulatory landscape. Things are changing daily and with so many regulatory bodies in the U.S. alone (such as Congress, state legislatures, and agencies like the SEC, CFTC, FinCEN, IRS, and Treasury Department), it’s a full-time job to keep up with the changes. My goal is for DAA to make it easier for people and companies to keep track, and to understand what the new regulations mean for the industry.
Hacking is of course a concern. The Bitcoin blockchain itself has never been hacked. But somebody’s wallet can be hacked if they fall victim to a phishing scam. Exchanges are also subject to hacking.
Do you have an idea of what’s next for it?
No, and if someone tells you they do know, they’re lying. Nobody knows for sure what will happen with bitcoin. In a year, it could be worth nothing, or it could be worth $50,000. It’s a day-to-day, see what the market does type of thing right now.
The cool thing about this is, unlike with traditional stocks, there is not a lot of insider information. Nobody owns Bitcoin as a whole, and the people who buy bitcoin talk about it openly online. They discuss it on Reddit, on Twitter, in Telegram and Slack groups. The code is publically available on Github. The developers take public stances on issues. This makes it easy to get a sense of public mood is towards it, which if quantified, can even serve as a makeshift price prediction tool. People are going crazy for bitcoin right now, and it is going up in price accordingly. If the tide turns, you will be able to see that play out on social media. When there is a scandal, people talk about it and it goes down in value. My only investment advice is to not invest more than you can afford to lose, because there are no guarantees with crypto.