Bitcoin: What You Need To Know
Let’s go back to the beginnings of cryptocurrencies, Gian… Where did this all start?
They’re a form of payment that was created in the late 2000s. They were conceived to be a form of digital electronic payment with no middleman. They are not backed by any central bank or intermediated by anything like commercial banks, which appeals to people who like the idea of decentralised, uncensorable payments that, once they are made, cannot be unmade.
How do they work exactly?
Instead of middlemen, cryptocurrencies tend to rely on decentralised networks of computers running blockchain technology. These networks jointly execute an energy-consuming process called mining, which creates a permanent record – namely the blockchain – of all the transactions carried out in a particular cryptocurrency. You don’t need a single, centralised middleman to oversee the next transaction because all of the information the blockchain network needs is there for everyone to see: who owned what at any single point in time since the currency’s very first transaction. To validate the next transaction, someone can just refer to this public ledger. That’s a pretty strong anti-fraud device – you can’t spend currency you don’t have, unless you can somehow convince more than half of the network to wave your illicit transaction through.
On the other hand, cryptocurrencies are not so good on real-world fraud. If someone strong arms you into paying for something in a cryptocurrency, or you buy a gold ring that turns out to be pewter, it’s impossible to reverse the transaction – that’s something a middleman would normally do.
Where does Bitcoin come in?
Bitcoin is a bit like the original cryptocurrency. It was developed in 2008 by someone using the pseudonym Satoshi Nakamoto, who published a paper that finally answered this question of how to use peer-to-peer technology to create a stateless, unpreventable payments system.
Why is there so much excitement about it today?
There are some competing explanations for this. One of them says that investing in Bitcoin right now is a way of hedging against the increasing uncertainty caused by the pandemic. Covid-19 has triggered lots of so-called ‘money printing’ by governments, which has led some people to become worried about inflation. For a lot of the original Bitcoin crowd, governments printing extra money is tantamount to debasing the value of the currency they hold. Even if you don’t subscribe to that view, you might still think it is sensible to hedge against what’s going on in the world by buying Bitcoin, whose supply can’t be affected by a government or central bank distributing too much of it.
At the same time, some high-profile advocates like Elon Musk and Twitter founder Jack Dorsey have lent Bitcoin further credibility as a smart investment. There’s also a lot of experimentation going on in this sphere that’s generating excitement – look at digital asset-backed art and non-fungible tokens at the moment, for example.
So there’s excitement about its real-world potential as well as simply the investment opportunity?
Yes, though it depends who you’re asking. Some people see it simply as an investment; some see it as an investment with some desirable qualities. Elon Musk, for example, probably sees Bitcoin as a good investment opportunity – I mean, he’s the world’s richest man, so he’s not someone who doesn’t care about money – but also sees its objectives as good.
Can you give us an example of the good Bitcoin can do?
It can be used to fund social or protest movements in which authoritarian governments block protesters’ bank accounts. In the protests against police brutality in Nigeria last year, human rights organisations had their accounts shut and the only way for them to transfer money was Bitcoin. This was its original intended use; it’s just it now also has a big chunk of institutional (or quasi-institutional) investors.
Bitcoin broke yet another record when it’s value passed $60,000 earlier this month. Are we looking at a bubble or something more permanent?
I'm not an economist, but I’m always very worried about using the word bubble in relation to anything, and especially in regard to cryptocurrencies and Bitcoin. Yes, there have been peaks and troughs, but it keeps on rising. That doesn’t mean the price won’t burst at some point, but I will call it a bubble once that happens, not before!
You mentioned the peaks and troughs. Why is its price so volatile?
That’s a matter of very deep investigation in some quarters. There are a few things to mention here. First, there are online exchanges and secondary markets where cryptocurrencies can be traded very easily and quickly, so trades are much faster moving than with other assets. Second, there is no monetary policy that underpins cryptocurrencies, which means the market tends to respond very quickly – and quite extremely – to events or news that is perceived to be positive or negative. You also have to remember that just a few key players hold a lot of the reserves of Bitcoin. If one or a few of these ‘whales’ suddenly decide they don’t trust Bitcoin anymore or think its price will fall, they can have a big impact by selling a chunk of their investment. I also think there is a certain amount of intentional manipulation of the price going on.
Tell us more about that manipulation… You’re not talking about Elon Musk moving the market, are you?
I would never dream of accusing the world’s richest man of such a thing! He is an interesting case because everything is so transparent: he must know when he speaks or tweets that a lot of people are going to follow his guidance, but when he’s playing around like that on Twitter, at least we can all see what’s going on in real time. I was really referring to big, faceless cryptocurrency traders who are dumping one cryptocurrency, then buying another in order to move the prices. Because of the concentration of ownership in cryptocurrencies like Bitcoin, it’s certainly possible to do this.
Are there any other cryptocurrencies we ought to know about?
One of the other popular ones is Ether, which is traded on a platform called Ethereum. To put it optimistically and perhaps too simplistically, it’s a blockchain that has the potential to create smart contracts that can be the basis of self-running businesses. Ethereum is also the platform where a lot of the experimentation with digital art I mentioned earlier is happening.
There’s also Tether. This is a different sort of cryptocurrency because it’s run by a company, so the decentralisation element disappears. You get one unit in exchange for one unit of a currency (a dollar, for instance) and you can effectively trade your virtual dollar on cryptocurrency platforms. When you’ve finished playing around with it, you can convert that unit back into a dollar. Because it has a baseline value, it’s relatively stable amid the volatility. For example, if you make a lot of money in Bitcoin, you can transfer your Bitcoin into Tether and theoretically – because we don’t actually know if the company has a dollar for every Tether it issues – you can lock in your money as if it was dollars.
Tell us about the major cryptocurrency platforms…
I don’t own any Bitcoin or other cryptocurrencies myself, so I’m not speaking from direct experience, but from reading around the subject, there are a few exchanges that are big enough, established enough and pretty much transparent enough that you will not be outright swindled on them as a first timer. Coinbase is the big one, then there’s Gemini which is run by Mark Zuckerberg’s old friends, the Winklevoss twins. This is probably where I would start.
Now the big question, Gian… Where will cryptocurrencies be in five years’ time?
I don’t know the answer to that, but I know where I will be looking for it. I will be watching what big tech and high-profile influencers like Elon Musk are doing. If someone like Jack Dorsey, who loves crypto, decided to launch a cryptocurrency linked to Twitter, that’d be something to keep an eye on. Facebook has already tried to launch a somewhat imperfect cryptocurrency called Libra, which has been rebranded as Diem and somewhat watered down, but there’s a network effect that big tech can still exploit. Not a lot of people have adopted Bitcoin just yet, but Facebook has billions of users it can put a cryptocurrency in front of.
One of the problems Facebook faced was that regulators and central banks around the world were angry with it for trying to create global private money. So I’d keep an eye on central banks too. A lot of them are looking to develop their own digital payment systems. These systems wouldn’t work like cryptocurrencies for various reasons, but they could help to normalise the idea of owning digital currencies and bring them right into the mainstream.
What does regulation look like for cryptocurrencies at the moment? Are we still in the wild west stage of development?
It is being regulated, especially in the US where there have recently been some high-profile arrests. Regulators at the moment tend to focus on the exchanges – the on ramps and the off ramps, they call them. Unless you are a trusted, transparent customer and definitely not a criminal, on regulated exchanges you won’t be able to exchange your Bitcoin for fiat currency and vice versa. Some of the people arrested have been suspected of not being strict enough about this on their exchange.
There are also particular cryptocurrencies that have been clamped down on because they’ve been sold as stocks instead of currencies, and been promoted as such, so the company behind them has effectively been hawking stocks, which is illegal.
I’ve already mentioned the digital art-based sales of the last few weeks. On the one hand, they could be an answer to some very serious questions about how digital artists can monetise their work. However, the crypto-based art tokens that are now being sold remind me to some extent of the securities tokens that were being sold three or four years ago. But if you’re selling something as ‘art’, you’re no longer going to fall foul of securities regulators. Have the crypterati just found a way to slip into a new skin and get around the clampdown? It’s something to keep an eye on.
Now you’ve got our attention, where else can we be going for reliable news and intelligence on cryptocurrencies?
I tend to just talk to a lot of people in this sphere because they are usually the best source of intelligence, and they are usually pretty public on Twitter or Reddit. There are crypto-specific news outlets like CoinDesk and I often read first-hand research reports by the likes of ConsenSys, but I really enjoy FT Alphaville – it tends to be a bit more irreverent – and Bloomberg has some very good financial journalists covering Bitcoin. The main thing is to look out for whether the person you’re reading has any skin in the game. You can talk to a lot of knowledgeable people and, even if they are very smart and very honest, you have to take into account that they may have a certain pro-cryptocurrency ideological perspective. The more cryptocurrencies become mainstream, the more you will be able to get even-handed perspectives.
Finally, Gian, is there anything else you think it’s important to mention here?
With Bitcoin, if you lose your password, you lose your Bitcoin and it’s gone forever, so always keep your password safe!
Pre-order Cryptocurrency: How Digital Money Could Transform Finance here. The first three books in the same new Wired series of guides are published tomorrow (25th March) – check out The Future of Medicine, Artificial Intelligence and Climate Change here. And follow Gian on Twitter.
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