Over the past few years, the world of cryptocurrencies has ballooned from a niche experiment to a sprawling, trillion-dollar financial sector, complete with its own heroes and villains and warring tribes.
But maybe you find yourself nodding along at parties when the conversation turns to the collapse of Sam Bankman-Fried’s empire, or the merits of proof-of-stake versus proof-of-work. (Or better yet, maybe your parties aren’t dominated by insufferable nerds?)
At any rate, it’s 2022, and a lot of people still can’t really wrap their heads around cryptocurrencies. If you’re one of them, stick around. We’re breaking down what this industry is and why it matters, even if you have no intention of ever investing in it.
The tl;dr version: Cryptocurrencies are a form of digital assets that are secured by a decentralized network of computers.
Unlike traditional “fiat” currencies, such as the euro or US dollar, cryptos reject the idea of being controlled by a central bank or government. The original crypto, bitcoin, emerged in 2009, out of the ashes of the worst financial crisis in modern history.
The pioneers of the digital currency world basically said, to heck with your government control, we want our own currency that can’t be manipulated by any one entity. (It’s that anti-establishment origin that makes some of the crypto faithful rather, shall we say, intense when they get a chance to talk about it.)
The term “crypto” harkens to the way the networks are secured, using cryptographic systems (think: really, really elaborate encryptions) that make the tokens virtually impossible to counterfeit. When we talk about “crypto,” we could be talking about the virtual tokens themselves, or the entire ecosystem of digital assets.
The other key ingredient to be familiar with is the blockchain. To save us all time, I’m going to dramatically oversimplify here: The blockchain is a digital public ledger that records transactions. It’s the record-keeping system upon which most cryptos are built.
“Think of the blockchain as a Google spreadsheet,” said Gareth Rhodes, former deputy superintendent at the New York State Department of Financial Services, who is now the managing director at research and advisory firm Pacific Street.
“If Gareth gives Allison $10, and Allison gives someone else that same $10, how do you know that Allison is giving those same $10 that she received from Gareth to her friend? You need some sort of way of verifying that every entry on that Google spreadsheet follows the one in front of it.”
Basically, there’s a vast community of auditors out there who are invested in the project (more on them in a minute).
Once the transaction is verified by the network it is stored — forever — in an immutable “block.”
Bottom line: Blockchain is the underlying technology of the crypto world. It’s the bones. And if you engage a crypto evangelist on it, you’re bound to get an earful about how it’s the most important technological innovation of our time.
And like, sure, people are starting to adopt blockchain systems outside the world of crypto, and they do seem to hold promise. Think about medical records — those need to be super secure but historically have been messy and inefficient to transfer. The global food supply is another area where a blockchain is making it easier for big food producers and distributors like Walmart to track items from farm to fork, and respond more quickly when contaminated items get into the mix.
But if I’m being honest, the hype around blockchain feels out of proportion to the use cases that have so far been laid out by its proponents.
If you want to dive deeper, the tech news site the Verge has a helpful article on blockchain here.
It may seem that crypto was invented out of thin air. To some extent, that’s true.
The bitcoin network went public in 2009, created by an anonymous developer (or group of developers) using the name Satoshi Nakamoto.
Fast forward to today, after several booms and busts, and that community is now a massive global network of very expensive, very powerful computers whose only function is to run algorithms that solve math problems in a process called mining.
Mining is a tricky concept — there are no headlamps or pick axes — so Rhodes suggests thinking of it as “auditing.”
“Mining is basically just a process through which people who are invested in securing and verifying the network verify those transactions” on the blockchain/Google spreadsheet, he said.
All the computers in the network are essentially racing toward a “target hash” — aka a really long numerical sequence — and the first computer to spit out the right sequence to match the target gets to create the new block, and is rewarded with bitcoin.
It’s basically a game with two functions: verifying transactions and putting new bitcoin into circulation. Another way to think of it is playing Powerball, where you have to match a set of numbers to win, and the more tickets you buy — or in the case of crypto the more hashes your computer can spit out — the better your chances of winning.
This computer competition is happening all the time, with a winner creating a new block in the chain roughly every 10 minutes, 24 hours a day, seven days a week.
The whole process eats up a stupid amount of computing power, which is why you hear people saying bitcoin is an environmental disaster. That may be something of an exaggeration — and advocates are quick to note that traditional finance isn’t exactly a green business — but it’s absolutely true that mining requires a huge amount of power, much of which is derived from fossil fuels.
That’s one of the main arguments made by devotees of the second-largest crypto, ether, which uses a different protocol to verify transactions that is far less energy-intensive.
LOL, not much. At the time of this writing, the number of things you can actually buy with crypto is growing, though it’s still very small. Some retailers and shopping platforms have warmed up to bitcoin — Home Depot, Overstock and Shopify, to name a few.
But the vast majority of retailers don’t accept it. Which kind of undermines its whole “currency” part of the cryptocurrency promise.
Most people who own crypto are treating it like an investment (albeit a speculative one).
The combination of FOMO and a bored populace stuck at home in the pandemic helped drive up demand for bitcoin and other tokens, a wave that peaked in late 2021. Since then, prices have cratered. Bitcoin has lost some 75% of its value since its high in November 2021. Ditto for ether.
If you’re thinking of investing, be prepared for wild and unpredictable swings in value. Crypto not for the faint of heart.
Indeed! And the US regulator in charge of overseeing stock markets agrees.
Gary Gensler, head of the Securities and Exchange Commission, earlier this year announced the agency was nearly doubling the size of its crypto department and warned that unregistered crypto exchanges may be operating “outside the law.” He’s also vowed to work with Congress to craft regulations for the industry.
That won’t happen overnight. Crypto is the Wild West, and writing rules for an industry founded on doing its own thing outside of government oversight is … complicated. As Bloomberg’s Matt Levine put it: “If you try to write all the rules from scratch in one go you will get things wrong. And then people will ruthlessly exploit whatever you get wrong.”
Ah, good question. The answer is yes. And no.
Are there scams within crypto? 100%. There are also plenty of scams within traditional finance (or TradFi, in crypto lingo). In addition to just generally high-risk bets and shady companies with snappy names, there are actual crypto Ponzi schemes playing out.
But are all cryptos a scam? Probably not. There’s still plenty of debate about the utility of assets such as bitcoin and ethereum, and whether their grand vision for the future is one we all want to get on board with.
The potential utility of cryptos can be a difficult concept for Americans to grasp because the US has a very sophisticated financial system, Rhodes tells me. “We can put our money in the bank and we don’t have to worry about it.”
But things aren’t always so reliable in other parts of the world. “You have all these scenarios outside of the United States where government control over the financial system can give authoritarian regimes enormous power over citizenry, and also the mismanagement of some of these countries’ economies.”
Being decentralized puts the power, in theory, in the hands of the people.
To be sure, the technology isn’t there — yet. A person wanting to stash their money in bitcoin because the dictator running the economy is letting inflation run wild could do so, and they could trade it within the crytpo ecosystem. But at some point, to use it to buy anything, they’ll most likely have to convert it back to fiat, aka good old-fashioned legal tender issued by a government.