Two buzz words are "blockchain" and "disruption" — not to be confused with the current "supply disruption" — the idea of using modern technology to provide more efficient solutions, making current items or processes obsolete.
In 2008, a white paper was published under the name of Satoshi Nakamoto. The title: Bitcoin: A Peer-to-Peer Electronic Cash System. The nine pages and work on open-source coding as early as 2007 led to the release on 12 January, 2009 of the software that supported it which could be used by anyone, anywhere, without a centralised authority.
All of this is attributed to Satoshi Nakamoto, a person or more likely a pseudonym for a group of people who have so far remained unidentified.
The idea is simple: settling a transaction needs some system for payment and record-keeping that both parties accept. It simply replaces the need for an intermediary, such as a bank, by using direct settlement.
No-one has ever seen a bitcoin, nor will they. A "holding" only exists as an entry in a ledger. If the bitcoin ledger says you have a bitcoin, then you have a bitcoin. That’s all a bitcoin is. So, the security of transactions and the ledger was, and is, paramount in making bitcoin acceptable, as it has become over the past 14 years.
So how is it done? The blockchain associated with bitcoin has a huge number of nodes: the ledger is maintained by everyone on the network keeping track of every transaction for themselves. Every bitcoin transaction is broadcast to the network. So, the ledger is not really just a list of addresses and their balances; it’s actually a record of every single transaction. Technically, that means that it is possible for anyone to find out all previous transaction related to their bitcoin.
Which brings us to the question of, "Where do bitcoins come from?" Every one of them, from the very beginning, has been "mined". The action of mining has three concepts associated with it: scarcity value, proof of work, and difficulty (if not impossibility) of reversing a transaction.
It stands to reason that there is an intrinsic value to items that are scarce. In the white paper the ultimate number of bitcoins is to be limited to 21 million. There are currently more than 19 million bitcoins in existence. New bitcoins are added about every 10 minutes, which is the average amount of time that it takes to create a new block of bitcoin.
Without going into detail, mining takes the form of guesswork — using an algorithm by high-speed computers — to try to get an acceptable number which results in the miner getting the whole block.
This is a race! Only one miner gets the block. This calls for special hardware and "always on" computers, which use large amounts of electricity and internet connection fees.
The electricity used in bitcoin mining worldwide is equivalent to that of some medium-sized countries. Given supply constraints, some countries have banned bitcoin mining. In any case, the mining reward was originally 50 per block but currently it is about 6.25. However, these costs represent "PoW", or proof of work.
This also makes the idea of trying to reverse a transaction very costly — and almost impossible due to the one-way nature of encoding employed.
So, working harder for longer, at greater cost, with more competition and lower rewards? No wonder bitcoin mining is losing favour.
What has all of this to do with the price of bitcoin which, as most people know, was very low at the beginning before its general acceptance and amid a lot of scepticism? It reached $US100 ($NZ159) in August 2013 and was over $US950 four months later. It passed $US2000 in May 2017 and $US16,000 seven months later.
No wonder that it became headlines and an attractive opportunity for people who saw it as a get-rich-quick scheme. That’s about where it is now but having touched its all time high of $65,000 in November last year. This time it is making headlines for the opposite reason — down more than 70% from the peak.
What about the second most well known cryptocurrency, Ethereum? Vitalik Buterin is the brains behind this one, starting in 2014. This is also referred to as the Ethereum Virtual Machine. Ethereum works a lot like bitcoin: people create transactions, they broadcast them to the network, the transactions are included in a block, the blocks get chained together, everyone can see every transaction, etc.
But whereas bitcoin transactions are mostly about sending payments, on the EVM you can also write a program to run on the computer to do things automatically, referred to as a smart contract. The instructions are broadcast to thousands of nodes on the network, and they each execute the instructions and reach consensus on the results of the instructions. Your program needs to run thousands of times on thousands of computers. That all takes time, which makes the computer slow.
To prevent what could become an extremely long program or infinite loop, Ethereum limits the number of computational steps or by value, depending on the amount of "gas" purchased.
Incredibly, you can also use a smart contract to create new cryptocurrencies. These cryptocurrencies are generally called "tokens." If you do that, people might pay a nonzero amount of money for it. What?
Let’s look briefly at one called Dogecoin. This was created in 2013 and meant to be a parody of the coin boom. Unlike bitcoin, which is designed to be scarce, Dogecoin is intentionally abundant — 10,000 new coins are mined every minute and there is no maximum supply.
It is an example that you can make up an arbitrary token that trades electronically that you hope people will buy for no particular reason! In January its price was $0.19104918 and is now $0.07839112 (yes, both quotes are to eight decimal places of a US dollar).
Of course, success breeds — well, at least an abundance of new offerings and variations and derivatives, including ETFs and NFTs. No need to explain what each of those acronyms stands for.
The most important one is Binance, the world’s first bitcoin-based Exchange Traded Fund which "invests in and holds substantially all of its assets in long-term holdings of bitcoin." Its price is therefore expected to mirror that of bitcoin. This saves the investor from having to remember the password, or keep track of all the transactions of bitcoin, as one of the nodes of the network.
It turns out that, if only by association by a public concerned about the contagion effect of the collapse of another cryptocurrency operation, FTX, Binance has experienced outflows, some in the form of coins, to the extent that it has (temporarily) halted withdrawals.
This is all made worse by the announcement by audit firm Mazars that they have halted work on "proof of reserves".
FTX is currently the subject of any amount of media coverage and regulatory investigation, especially of its founder Sam Bankman-Fried.
Much discussion, accusations and trial-by-media remains to be seen.
Part 2 of this series emphasised that the crypto environment has been characterised by a lack of regulation. No doubt, a new regulatory environment will be demanded to protect the financial system.
The question is whether this is a "tulip bulb" or "light bulb" moment for many relatively new entrants to the fields of investment and speculation.
- Liston Meintjes is an independent consultant and analyst of business, economics and markets, with many years’ experience in the investment industry.
