Decoding Cryptocurrency

You can hardly turn around these days without hearing about Bitcoin, Ethereum, NFTs and that dog that’s been made into a digital currency. After about a year of reading and attending virtual webinars, we finally have some understanding of Bitcoin and its brethren. We want to emphasize ‘some’ understanding. We are not computer scientists nor facile with, say, blockchain, so no doubt certain readers will be able to run circles around us in this regard. This piece is more for the casually curious.

Here are the basics, with many of these questions gleaned directly from what clients have asked us:

  • Can you actually hold a Bitcoin, ie does it have a physical representation? No. Bitcoin and other digital currencies exist only digitally. This is not too different from, say, a credit card payment. Actual currency may never change hands when you make a credit card payment. Instead, all the transfers – from you to an intermediary to your seller and to his bank account – happen in the form of digital entries.
  • Why does Bitcoin have value? Isn’t it just a bubble ready to pop? Value is conferred by people who make judgments, which applies to any currency. Bitcoin offers intangible attributes that ordinary currency does not such as anonymity, easy and fast passage across borders, universal recognition, and the fact that institutional trust is unnecessary for its use. We in the US do not think about this latter item but if you lived in Caracas, you would. Bitcoin production in particular (but not the universe of cryptocurrencies) is limited so if demand rises, so must the price. In the future Bitcoin may be necessary to make some applications function, which is true of Ethereum now. Recent history, however, implies that cryptocurrencies are the ultimate risk asset, rising with the stock market, and falling when it declines. If Bitcoin ever deviates from that relationship, it will mark a sea change in the ‘valuation’ of this elusive asset.
  • Isn’t Bitcoin just for criminals? No. The estimate of criminal activity conducted in Bitcoin is low. In reality, far more crime is geared towards acquiring and using the world’s reserve currency, namely the US dollar.
  • How can Bitcoin be a ‘currency’ if it is so volatile? The word ‘currency’ is a misnomer, or if you don’t accept it as a misnomer, then you need to think about currency a different way. Today, a gallon of gasoline averages $3.78 in Oregon. Last year at this time, the Oregon average for a gallon of gas was $2.67. The dollar has dropped in value in a short period, versus gas, by 42%. We do not think of the dollar as volatile in this way, but it is. It buys more or less of various items over short time frames routinely. Bitcoin is just another ‘thing’ priced in US dollars that fluctuates in value. Every day the value of the yen, the lira, the Euro, changes against the dollar. Granted, Bitcoin changes a lot more in short time frames, but whether this volatility lasts or not is to be determined.
  • What is blockchain? Blockchain is a secure, immutable, programmable digital ledger. Affirmation of an addition to a blockchain is decentralized and anonymous, time-stamped and irreversible. All participants in the blockchain must unanimously agree to a transaction. Participants are paid for ratification in cryptocurrency or fees. One ‘use case’ for blockchain is to record the title to a house; another could be your ownership of Bitcoin. Interestingly, Bitcoin can be fractionated into very tiny slices. Blockchain allows that; so you can imagine that fractional interests in assets become much easier to achieve in a blockchain environment. No legal contracts, no docusign!
  • What is an NFT? NFT stands for non fungible token, and it is a digital representation of something. It can be a moment (TopShot is selling NFTs of great moments in basketball history), a static piece of art, a magazine cover, or it can provide access to an event. “Non fungible” refers to the fact that it is not exchangeable for anything else, ie it is unique. NFTs are sold largely in Ethereum. If you own an NFT, no one else can also own it. Others can look at it, copy it (sometimes) but only you can own it.
  • What will happen if governments ban Bitcoin? Banning Bitcoin would be tough. It can exist in a completely private wallet – not on the internet – that you can trade with someone else privately. Ownership is represented by very long public and private keys, which are currently impossible to hack in a human lifetime. Some governments have banned various aspects of cryptocurrency – like the trading it, but not ownership of it, transactions for goods but not trading it – but it does tend to pop up in other countries that have not banned it, simply moving around the world to more hospitable jurisdictions. If you think the world’s countries can all get on the same page to ban cryptocurrency, then stay away from cryptocurrency!
  • How can Bitcoin or blockchain be used? We gave an example above, using blockchain to record the title to a home. Bitcoin and Ethereum are used today in payment systems like Flexa, Coinbase Commerce, Bitpay and others. So if a retailer uses one of those payment systems, you can send your Bitcoin or ether to, for instance, pay your AT&T bill (via Bitpay).
  • How do you store Bitcoin? Bitcoin and other cryptocurrencies can be stored in a myriad of ways. We already mentioned a private wallet. A wallet can be a hardware wallet, like a flash drive with your keys recorded on it stored in your safe; or a software wallet, which resides on your computer hard drive (better keep track of that computer). You can also use an exchange like Coinbase which keeps your keys for you. Exchanges have been hacked in the past so beware this option. Casa offers the equivalent of a private bank/Fort Knox for Bitcoin holdings, complete with concierge service.
  • Should Bitcoin be in my portfolio? Other than indicating that you should only use money that you can afford to lose to participate in the digital currency wave, we are not currently making any recommendations pro or con regarding adding Bitcoin to client portfolios. At this point we can only act as a resource to research the topic and tell you what we know.

This overview barely scratches the surface of a complicated topic. We’ll be continually learning as these markets develop, so check back if you want to know more.