The Los Angeles Lakers’ home game on Christmas Day against the Brooklyn Nets will be a coming out party for crypto.com Arena, the new name for the facility formerly known as Staples Center. The goal of the name change deal, which will reportedly cost the Singapore-based company more than $700 million, is to promote crypto.com as the best way to buy and sell cryptocurrencies and related digital goods.
Today, however, only a fraction of the TV-watching world could explain the difference between a bitcoin and an Amazon gift card, or between a non-fungible token and a Chuck E. Cheese token. The hype surrounding cryptocurrencies may be inescapable, but that doesn’t mean people understand how they work or why some of their values have swung so wildly.
Here are some of the basics to help you get up to speed. Do not interpret any of this as an endorsement of cryptocurrencies, which today are not particularly useful as currencies or reliable as investments.
What is cryptocurrency?
To understand cryptocurrency, it’s helpful to consider that bitcoin rose from the ashes of the 2007-08 global financial crisis.
Created by an individual or group using the pseudonym Satoshi Nakamoto, bitcoin, the first cryptocurrency to gain a global foothold, was billed as a digital version of money that was independent of banks and impervious to government interference. Anyone could trade bitcoins with anyone else at any time for any reason.
But cryptocurrency is just the first use of a technology, called “blockchain,” that is slowly spreading to (and potentially shaking off) other activities, such as real estate, music and gaming. The Bitcoin blockchain exists solely to keep track of bitcoins, but Ethereum and later initiatives use blockchains to run “smart contracts,” applications that could be activated on demand. As a result, blockchains offer an alternative not only for banks and government record keepers, but also for computer servers.
Blockchains rely on an extensive network of computers to store and update a permanent digital record of every transaction, eliminating the need for a centralized ledger or registry. They use cryptography, mathematical techniques that convert information into an essentially unbreakable code, to ensure that the people exchanging bitcoins are who they say they are and to allow computers on the network to keep identical and immutable records. That prevents bitcoins or any other asset tracked by a blockchain from being duplicated or spent more than once, though they can still be lost or stolen (more on that later).
Records on a public blockchain like bitcoin are open for all to see; anyone can inspect the list of transactions (even while they’re taking place, though that’s like trying to read the labels on boxes speeding down a conveyor belt) or track the activity of any individual account holder. But the identities of the account holders are encrypted, so it is not possible to know who is behind the accounts that carry out those transactions.
But what is it worth?
Cryptocurrencies are worth what the market says they are worth. Investors have poured more than $2 trillion into bitcoin and other cryptocurrencies, presumably in the expectation that future investors will be willing to pay more for them.
One could argue that this is all sleight of hand, the conjuring of money out of thin air. Technically, each bitcoin started out as payment that some person gave themselves for doing the computer-intensive cryptographic work required to record transactions on the blockchain (an activity called “mining”). But their value depends on what people are willing to pay for them, which in turn depends on where people expect the price to go over time.
The bulls note that the bitcoin supply is capped at a level that warrants scarcity; there will never be more than 21 million bitcoins, while the world population is 7.9 billion and growing. In his opinion, the more bitcoin is used, the more demand will drive price growth.
The bears argue that wild price swings (Bitcoin has seen two boom-and-bust swings in 2021 alone) will deter most people from jumping on the crypto bandwagon. So could the vulnerability of cryptocurrencies to price manipulation and the whims of momentum-driven investors.
In a paper summarizing economic research on bitcoin, Parthajit Kayal and Purnima Rohilla of the Madras School of Economics in India warned that the price of bitcoin could fall to zero if the benefits bitcoin offers “are taken away by the government or currencies are hampered.” for fraudulent activities or if a better alternative emerges on the market.” There is certainly no shortage of alternatives; there are more than 7,500 cryptocurrencies in circulation now, according to Statista.com.
Is it really currency?
As a medium of exchange, cryptocurrency leaves a lot to be desired. To begin with, few companies accept these coins as payment today.
The list of places where you can spend bitcoins includes a handful of tech companies, a couple of sports franchises, and a handful of retail stores and restaurants around the world. There are workarounds like Purse, which allows you to exchange bitcoins for Amazon gift cards, but the need for such services underscores how poor a cryptocurrency substitute for dollar bills currently is.
One place you won’t be able to spend crypto today is crypto.com Sand. Steven Kalifowitz, crypto.com‘s, said the company is working on how it will integrate its cryptocurrency-based payment app and other products into the venue and its other partnerships.
Just as important, bitcoin has not held its value in the short term, a key attribute for any currency. The value of the US dollar rises and falls relative to the currencies of other countries, and its purchasing power decreases over time due to inflation. But it doesn’t jump 33% in a week, as bitcoin did in the first week of October, nor does it lose nearly a quarter of its value in a week, as bitcoin did in mid-May. A 2017 study found bitcoin prices to be 30 times more volatile than the dollar, euro, or yuan.
On top of that, you have to pay fees to get your cryptocurrency payments or other transactions added to the blockchain. Those fees tend to be a small percentage of the transaction value, less than what merchants pay credit card processors. But if you want your transaction processed quickly, you may have to pay a higher fee. Otherwise, the wait could be hours or even days.
Given the dramatic price fluctuations and other drawbacks, why would anyone use bitcoin or similar technologies as a medium of exchange? Possibly because cryptocurrencies can be spent anonymously, like cash, but remotely. That may explain why digital currencies are the preferred payment in ransomware schemes and contraband purchases on the dark web.
For those who really want to use their cyber coins as currency, there is a class of tokens called stablecoins whose value is pegged to the value of the dollar or some other non-crypto asset. The most popular of these is called Tether; its creators promise that each Tether token is backed by $1 in cash and other reserves (although the value of those reserves has been disputed), and its price has remained at or near $1 for much of its history.
So what is that?
For most people who buy cryptocurrencies, it is an investment. But as the roller coaster nature of crypto markets indicates, it is unconventional.
Cryptocurrencies are not like shares of corporate stock, whose value is at least nominally tied to something concrete (namely, the growth and profitability prospects of the company). Nor are they like commodities whose supply and demand can be forecast.
Instead, they are more like a collectible item, like stamps, whose value is largely due to their scarcity. There are no quarterly reports or analysis, production forecasts or fundamental measures like earnings per share to guide investors. Instead, they have to rely more on any evidence they can find about which cryptocurrencies are having momentum in the market.
According to Kayal and Rohilla’s article, researchers have noted a number of factors that appear to be correlated with bitcoin values. One is geopolitical risks around the world; Bitcoin prices become more volatile as the index of those risks increases. Meanwhile, interest rates after inflation and tax charges are “significant in determining Bitcoin prices,” they wrote. The researchers also found that bitcoin prices rose as stock trading volume increased, but fell as stock prices rose, Kayal and Rohilla reported.
One final factor that suggests cryptocurrency trading is an insider’s game: studies show substantial evidence of price manipulation in bitcoin securities. For example, a 2018 study by the doomed Japanese bitcoin trading site Mt. Gox found that “Bitcoin prices increased on approximately 80% of days on which suspicious trading activity was recorded, while increasing on a comparatively smaller number.” of days, 55%, in which no such suspicious activity was observed,” Kayal and Rohilla wrote.
How do you start?
Most cryptocurrencies are available for anyone to buy. All you need is a way to submit your request to the blockchain for the coin in question.
The easiest way to do this is to use an exchange, such as those operated by Binance and Coinbase. These are the cryptocurrencies equivalent to a mall, offering access to many cryptocurrencies. Typically, these sites will provide a digital wallet that looks a lot like a checking account, except it’s protected by a personal cryptographic key instead of a PIN. Deposit cash or cryptocurrency into the wallet, and finance your purchases, keep track of your holdings, and store digital receipts that track what you’ve bought and sold.
That’s called an “escrow” wallet, which means it’s stored in the cloud and maintained by a third party who can help you recover your password. One drawback is that it relies on centralized servers that can be attacked by hackers, as the BitMart exchange was this month, resulting in $150 million or more in cryptocurrency losses. Such losses may be covered by insurance, as appears to be the case with BitMart. But sometimes they are not.
If you’re worried about that kind of threat, you can make one more transaction on your exchange to transfer your holdings to a “non-custodial” wallet in your possession. It could be a software application on your computer or phone, like the one in MetaMask, or a specialized high-security USB drive (called a “hardware wallet”). Either way, you just keep it, and if you lose your password, you’ve lost your cryptocurrency.
If you jump into the crypto pond, watch out for sharks. According to Chainanalysis, crypto users lost more than $7.7 billion to scams and other crypto-based crimes in 2021 alone.
Los Angeles Times (TNS)