In defense of crypto

2021-11-05

In this blog, I'll be addressing the mainstream view of the crypto space and the things that people quickly point to in dismissing the technologies. The idea for creating this rebuttal to the mainstream critiques came from someone who has played instrumental role in shaping the way I think. Kenneth Hawkins, a calculus and computer science teacher I had in highschool, always seemed to be a nonconforming thinker, one who always has a healthy dose of skeptism. He, knowing that I have been diving into the crypto space, had recently shared with his students a video parody on crypto. It's a pretty hilarious video that I recommend watching before reading the rest of the blog and it does a great job at highlighting the different critiques that the mainstream makes.

He offered me a rebuttal and I accepted.

Crypto Parody Video

Crypto parody thesis

My takeaways from the video:

The dollar is strong
Bitcoin, or other crypto, cannot be used as a currency
Crypto is bad for the environment
Crypto is only for criminal activity
NFT's are worthless
It's easy to lose your funds

My crypto thesis:

Blockchain and crypto technology can level the playing field and achieve a fairer world through the automation of trust. Our world is built on trust and trust can be and is easily corrupted; absolute power corrupts absolutely. When something is unfair, there's an unequal distribution of power. Someone has the ability to pull levers changing the dynamics of the game that you don't have access to or have visiblity into.

This is not the mainstream view, rather it is one of narrow scope. People generally see the crypto purely as a basket of highly speculative fictional currency. What is potrayed to people is the coin abbreviation, BTC, ETH, LITE, the $ sign, and a daily % gain. From a surface level, it makes sense why many equate it to the tulip mania event in 1634, where there was an asset, a tulip, with no underlying utility that had been inflated to unprecedented levels, due to speculation and eventually crashed. But the difference is, there is utility behind crypto. There is a diverse and wide set of applications that are enabled by this technology.

From a high level, by the automation of trust, this technology enables:

Programmable money:
- Decentralized finance
- Smart contracts
Programmable ownership.
Store of value
Global payment rails
Decentralized autonomous organizations
Decentralized computing
Implementation of the perfect currency.

I won't be covering all of the different use cases of this technology as I will be mainly arguing against the critiques made in the parody view. However, it is important to keep in mind that crypto has far more applicability than what the parody video potrays.

Like all new technologies that promise a revolutionary new world, there is a lot of hype and speculation. You can absolutely get scammed. This does not mean the technology is not inevitable, rather that it requires a lot more due diligence in being an early adopter. Similar the dot-com boom in 2001, the technology itself was inevitable and so was the amount of greed. Early adopters of the dot-com space that separated the signal from the noise faired extremely well.

The dollar is strong

Many of the critics of Bitcoin live in financially priveledged areas of the world which only compromise 13% of the population. To have a relatively stable currency with relatively good monetary policies, is the exception rather than the norm. The other 87% of the world live under much different conditions being born into autocratic control or into significantly more instable currencies. The world doesn't run on democracy. The world is operated under a select few individuals who get to pull the levers and make the decisions. 4.3 billion people live under authoritarianism.[1] 1.3 billion people live under double or triple digit inflation. Further, 56 distinct hyper inflation events have occured between 1975 and 2009 with none happening under currencies constrained by a commodity standard. How can your quality of life improve when you're financially in a constant uphill battle that's growing faster than you can climb it. You're stuck at the bottom with an unpredictable and untrustworthy monetary policy with no way to climb out and build wealth.

Contrasting the fiat currencies of today, bitcoin offers a transparent, predictable, borderless, democratic, incorruptable and censorship resistant means to build weath. All you need is an internet connection, which increasingly is the case.

All facets of bitcoin are completely transparent and predictable as bitcoin is entirely open source code. The number of bitcoin that will ever be mined is 21 million, of which 18 million exist today. The rate at which bitcoin is minted, (mined), and the compute cost for transactions is public. The cost of bitcoin is determined by a global open market and not set by any single entity. Just go to github and look at the code! You don't have to trust anybody, the monetary policy has been codified.

Bitcoin is borderless, you can make a transaction to anyone from anywhere in the world with an internet connection. In the fiat currency world, citizens get forced into using their countries instable and unpredictable currency. When Afganistan was recently taken over by the Taliban, much of the country saw their savings gone overnight. Banks froze withdrawals and western union paused transfers. A few individuals with the foresight fortuitously transfered their money into bitcoin and now were able to move anywhere in the world with their wealth safe.

Bitcoin is democratic as all improvements are made by the community and approved by the community through the use of BIPs, Bitcoin Improvement Proposals. These get vetted by the community and rejected if they don't find enough approval. This is why Bitcoin moves much slower than the rest of the crypto space. But many argue that it is a feature rather than a bug as it means it is the most decentralized. The is no leader in Bitcoin and all changes have to be filtered through the community.

Bitcoin cannot be easily corrupted or censored due to the security guarantees that the proof-of-work consensus algorthmn provides. To stage an attack, you would need to control of 51% of the network which is an unfathomable amount of resources.

Bitcoin cannot be used as a currency

To this, I ask, why can't it? Let's look at what attributes would make the perfect currency and then see how traditional currencies versus bitcoin stack up.

Attributes of the perfect currency:

Borderless. Currency is suppose to faciliate trade and currency that is constrained by borders restricts it.
Transportable. You should be able to take it anywhere in the world easily and without friction.
Effecient. There shouldn't be a high overhead per transaction.
Valuable. You shouldn't be forced to play hot potatoe with your currency and immediately be forced to trade out of it or be penalyzed if not. There should be properties of this thing that everyone in the world can value.
Secure. You want your currency protected from malicious attacks. Forgery of any kind should not be possible.
Transparent. All aspects of the currency should be viewable.
Democratic. Any sort of policies around the currency should be democratic. Power figures should not be able to dictate the currency that you denominate your wealth in.

Attributes of Fiat Currency:

~~Borderless~~ Fiat currencies are only spendable within a countries borders.
~~Transportable~~ Because it's not borderless you have to exchange your currency into the currency of the place you are traveling. Many times you literally have to carry the cash with you. To transfer money to people across borders you have to rely on expensive and slow third parties like Western Union.
~~Effecient~~. Traditional payment rails like Visa and Mastercard charge anywhere from 1.3% to 3.5% per transaction. To send $100 from the US to India using a credit card and western union you face a 10.2% fee. You don't always see this because the cost is baked into the price or the exchange rate.
~~Valuable~~. People value things with high utility. People value having a sound form of money that they can build wealth and transact with. People value Bitcoin.
~~Secure~~. Fiat currencies can be forged and banks can fail. The monetary policy is not secured against bad actors.
~~Transparent~~ The information provided to people about the economy and the monetary policy is far from the truth. Decisions are being made on the monetary policy based on very weak and unreliable data. One of the biggest CPI figures, rent, reported on by the federal reserve, was over 50% off when compared to real time data retrieved from Zillow.
~~Democratic~~ The majority of the world's population lives under autocracy. For the U.S., the levers of the economy live under a priviledged few individuals that can act on their own accord. Our link to who these individuals are and what decisions are being made by them is far from direct.

Attributes of Bitcoin:

Borderless. All you need is an internet connection and you can transact with anyone for anything anywhere in the world.
Transportable. All you need is your private key and you can take your bitcoin anywhere in the world.
Effecient. Transactions cost a fraction of what traditional payment rails cost with the innovation of layer 2 networks like the Lightning network that is currently being used in El Salvador and elsewhere globablly.
Valuable. People value things with high utility. People value having a sound form of money that they can build wealth and transact with. People value Bitcoin.
Secure. The network is secured cryptographically and by proof-of-work.
Transparent. Bitcoin exists as open source code where every decision that has been ever been made on the future of bitcoin is viewable as well as the direction that it is heading.
Democratic. All improvements to Bitcoin are made through Bitcoin Improvement Proposals which anybody can construct and the community vettes. Bitcoin exists as open source code.

Crypto is bad for the environment

The reference to crypto's wastefulness on the environment is a reference to the proof-of-work algorithmn, one mechanism that a subset of the blockchains use that allows for a globally decentralized database to work. This algorthimn was made famous by Bitcoin as it was the first mechanism used to achieve consensus on a globally decentralized database known as the blockchain. One pseudo anonymous person or small group of people known as Satoshi Nakamoto founded Bitcoin in 2008. While the application of proof-of-work to achieve a globally decentralized database was revolutionary at the time, the parody assumes that the technology cannot iterate or improve. If anything is inevitable in life, bar complete catastrophe, it's evolution.

In 2012 with peercoin, an alternative algorithmn, proof-of-stake, emerged to achieve consensus on a global decentralized database. More widely adopted protocols such like Caradano in 2017 followed suite. Proof-of-stake is another class of consensus algorthimns, but unlike proof-of-work it does not incentivize energy consumption. With proof-of-work the more computational horsepower or hashrate that you have, the more voting power you have to validate transactions. This makes it extremely hard to be a bad actor in the network as it is prohibitevly expensive to buy enough equipment and consume enough power to overtake the decentralized network. Proof-of-stake on the otherhand makes it prohibitevly hard to overtake the network by distributing voting power proportionally to those who have stake in the currency; those who hold it. Proof-of-stake sideskirts the electricity consumpiton completely and it's energy usage is primarly validating transactions. Cardano's most recent iteration of it's proof-of-stake algorithmn is estimated to be 4 million times more effecient than the proof-of-work blockchains like Bitcoin.

However, it doesn't seem like proof-of-work is going to be completely replaced. Afterall, the two largest non stable-coin currencies by marketcap are Ethereum and Bitcoin which both use proof-of-work. Cardano's proof-of-stake comes in third. Ethereum is currently transitioning to proof-of-stake right now and this would leave just Bitcoin. Bitcoin is more decentralized than the others. It has no known founders and is supported completely from the ground up. It moves slower and needs more consensus among the community to change the protocol, contributing to the reason why it is still proof of work.

So, it is argued that Bitcoin does use proof of work and therefore requires more energy and is therfore bad for the world to adopt, but this is just a surface level analysis.

According to a 2020 anaylsis, Bitcoin consumes 0.04% primary energy consumption, 0.2% electricity and 0.1% carbon emissions. To digest these numbers and their significance, you need some context, you need something to compare it to. Our socieity has accepted other technological innovations despite their energy requirements based on the utility they provide. Modern luxuries such as Aviation, A/C, and Tumble air dryers consume 125x, 33x, and 2x as much energy as Bitcoin. Gold, Bitcoin's analog, a physically mined product, produces an estimated 3x the energy emissions. Unlike many of these luxuries which have been only adopted in 1st world countries, Bitcoin is being adopted globally.

People would like to point out that Bitcoins energy consumption is growing exponentially when looking at the global estimated hashrate, when in fact it's growing proportional to the number of users in the network. For example, A/C has not been adopted globally due to the cost of standing up that service in many poorer countries, but if we saw the adoption double every year until we the global population was reached, we'd too see a exponential increase. In fact, if we reached global adoption of Bitcoin, we'd actually see the carbon emissions start to decrease over time as we innovated in renewables, mining hardware and as the block difficulty increased.

When analyzing the hashrate in the context of energy consumption it's important to remember that it does not scale proportional to the energy consumption of the network. In the early days of bitcoin mining it was economically feasable to mine bitcoin with a standard personal computer. However, Bitcoin has a baked in feature that reduces the amount of bitcoin mined every 4 years, known as halvings. Miners are incentivised to use more and more effecient hardware to mine, effectively deprecating older hardware. Miners now use application specific integrated circuits, ASICS, to mine. If you try to mine with less effecient hardware, you are going to lose a lot of money. An anaylsis of the lifespan of current hardware is 3-4 years at most. Looking historically, you can contrast this with how much compute power the old building-sized main frame computer produced relative to its energy consumption. Today, the phones in our pockets are millions of times faster and consume many orders of magnitude less energy. However, for the energy Bitcoin does consume, where is it sourced?

It's obvious that we don't live in a world yet that runs on 100% renewable energy, but that world is rapidly approaching us and miners are economically incentivised to use the most effecient source. Between 2010 and 2019 the cost of on-shore wind and photo-voltaics decreased by 82% and 38% respectively. The renewables are starting to be cost effective against fossil fuels. It should be obvious that over time extracting energy from a finite source versus from a near-infinite source, will be increasingly be more cost-effective in the direction of renewables.

Yes, Bitcoin consumes energy, just like every other technological innovation. The utility per unit of energy it provides is high compared to other innovations. The energy it consumes scales proportional to the rate of adoption. Nearly any adoption of any technological innovation that grows exponentially will have an exponential increase in energy. The energy consumed is only negative in the context of bad energy sources which is rapidly decreasing overtime. Miners and energy producers are economically incentivsed towards renewables. On top of this Miners are incentivised with increasing block difficulty and decreasing bitcoin block rewards to use ever effecient hardware contributing to an ever growing hashrate which many mistake as a 1-1 correlation to the energy consumed. Finally, technology is the epitome of evolution. Bitcoin was the first step in the evolution of the crypto industry, with most modern solutions side stepping this energy concern all together with the proof-of-stake consensus algorithmn.

Crypto is only for criminal activity

It's true, the crypto industry has been tainted with high profile hacks on major exchanges, used for the creation of ponzi schemes that span as far the eye can see, and used to facilitate illicit black market activity. The notorious Mt. Gox. hacks that occured from 2011-2014 caused a loss of trust from the public. $350 million dollars were stolen over this time period from an exchange that handled 70% of the btc transactions globally. However, we must not lose sight of the fact that these exploits can be fixed. The industry is still very young and developing. Further, we have to again examine this within the context of the financial ecosystem that exists today, which is in comparison to the traditional finance system that is riddled with issues. In the US alone, 11.4 billion dollars in fines were made to banks for illicit activity, the same institutions that are suppose to have the utmost integrity in our society. Crypto wields its user great power, a power that can be a substantial net positive effect on the world, but with that power comes great responsiblity.

As an example of the double edged sword, we have on one side of the token, pun intended, activist groups that are fighting the tryanny of their government by utilizing crypto as a funding avenue protected from oppression. The government may be able to freeze known activists bank accounts, but they can't freeze the blockchain. On the flip side, this decentralized protection that the activist group may enjoy may be the same protection terrorists, money launders and scammers benefit from.

How bad is that flip side? Crypto being a nascent industry, is a target for the media just like any other new idea, concept or industry. Any flaw or negative event sells like hotcakes. Most people do not like change, people want to see it fail and the media assist in that endeavor. We need to separate the signal from the noise and gain some understanding of the nefarious activity in comparison to the traditional financial system.

In a 2021 study by Chainalysis, it was found that in 2019, 2% of all crypto and received came from illicit entities and decreased to 0.34% in 2021. This decrease can in part be due increase in adoption worldwide by retail and institutional users. This activity is small in comparsion to the traditional finance system where the United Nations estimates that 2-5% of global GDP is generated through illicit activity.

Of the criminal activity that exists in crypto, scams account for greater than 50% followed by darknet markets and finally ransomware at 7%. This is where our responsiblity is lacking.

Scams and ransomware are exploits on education and network security. Scams occur because of inbalance of information. One party knows something that the other doesn't. Scams are consentual, in that you can opt out if you had the proper knowledge to vette the validity of the transaction. With regards to ransomware, the issue is of network security. There is a breach in the firewall of an organization that could have been prevented. Organizations regardless of the crypto industry need to invest in more secure networks and cyber security training for their employees. Warfare has been long transitioning to the virtual space and those that do not build up defences will be attacked. An educated person and organization can prevent 100% of these attacks.

Darknet market activity is a more difficult problem to address. How can you prevent illicit transactions from taking place on something that is so censorship resistant?

You kill the demand. The darnet market is a market afterall and if there is no demand, you have no market. I have split the traded goods and services of the black market as listed by wikipedia in the following two categories:

Things that should have a legal market

Personal information
Illegal drugs
Sex toys
Alcohol
Tobacco
Currency
Transportation providers
Fuel
Weapons: In my eyes, this can be legalized to an extent. There's weapons and explosives that can cause massive damage and should not be legalized.

Things that should not have a legal market

Forced labor
Racketeering
Housing rental (charging higher rent on a rental that has fixed rent laws in place)
Counterfeit medicine, essential aircraft and automobile parts
Copyrighted media
Illegally logged timber
Animals and animal products (Non domesticated animals. Endangered animals and etc)
Biological organs

I would argue that there should be a competitive, regulated, and open market for the top items. They should not be illegal, they should be regulated. Currency would not be an item listed in the black market if imperfect currencies weren't in use, currencies that are artificially pegged to something. There is no black market for crypto exchange as you cannot acquire crypto at artificially low prices. The market for personal information can be eliminated as we advance globally, our means of identification. Incorruptable biometric identification can mute the market for counterfeit ids. Lastly, while not the top category, biological organs only exist in the black market so as long as we cannot manufacture them and we are rapidly approaching a time in which we could.

The latter items prove to be a more difficult problem to solve. These categories represent things that should not have an open market and are inherently bad things. I define bad as things that are not mutually consentual between the parties involved in the transaction. When one possesses illegally acquired movies and sells them, they involve the buyer, the seller, and the creator. The creator is harmed in this transaction by the seller profiting off of their illegally acquired time and energy. The black market for weapons puts the public in danger and etc.

For these, how can we eliminate the market? How can we kill the demand? I would argue that a leveling of the playfield in which we all operate could assist in this endeavor. People use black markets as a way to game the system, the system that has been gaming them for so long. When the game is fair, you are less incentivised to take unlawful actions to get ahead.

It's important to note that currently all of this blackmarket activity is currently operable under the usage of cash as its transactions are all offline and untracable. If we eliminated cash and all currency was governed by one central authoritiy in the world, we could trace every single transaction outside of bartering as every unit of currency held could be assigned to an identity maintained by the government. Howver, I don't belive this level of centralization of power is something that we want. We don't want a select few to have the power to govern, surveil, and censor the entire world.

In my eyes, we need to weight the value and utility that crypto can bring the world against the bad. I believe enabling financial soverignty for every individual will create a far better world than what exists in our current system. We can fight the bad with an increased sense of responsiblity. We need better security and education for our internet enabled technologies and people. For the transactions that need to be decriminalized, we need to transfer the demand from the blackmarket to a legal regulated and competitive open market. In enabling crypto, we level the playing field, disincentivizing people to act in malicious ways. As institutional investment increases, we will see that a smaller and smaller share of the market cap will be criminal activity. Finally, I don't believe we have the power to stop this technology from proliferating. As we saw with China's recent ban, the network only grew larger. We should embrace crypto.

NFT's are worthless

Far from it. NFT's, or non fungible tokens, enable secure property rights and ownership for anyone anywhere. Bitcoin does this is a similar manner, enabling property rights over the coins themselves, but NFT's differ in that they manage ownership of non fungible things; the unique digital and physical items that you claim to own. NFT's are disrupting the legacy implementation of property rights and is providing financial soverignty for the world.

As a thought experiment, how can you claim that you own anything at all? Why can't somebody else just claim it's theirs? Well, they can. Ownership has been forever enforced by physical might, or the ability to defend the ownership of your asset physically. Overtime, this defense against property ownership grew larger, expanding from the person to the tribe, to the city, to the government. Today, our property rights are enforced by the government. If you can overthrow the government, you can own everything. Think in recent times about Afganistan. In this evolution, the amount of trust any individual person needs to ensure ownership over their property increased over time. The people that are enforcing the property rights have to be trusted. Power corrupts and we see this eroding of property rights across the world. Your authoritiarian government owns everything you think you own and your life too.

NFT's change this. NFT's create provable and secure ownership of anything digital or physical.

However, there is a lot of hang up on how the physical space could utilize NFT's. Wouldn't you still need some sort of physical protection for your assets? You would, but this misses the point. NFT's would provide a global way to recogonize ownership. Like digital art, it's not the art itself that is being secured, it's the publicly recogonized ownership of the art. If you were on the buying end of the asset, you wouldn't want to pay for it without being able to prove the authenticity and transfer the ownership. If you're asset was stolen by force in the physical space, then the only space that it can live in is the black market. All of the stolen assets could be virtually blacklisted for trade.

In this, the government still could provide physical protection for your asset, but the ownership could be on a public ledger that is immutable from modification unless you have the private key of the owner.

Ownership of assets in digital space is what comes to mind for most when they think about NFT's. They think about multi-million dollar art auctions for digital monkey jpegs and quickly dismiss the whole space. NFT art should not be dismissed and the digital asset space is far bigger than just digital monkeys. The following is examples of real use cases:

Digital Asset Usecases

Domain names: No longer do you need to register your domain name with a central authority who you pay a yearly fee to in order to "own" your domain name. See UnstoppableDomains.com for information on NFT domains.
Financial Instruments: Just like how bankers are able to sell mortgage loans as an asset, you tokenize any financial product and sell it on the secondary market. This includes loans, insurance, options, futures etc.
Collateralized Loans: Home equity loan is an example of a collateralized loan. You have an asset you don't want to sell, but you want to borrow money collateralized with that asset. NFT's allow you to do this with any NFT you own.
Tickets: Have a global marketplace for tickets to any event. No forgery possible.
Digital art: Like the mona lisa, the value is from it being the original piece. The perfect copies made of the piece are valueless because their authenticity cannot be proven. Creators in the digital space can now sell ownership to art pieces like what is done in the physical world. In addition, creators can bake in royalty functionality to their art so that future sales generate passive income for them.
Video game assets: Scarcity in video games is huge. I use to play the game Runescape as a kid and there are rare items in the game that today sell for thousands of dollars. These items function as art as they have zero underlying utility. There has be consistent demand for over a decade. https://www.rpgstash.com/runescape/rs3-party-hats. NFT's can securely manage the ownership of these unique assets.

The digital space of asset ownership extends far beyond what I've listed here and I encourage you to look into it more. However, in the space of physical assets, it hasn't yet been as prolific a technology. This is because there is more friction in the upheaval of the legacy system of physical asset ownership.

Today, ownership of physical assets of significant value are managed by the government. Legislation has been made around real estate, auto, rv, and other assets that require ownership be registered and managed through the government. This is a costly, slow, and trust requiring process. Again, if you don't own your assets, then someone else does and that someone else, the middle man, has to be paid to transfer the ownership for you. Assets that aren't governed by the government are prime candidates for adoption of this technology. Ownership and authenticity can be managed outside of the government at a fraction of the cost and with better security guarantees.

The following are examples of real use cases of physical assets tied to NFT's:

Physical Asset Usecases:

Tickets: I've included tickets in both the physical and digital space as they exist in both currently.
Physical Art: Traditional art lacks in the transparency around managing ownership. Did the previous owner acquire the piece in a legal manner, who are the chain of owners, and how can I verify the authenticity of the ownership?
Clothing/Sneakers: Limited edition clothing and sneakers: clothing sneakers
Real Estate Ownership: Deeds for land or housing can be replaced by tokenization on the blockchain but require legislative approval.
Real Estate Fractional Ownership: Fractionalize ownership in an investment property by tokenizing the ownership. This is similar to the analog version of real estate syndication where an investor raises a bunch of money from passive investors to purchase property a property and gives out dividends for returns made on rent and resale. Tokenized Real Estate Investing
Auto / Boat / RV: Titles for these assets can be replaced by tokenization on the blockchain but require legislative approval.

These are just some of the physical assets being tokenized. In principle anything and everything can be tokenized.

NFT's are the next gen innovation in asset ownership. Tokenizing your asset, digital or physical, gives you a trustless way to manage the ownership of your asset. You can verify it's authenticity, transfer ownership, and see the history of ownership all without a middle man for a fraction of the cost. Further, it provides a means of creating value in an infinite digital world. We value things in the physical space for their scarcity. NFT's engineer this back into the digital space.

Easy to lose your funds

It's true. If you forgot your password, you lose your funds. This is a feature not a bug. Nobody should own your wealth but you. However, if you don't trust yourself and would rather take on the counterparty risk and any associated fees, you can store your funds with a custodian which is the equivalent of a standard fiat currency bank.

References:

Crypto Blockchain Finance Liberty Sovereignty