Crypto Dip-Toe

“I guess you guys aren’t ready for that yet. But your kids are gonna love it.” -Marty McFly.

After bringing the Enchantment Under the Sea Dance to a dead stop with a blazing rendition of “Johnny B. Goode,” today’s quote was the line Marty uttered to the awestruck crowd before leaving the stage. I’d like to think that if they make a Back to the Future reboot that begins in the year 2045, and Marty travels back in time 30 years to 2015 (instead of the original 30-year leap from 1985 to 1955), he could use the same quote after giving a cryptocurrency/blockchain presentation at a retirement community. I’ll let you choose your own adventure regarding the backstory of why he would be doing such a thing, but perhaps it’s to trick an elderly Bif into unwisely investing his retirement savings? (I know, I should really get into writing screenplays).

The whole “crypto” movement may feel very futuristic for many investors. While no one knows what the future holds, the extreme perspectives range from crypto/blockchain eventually being involved in nearly everything to just being a short-lived fad. What is for sure is that the crypto phenomenon has gained a lot of traction, grabbed a lot of headlines, and created/destroyed a lot of wealth over the last decade. And, since it’s “a thing” and definitely an alternative investment, it’s about time – now 36 posts into Alt Blend – that we learn the basics of how it works and what potential utility it holds for us and future generations. I’m not an expert on cryptocurrencies or the blockchain, so this may be more of a research project than most editions of Alt Blend, but maybe that means we’ll collectively learn even more than usual. Here we go!

Beginning at the Beginning

Anecdotally speaking, it’s generally thought that this whole blockchain/crypto movement started with Satoshi Nakamoto’s 2008 whitepaper and then the subsequent 2009 creation of the first blockchain using bitcoin. However – similar to our venture-capital lesson, where we learned mRNA vaccines had about 50 years of thankless development before the real-world Covid application – bitcoin has much lengthier roots. As concisely conveyed in this ICAEW overview, some very forward-thinking people began building the foundational knowledge for a “cryptographically secured chain of blocks” in 1991 while figuring out How to Time-Stamp a Digital Document. Their thinking was well ahead of its time. When all of that groundbreaking research took place, I was still anxiously awaiting monthly shipments of CDs from BMG and Columbia House to bolster my music collection. Thus, we were many years away from even being able to download music, let alone embrace “the blockchain” via the high-speed interconnected global digital network that exists today.

The timeline goes on to include the notion of the “decentralized digital currency” in 1998, during which Nick Szabo aimed to overcome problems of how that concept could work. It built on the idea of digital timestamping to solve for “double-spending” the currency (which he coined “Bit Gold”) and (I think) more importantly, “introduced the concept of value based on the cost of computational resources” (as described by blockgeeks.com). Then, in the year 2000, another whitepaper was written that helped advance the cryptography aspect of the equation (here’s the 81-page German text by Stefan Konst), which I gather had a lot to do with proving the authenticity of the blockchain.

And Now We’re Getting Somewhere

Still, it wasn’t until eight years later that Satoshi Nakamoto (a pseudonym) published the whitepaper on Bitcoin, which was already 17-or-so years into the crypto story. Bitcoin was able to build on the thinking of Nakamoto’s predecessors (including the distributed ledger and security features) to present “a practical use-case for blockchain.”

Nakamoto synthesized the ideas of cryptography and blockchain pioneers while solving previously encountered roadblocks. One significant advancement of Bitcoin was allowing the currency value to be determined by an open market instead of the Bit Gold construct of deriving value from computational cost. That may sound minor, but it was a major evolution, according to blockgeeks.com:

“If the value is directly correlated with the computation cost, it can create discrepancies in the network, as one coin will be higher in value than the other, just because of the underlying computation cost. In the case of Bitcoin, the value of a single Bitcoin mined in 2010 has the same value as the Bitcoin mined today. If Bitcoin’s value was correlated with the computation cost, then all the Bitcoins mined in 2010 would be way cheaper than Bitcoins that are mined today because the computation needed to mine a Bitcoin in 2010 was much lower.”

The Curiously Strong Mint (-ing of a new currency)

Yes, that’s a pretty terrible Altoids pun, but bear with me while we take a step back and try to demystify this topic.

With the above backdrop in mind, the whole crypto craze has seemingly been driven by a core element of what it is to be human: curiosity. People were trying to answer questions like, “hey – if everything were digital, how could we prove something is unique.” The concept of the blockchain has so far addressed that problem.

The security of the blockchain comes from it being a decentralized, fully transparent, permanent record. Investopedia describes the blockchain process as follows: “As new data comes in, it is entered into a fresh block. Once the block is filled with data, it is chained onto the previous block, which makes the data chained together in chronological order.”

Hence the very intuitive term “blockchain.” It’s easy to visualize a big chain and pretend that there’s information contained in each of the links. Once the following link is put on the chain, it can never be undone, but anyone can go back to see what’s contained in the chain forever.

If You Have a Hammer…

Of course, this is all very easy in hindsight, but – after the concept of the blockchain came about – we can imagine a subsequent question was, “Given an ability to prove the authenticity of digital assets in a decentralized way, what could that be used for?” Perhaps something that a) has historically been centralized (i.e., fully controlled by governments) and b) is subject to counterfeiting? We know at least one answer to those questions was “currency,” hence the advent of Bitcoin.

The other term we glossed over in the opening paragraphs is cryptography. Officially, it is “the practice and study of techniques for secure communication in the presence of adversarial behavior.” In practical terms, it’s the security element of the technology, and it’s at the very core of making blockchains and digital currencies possible. Let’s then assume someone stirred together cryptography and digital currency (in a digital bowl, of course), and – voila! – the now-omnipresent term “cryptocurrency” was born.

The Next Blocks in Our Chain

Now that we’re more comfortable with the origins of crypto and blockchain – what they are and why they exist – we can dive deeper into many other aspects of this general topic: e.g., specifics of Bitcoin, features of other major cryptocurrencies, the importance of cryptography in blockchain, current and potential use cases of these technologies, current challenges and possible solutions, and arguments for/against value and ownership of crypto/blockchain assets.

Until next time, this is the end of alt.Blend.

Thanks for reading,

Steve

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About the Author

Steven Tresnan, CAIA®, CFP®

Private Wealth Advisor

Steve is a Certified Financial Planner as well as a Chartered Alternative Investment Analyst®. He is also an Accredited Investment Fiduciary, which helps him offer guidance to clients with fiduciary responsibilities, such as board members of trusts, foundations, and endowments. Steve earned a Bachelor of Science degree in Industrial Engineering from Penn State University.

Steve serves on the board and finance committee of New Music USA – a national nonprofit devoted to the development and appreciation of new music in the U.S. – and volunteers as the Treasurer for Campus Fun & Learn, a child development center on the campus of Rockland Community College in New York. 

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