The basics of cryptocurrency

This is part of “The Latecomer’s Guide to Crypto,” a mega-FAQ about cryptocurrency and its offshoots. Kevin Roose, a Times technology columnist, is answering some of the most frequently asked questions he gets about NFTs, DAOs, DeFi, web3 and other crypto concepts.

>> Kevin RooseThe New York Times
Published : 19 March 2022, 01:55 PM
Updated : 19 March 2022, 01:55 PM

LET’S START FROM THE BEGINNING: WHAT IS CRYPTO?

A decade or two ago, the word was generally used as shorthand for cryptography. But in recent years, it’s been more closely associated with cryptocurrencies. These days, “crypto” usually refers to the entire universe of technologies that involve blockchains, the distributed ledger systems that power digital currencies like Bitcoin but also serve as the base layer of technology for things like NFTs, web3 applications and DeFi trading protocols.

AH YES, BLOCKCHAINS. CAN YOU REMIND ME, WITHOUT GOING INTO TOO MUCH TECHNICAL DETAIL, WHAT THEY ARE?

At a very basic level, blockchains are shared databases that store and verify information in a cryptographically secure way.

You can think of a blockchain like a Google spreadsheet, except that instead of being hosted on Google’s servers, blockchains are maintained by a network of computers all over the world. These computers (sometimes called miners or validators) are responsible for storing their own copies of the database, adding and verifying new entries and securing the database against hackers.

SO BLOCKCHAINS ARE … FANCY GOOGLE SPREADSHEETS?

Sort of, but there are at least three important conceptual differences.

First, a blockchain is decentralised. It doesn’t need a company like Google overseeing it. All of that work is done by the computers on the network, using what’s called a consensus mechanism — a complicated algorithm that allows them to agree on what’s in a database without the need for a neutral referee. This makes blockchains more secure than traditional record-keeping systems, proponents believe, since no single person or company can take down the blockchain or alter its contents, and anyone trying to hack or change the records in the ledger would need to break into many computers simultaneously.

The second major feature of blockchains is that they’re typically public and open source, meaning that unlike a Google spreadsheet, anyone can inspect a public blockchain’s code or see a record of any transaction. (There are private blockchains, but they’re less important than the public ones.)

Third, blockchains are typically append-only and permanent, meaning that unlike with a Google spreadsheet, data that’s added to a blockchain typically can’t be deleted or changed after the fact.

GOT IT. SO BLOCKCHAINS ARE PUBLIC, PERMANENT DATABASES THAT NOBODY OWNS?

You’re getting it.

NOW REMIND ME: HOW ARE BLOCKCHAINS RELATED TO CRYPTOCURRENCIES?

Blockchains didn’t really exist until 2009, when a pseudonymous programmer named Satoshi Nakamoto released the technical documentation for Bitcoin, the first-ever cryptocurrency.

Bitcoin used a blockchain to keep track of transactions. That was notable because, for the first time, it allowed people to send and receive money over the internet without needing to involve a central authority, such as a bank or an app like PayPal or Venmo.

Many blockchains still perform cryptocurrency transactions, and there are now roughly 10,000 different cryptocurrencies in existence, according to CoinMarketCap. But many blockchains can also be used to store other kinds of information, including NFTs, bits of self-executing code known as smart contracts and full-fledged apps, without the need for a central authority.

WEREN’T TECH PEOPLE TELLING US, YEARS AGO, THAT CRYPTO WAS A NEW AND EXCITING FORM OF MONEY? AND YET, NOBODY I KNOW PAYS RENT OR BUYS GROCERIES IN BITCOIN. SO WERE THOSE PEOPLE JUST … WRONG?

Good question. It’s true that today, hardly anyone pays for things in cryptocurrency. In part, that’s because most merchants still don’t accept crypto payments, and hefty transaction fees can make it impractical to spend small amounts of cryptocurrency on daily living expenses. It’s also because the value of popular cryptocurrencies like Bitcoin and Ether has historically gone up, making it somewhat risky to use them for offline purchases. (The counterexamples are usually cited with pity, like the guy who in 2010 bought two Papa John’s pizzas using Bitcoin that was worth about $40 at the time but would be worth roughly $400 million today.)

It’s also true that the value of cryptocurrencies has grown enormously since the early Bitcoin days, despite them not being most people’s daily spending money.

Part of that growth is speculation, people buying crypto assets in hopes of selling them for more later on. Part of it is because the blockchains that have emerged since Bitcoin, like Ethereum and Solana, have expanded what can be done with this technology.

And some crypto fans believe that the prices of cryptocurrencies like Bitcoin will eventually stabilise, which could make them more useful as a means of payment.

WHAT ARE THE ACTUAL USES OF CRYPTO, BEYOND FINANCIAL SPECULATION?

Right now, many of the successful applications for crypto technology are in finance or finance-adjacent fields. For example, people are using crypto to send cross-border remittances to family members abroad and Wall Street banks are using blockchains to settle foreign transactions.

The crypto boom has also led to an explosion of experiments outside of financial services. There are crypto social clubs, crypto video games, crypto restaurants and even crypto-powered wireless networks.

These nonfinancial uses are still fairly limited. But crypto fans often make the case that the technology is still young, and that it took the internet decades to mature into what it is today. Investors are pouring billions of dollars into crypto startups because they think that someday, blockchains will be used for all kinds of things: storing medical records, tracking streaming music rights, even hosting new social media platforms. And the crypto ecosystem is attracting tons of developers, which is an auspicious sign for any new technology.

I’VE HEARD PEOPLE CALLING CRYPTO A PYRAMID SCHEME OR A PONZI SCHEME. WHAT DO THEY MEAN?

Some critics believe that cryptocurrency markets are fundamentally fraudulent, either because early investors get rich at the expense of late investors (a pyramid scheme), or because crypto projects lure in unsuspecting investors with promises of safe returns, then collapse once new money stops coming in (a Ponzi scheme).

There are plenty of examples of pyramid and Ponzi schemes within crypto. They include OneCoin, a fraudulent crypto operation that stole $4 billion from investors from 2014 to 2019, and Virgil Sigma Fund, a $90 million crypto hedge fund run by a 24-year-old investor who pleaded guilty to securities fraud and was sentenced to 7 1/2 years in prison.

But these cases aren’t usually what critics are talking about. They’re generally arguing that crypto itself is an exploitative scheme, with no real-world value.

AND ARE THEY RIGHT?

Well, let’s try to understand the case they’re making.

Unlike buying stock in, say, Apple, a purchase that (theoretically, at least) reflects a belief that Apple’s underlying business is healthy, buying a cryptocurrency is more like betting on the success of an idea, they say. If people believe in Bitcoin, they buy, and Bitcoin prices go up. If people stop believing in Bitcoin, they sell, and Bitcoin prices go down.

Crypto owners, then, have a rational incentive to convince other people to buy. And if you don’t think that cryptocurrency technology is inherently valuable, you might conclude that the entire thing resembles a pyramid scheme, in which you primarily make money by recruiting others to join.

I’M SENSING A “BUT” COMING ON.

But. Even though there are scams and frauds within crypto, and crypto investors are certainly fond of trying to recruit other people to buy in, many investors will tell you that they are going in with their eyes wide open.

They believe that crypto technology is inherently valuable, and that the ability to store information and value on a decentralised blockchain will be attractive to all kinds of people and businesses in the future. They would tell you they’re betting on crypto the product, not crypto the idea, which on some level isn’t all that different from buying Apple stock because you think the next iPhone is going to be popular.

Matt Huang, a prominent investor, spoke for many crypto fans when he said on Twitter: “Crypto may look like a speculative casino from the outside. But that distracts many from the deeper truth: the casino is a Trojan horse with a new financial system hidden inside.”

You can argue with that position, but crypto investors clearly believe it’s worth something.

IS CRYPTO REGULATED?

Only slightly. In the United States, certain centralised crypto exchanges, such as Coinbase, are required to register as money transmitters and follow laws like the Bank Secrecy Act, which requires them to collect certain information about their customers. Some countries have passed more stringent regulations, and others, like China, have banned cryptocurrency trading entirely.

Compared with the traditional financial system, crypto is very lightly regulated. There are few rules governing crypto assets like “stablecoins” — coins whose value is pegged to government-backed currencies — or even clear guidance from the IRS about how certain crypto investments should be taxed. And certain areas of crypto, like DeFi (decentralised finance), are almost completely unregulated.

Partly, that’s because it’s still early, and making new rules takes time. But it’s also a property of blockchain technology itself, much of which was designed to be hard for governments to control.

THIS QUESTION COMES FROM THE (APPARENTLY CRYPTO-CURIOUS) RAPPER CARDI B: IS CRYPTO GOING TO REPLACE THE DOLLAR?

Sorry, Cardi. The dollar is the world’s reserve currency, and dislodging it would be a huge, costly project that isn’t likely to happen any time soon. (To give just one small example of the enormousness of the task: Every financial contract that is denominated in dollars would have to be re-denominated in Bitcoin or Ether or some other cryptocurrency.)

There are also technical hurdles crypto needs to overcome if it’s ever going to displace government-issued currency. Today, the most popular blockchains — Bitcoin and Ethereum — are slow and inefficient compared with traditional payment networks.

And for a cryptocurrency like Bitcoin to replace the dollar, you would need to convince billions of people to use a currency whose value fluctuates wildly, that isn’t backed by a government, and that often can’t be retrieved if it’s stolen.

WHAT KIND OF PEOPLE ARE INVESTING IN CRYPTO? IS IT ALL — TO QUOTE A RECENT “CURB YOUR ENTHUSIASM” EPISODE — “NERDS AND NAZIS”?

It’s hard to say who’s investing in crypto, especially since a lot of activity takes place anonymously or under pseudonyms. But some surveys and studies have suggested that crypto is still dominated by affluent white men.

Gemini, a cryptocurrency exchange, estimated in a recent report that women made up only 26% of crypto investors. The average crypto owner, the group found, was a 38-year-old man making approximately $111,000 a year.

But crypto ownership does appear to be diversifying. A 2021 Pew Research Center survey found that Asian, Black and Latino adults were more likely to have used crypto than white adults. Crypto adoption is also growing outside the United States, and some studies have suggested that crypto adoption is growing fastest in countries like Vietnam, India and Pakistan.

My colleague Tressie McMillan Cottom has made the case that crypto, because it relies on permanent, irrefutable records of ownership of digital goods and currencies, is particularly attractive to people from marginalised groups who may have had their property unjustly taken from them in the past.

“If I live in a community where the police absolutely use eminent domain to claim my private property and I cannot do anything about it,” she wrote, “that sense of everyday powerlessness would make the promise of blockchain sound pretty good.”

That said, some recent studies have also found that a small number of people own the vast majority of crypto wealth, so it’s not necessarily an egalitarian paradise.

AND WHAT ABOUT EXTREMISTS? ARE THEY INTO CRYPTO?

Some are. Because you can buy and sell cryptocurrency without using your name or having a bank account, crypto in its early days was a natural fit for people who had reasons to avoid the traditional financial system. They included criminals, tax evaders and people buying and selling illicit goods. They also included political dissidents and extremists, some of whom had been kicked off more mainstream payment services like PayPal and Patreon.

As a result of their well-timed entry into the crypto market, some extremists have gotten rich. A recent investigation by the Southern Poverty Law Center found that several prominent white supremacists have made hundreds of thousands or millions of dollars by investing in crypto.

There are millions of crypto owners, the vast majority of whom are not white supremacists. And the same properties of anonymity and censorship-resistance that make crypto useful to white supremacists might also make it attractive to, say, Afghan citizens fleeing the Taliban. So labelling the entire crypto movement an extremist group would be overkill. Regardless, it’s safe to say that crypto has become attractive to all kinds of people who would rather not deal (or can’t legally deal) with a traditional bank.

ANOTHER CRITICISM I’VE HEARD IS THAT CRYPTO IS BAD FOR THE ENVIRONMENT. IS THAT TRUE?

This is a real can of worms, and one of the most frequent objections to crypto.

Let’s start with what we know for sure. It’s true that most crypto activity today takes place on blockchains that require large amounts of energy to store and verify transactions. These networks use a “proof of work” consensus mechanism, a process that has been compared to a global guessing game, played by computers all competing to solve cryptographic puzzles in order to add new information to the database and earn a reward in return. Solving these puzzles requires powerful computers, which in turn use lots of energy.

The Bitcoin blockchain, for example, uses an estimated 200 terawatt-hours of energy per year, according to Digiconomist, a website that tracks crypto energy usage. That’s comparable to the annual energy consumption of Thailand.

And Bitcoin’s associated carbon emissions have been estimated at roughly 100 megatons per year, which is comparable to the carbon footprint of the Czech Republic.

HOW DO CRYPTO FANS JUSTIFY THAT KIND OF ENVIRONMENTAL IMPACT?

Crypto advocates often quibble with these statistics. They also argue that:

— Our existing financial system also uses a lot of energy, between powering millions of bank branches, ATMs that sit idle for most of the day, gold mines and other energy-intensive infrastructure.

— Many crypto-mining computers are already powered by renewable energy sources, or by energy that would otherwise be wasted.

— Most newer blockchains are built using consensus mechanisms that require much less energy than proof-of-work.

AND ARE THOSE ARGUMENTS VALID?

Partly. It’s true that most newer blockchains are designed in a way that requires considerably less energy than Bitcoin, and that Ethereum’s scheduled switch to a new type of consensus mechanism called proof-of-stake consensus mechanism will greatly shrink its environmental footprint, if and when it happens.

But it’s also a bit convenient to steer attention away from Bitcoin, which is still the most valuable cryptocurrency in the world. Bitcoin’s energy needs aren’t expected to fall significantly anytime soon. And even if every Bitcoin miner ran entirely on renewable energy, there would still be an environmental cost associated with maintaining the blockchain.

All told, it’s clear that crypto as we know it today has a significant environmental impact, but it’s hard to measure exactly how significant. Many frequently cited statistics come from industry groups, and it’s hard to find trustworthy, independent data and analysis.

But few crypto fans would dispute that blockchains consume substantially more energy than a traditional, centralised database would, just as 100 refrigerators use more energy than one refrigerator. They just argue that crypto’s environmental impact will shrink over time, and that the benefits of decentralisation are worth the costs.

GOT IT. AND THOSE BENEFITS, AGAIN, ARE …

Some crypto proponents will tell you that the biggest benefit of decentralisation is the ability to create currencies, apps and virtual economies that are resistant to censorship and top-down control. Imagine a version of Facebook, they’ll say, in which Mark Zuckerberg couldn’t unilaterally decide to kick people off.

Others will say that the biggest perk of decentralisation is that it allows artists and creators to control their own economic destinies more directly by giving them a way to bypass platform gatekeepers like YouTube and Spotify, and sell unique digital works directly to their fans.

Still others will say that crypto is most useful to people who don’t live in countries with stable currencies, or to dissident groups living under authoritarian regimes.

There are a million other hypothetical benefits of decentralisation and crypto, some of which are realistic and some of which probably aren’t.

HOW DO YOU ACTUALLY USE CRYPTO?

The quickest way to get started using cryptocurrencies is to set up an account with a crypto exchange like Coinbase, which can link to your bank account and convert your U.S. dollars (or other government-issued currency) into cryptocurrency.

But many crypto users prefer setting up their own “wallets,” secure places to store the cryptographic keys that unlock their digital assets. Once you’ve got some crypto in your wallet, the process can be pretty simple. Just type in the recipient’s crypto wallet address, pay a transaction fee (if applicable) and wait for the payment to clear.

OK, I’M READY TO DIVE INTO THE REST OF YOUR EXPLAINERS. BUT FIRST, I HAVE ONE FINAL QUESTION ABOUT CRYPTO’S CULTURE: WHY IS IT SO WEIRD AND INSULAR?

This is maybe the question I get asked most about crypto. People see their friends, co-workers and relatives diving down the crypto rabbit hole and emerging days or weeks later with a new obsession, new internet friends, and the seeming inability to talk about anything else. (There’s even a word for this — getting “cryptopilled.”) People who believe in crypto tend to really believe in it to the point that they can appear more like evangelists for a new religion than fans of a new technology.

I was a religion reporter once, and I don’t think the comparison is totally inapt. It’s also not necessarily a bad thing. Plenty of people find meaning and community and intellectual stimulation in religion. As people like Bloomberg journalist Joe Weisenthal have pointed out, crypto has similar elements to an emerging religion: an enigmatic founder (the still-anonymous Satoshi Nakamoto), sacred texts (the Bitcoin white paper) and rituals and rites to mark yourself as a believer, such as tweeting “gm,” (crypto speak for “good morning”) to your fellow believers, or photoshopping laser eyes onto your profile picture.

It’s fun to laugh at the (often cringeworthy) ways crypto fans try to entertain and inspire one another. But focusing too much on their behaviour might mean missing what’s genuinely novel and what is either exciting or dangerous about the technology itself. Which is why, when my friends ask me how to talk to their cryptopilled relatives, I advise them to start by trying to understand what’s gotten them so excited in the first place.

© 2022 The New York Times Company

Toufique Imrose Khalidi
Editor-in-Chief and Publisher