Demystifying Bitcoin: Essential FAQs on Cryptocurrency Unveiled

DISCLAIMER: I am not an investment adviser and these are just my opinions. There are serious risks involved in placing any investment in securities including Bitcoin and other cryptocurrencies -especially cryptocurrencies given their ongoing volatility. None of the information in the below FAQ is intended to form the basis of any offer or recommendation or have any regard to the investment objectives, financial situation, or needs of any specific person reading this. Additionally, these are not even necessarily the right or best answers, just the ones I came up with for myself as of this writing.

Q: What is money?

A: Money is a concept in which a scarce element is agreed upon by a collection of people. Today, that collection of people is comprised of armed governments with centralized banks that break down at international borders. The people who currently secure that money from the government on your behalf take a big chunk of it as payment for doing so — roughly one third of the economy.

Q: What is the function that money serves?

A: A store of value, a medium of exchange, and a medium of account. A currency can meet any of these requirements but doesn’t necessarily need to meet all three to have value.

Q: What is a cryptocurrency?

A: A trusted way to exchange value with an untrusted party by using a network of distributed computers to verify the transaction with complex cryptography.

Q: So Bitcoin and cryptocurrency are synonyms?

A: No, Bitcoin is just a form of cryptocurrency, albeit the one with longest history and largest trading volume as of now. Just like the US Dollar, Euro, and Yen are types of government currencies, Bitcoin is also a type of cryptocurrency.

*Update: When I first started playing with Bitcoin, it was headed into a vertical trajectory which was then matched with an equally spectacular fall. So is it really a tenable “currency” right now? Not really. If a given amount of money buys you a cup of coffee today, but the same amount buys you a jacket next month, a motorcycle a few years later and then only a sandwich months after, it’s not really suited for transactional purposes. Crypto-”currency” is a little deceiving in its moniker, and is really an asset class. Bitcoin Cash (BCH) spun up in 2017 as a technology that would be more suited for transacting, but after a short-lived spike in value, it hasn’t done much since.

Q: So Bitcoin is just another way to digitally transact, like PayPal or Venmo?

A: No, those are examples of centralized clearing houses that offer a service for a fee. Because of its centralized nature, PayPal could fail in a variety of ways at that single point. Bitcoin is not a service, but instead a protocol for trust across a distributed network. For this reason, people have a hard time grasping it, as we have never had the combination of a currency and a protocol for transacting combined into one product.

*Update: To further muddy the waters on this, in October of 2020, PayPal announced the ability to buy, sell, and hold Bitcoin on its platform.

Q: What is the “cryptography” in cryptocurrency?

A: It is a one-way hash function (encoding) that is virtually impossible to work backwards. These mathematical functions write transactions to the ledger. These distributed hash functions become the authority that legitimizes the transactions.

Q: Are any cryptocurrencies like Bitcoin an official government currency?

A: No, and it should be noted that none are FDIC insured or backed by any traditional banks. However, as an exchange, Coinbase is currently insuring positions up to $250K.

Q. What makes cryptocurrency better than government issued currencies?

A: There are many things, but a few of the big ones:

There is no required trusted third party (banks, credit cards, intermediaries) to verify a transaction. Everything is settled by a network of computers, all with a local copy of the ledger, as opposed to the centralized, fee-grabbing institutions.

For global commerce, the majority of the planet’s citizens are unbanked. Sometimes dealing in hard cash is the only option and often puts them at multitude of risks.

It is easier to store, transport, subdivide, and is transactionally more defensible than any other currency or commodity

Q: What is a blockchain?

A: This is essentially the database, or ledger, for cryptocurrency transactions. Every time an entry to the ledger is made, it involves a series of computations called “blocks”, running on many thousands of computers using complex cryptography that cannot be undone once encoded. This series of blocks is referred to as the blockchain. Like a fly trapped in amber, a transaction in the blockchain is undeniably set in its place and new transactions (like additional layers of amber) form on top of it over time. These blockchains are replicated by all these computers on the cryptocurrency network. Current banking ledgers are like Word Documents. Every time there is an edit, any other authoring parities are locked out because it is a centralized document managed by one person. Like a local Word Doc, a bank uses a centralized ledger and is locking out other “authors” when waiting to verify deposits, send wires, make transfers, etc. A blockchain ledger is like a Google Document, where multiple authors can all have real-time access to the same data. This distributed network of other authors has no single point of failure and can not be corrupted based on its architecture.

Q: What is Bitcoin Mining?

A: Every transaction on the blockchain ledger requires a significant amount of computing, which is done by the computers on the Bitcoin network. This computing involves very complex mathematical problems which involve encrypting a new block on the blockchain. When a node on the network solves one of these problems, it is awarded some Bitcoin. These awards for proof of work are the “new” Bitcoins that go into circulation. Every four years of operation of the Bitcoin network yields half the coins to be released in the prior four years, giving the coin its inherent scarcity.

Q: Can’t the program just keep creating more and more Bitcoins like the Fed prints money we can’t back?

A: No. As part of Bitcoin’s programmatic architecture, there can only ever be 21 million Bitcoins, and all cryptocurrencies have these types of hard-set limitations.

Q: What is a private key vs a public key?

A: Your private key can encrypt and decrypt transactions, but your public key can be used by others to send you currency.

Q: What is an exchange?

A: These are kind of like banks or other institutions that sell or exchange currencies and other securities. Like banks, these third parties are subject to security holes and theft. However, aside from earning a cryptocurrency or receiving a direct transfer from another party, exchanges are your best bet to procure it.

Q: What is Coinbase?

A: Coinbase is an exchange that currently deals in Bitcoin, Ethereum, and Litecoin (and as of this writing just added Bitcoin Cash). In addition to a very cleanly designed web app, they have a native mobile app that also enables you to transact. Compared to other exchanges out there, it is like the friendly face of Cryptocurrency. Their claim to fame is simplicity. Connecting your accounts is simple as are the transactions. You can fund your account with a wire transfer (fastest), an ACH transfer from your bank, and even credit cards. Coinbase is also a managed wallet. “Managed” means that this third party is holding your funds, as would a bank. Coinbase is also FDIC insured for American citizens for up to $250K. However, the pretty face and insurance comes with transaction fees that range from 1.5–4%.

*Update: Coinbase has filed its S-1 to go public this year and as of this writing has 35 million users and $25B of assets on its platform and now trades 50 types of cryptocurrency.

Q: What is GDAX?

A: First off, it is the same company as Coinbase. GDAX is a full-fledged trading platform that deals in the same Cryptocurrencies as Coinbase, as well as USD and EUR fiat currencies. This platform will look familiar to those seasoned in the stock market and can handle a variety of orders such as Market Orders, Limit Orders, Stop Orders, and Margin Orders. Being the same entity, transferring funds between your Coinbase and GDAX accounts is free, instant, and easy. At .25% or less per transaction, the savings over Coinbase can be considerable based on your trade volume. Another note about GDAX is that even though it is the same company as Coinbase, the insurance does not apply to GDAX as it is under different regulations as a full-fledged trading desk.

*Update: GDAX has been rebranded as Coinbase Pro and like Coinbase, has native mobile apps as and is also FDIC insured for the same value of $250,000. Compared to Coinbase, it looks much more complex but retains its lower trading fees and features more familiar to seasoned securities traders.

Q: What if I want to trade other coins like EOS, Zcash or Ripple?

A: There are over 1,300 cryptocurrencies and 150 exchanges, and counting. If you’d like an alt coin (what has been referred to as anything other than Bitcoin), it’s probably safest to use an exchange that is doing a ton of volume like Binance or Kraken. When using one of these exchanges coming from Coinbase, you’ll see a huge step up in complexity and stability. For example, 9 out of 10 times that I log into Kraken, I get a SSL connection error and am unable to get to my account. Not very reassuring since time that you’d likely want to move currencies would coincide high volume times on the exchanges. However, even Coinbase has been overloaded by traffic on many occasions. One thing that you’ll find on different exchanges is varying levels identity verification. Coinbase feels the most like signing up for PayPal whereas Kraken has you upload photos of you holding up your passport with a handwritten authorization note. Other exchanges may have higher transaction fees, but offer complete anonymity.

*Update: Many “alt coins” have gone sideways but several others that have stuck around are now supported to trade and store on Coinbase (50 in total as of this writing).

Q: What is a digital wallet?

A: Digital wallets enable users the complete control to create addresses for sending and receiving cryptocurrencies. They also allow you to store a private key and many run on both desktop and native mobile. Many advise against leaving any money sitting in an exchange. While an exchange like Coinbase does have a “wallet” feature, it does not allow the full access of totally removed one, and it currently is only capable of holding three currencies. I am currently using Jaxx, an open source wallet that manages Bitcoin and about a dozen other cryptocurrencies. It also has Shapeshift integration to make the exchange of currencies very easy. It uses a 12-word “Masterseed” to manage the private keys to your various cryptocurrencies. While maintaining a wallet outside of an exchange like Coinbase is an additional layer of complexity, it also stays true to the spirit of a decentralized experience, and does not have the dependency and lack of control that comes with keeping your money in an exchange. Many also fear the security or solvency of exchanges, and prefer to use them to transact, and then get their currencies off them asap. While it seem unlikely that an entity like Coinbase, that has exchanged over $50B in digital currency, would ever be hacked or come toppling down, many people thought the same about Mt. Gox. Mt. Gox was the world’s largest Bitcoin exchange, handling 70% of all Bitcoin transactions online. In February of 2014, they shut down their site and reported that $450M in Bitcoins had been stolen by hackers. Today, that would be roughly $16B. They also reported a $27M loss in cash. There are still 650,000 Bitcoins unaccounted for. When it comes to where and how you store your currencies, there is always the balance to strike of trusting others (exchanges/managed wallets) and trusting yourself (shit, I lost my private key). Historically, the finance industry has trained us to not trust ourselves, so there is a huge paradigm shift to be had around actually outright owning complete access to your own funds. Incidentally, Bitcoin went into circulation right after the FDIC began to close 465 banks beginning in 2008.

*Update: While I still wholeheartedly believe in the merits of separating a wallet from an exchange in the true decentralized fashion, the method of storage needs to match one’s personal comfort level and competence. I never intended to actively trade, and was looking at any coin positions as long term holds — no different than a US index fund or 401k. However, when crypto took a nosedive a couple years back, it was a lot less fun to look at my holdings. In fact so much time went by before it surfaced in the news again with its massive rally, that I struggled to remember all the wallets and exchanges I had distributed not only cryptocurrencies, but USD positions to buy with. One such wallet was about to be deprecated in a matter of hours before I recovered it. Other accounts took several days to recover since I didn’t even own the same mobile device that my two-factor authenticator resided on. Talk about nerve-racking. In hindsight, it was pretty sloppy of me to organize it the way that I did, and I’d consider myself more digitally organized and secure than the average bear. The whole experience left me with a little less faith in my own custodial practices, and a little more in established institutions. That said, nothing is hack-proof and serious levels of security should be applied that exceed that of your credit card or bank account. Cryptocurrencies are almost akin to a pile of untraceable cash when left unsecured.

Q: What is a hardware wallet?

A: A dedicated device separate from your computer, most commonly a USB stick with its own chip, that stores your private key. If your computer is connected to the internet, there is an inherent security vulnerability. I do not currently own a hardware wallet. While it is conceivable to lose or destroy your hardware wallet, unlike paper money or gold, you can make backups to store in multiple locations.

*Update: Given my most recent heart-attack when recovering the slew of accounts and wallets I had around the web, there is simply no way I’d trust myself with a physical wallet. My favorite tech journalist, Kara Swisher, tells the story of a missing USB stick she had a handful of Bitcoins on, acquired on a whim when writing a story back when the coins were relatively worthless. Today, that’s a few hundred thousand dollars in Bitcoin and she has absolutely no idea what happened to that USB drive.

Q: What is a paper wallet?

A: Usually a document stored in a secure location (like a safety deposit box) containing all the data required to generate any number of cryptocurrency private keys. You can put your credit or debit card into a Bitcoin ATM and withdraw funds from your bank account in exchange for Bitcoin. What the ATM gives you is a piece of paper with a key represented in a 2D (data-matrix) code. You could then take this “paper wallet” and put in your own leather wallet, a safety deposit box, or under your mattress. Alternatively, you could send this Bitcoin into your digital wallet by scanning the code on the paper receipt with the wallet app on your phone.

Q: What is cold storage?

A: Any offline storage method such as a hardware wallet, paper wallet, or memorization of keys. These usually for large amounts of currency that do not require regular access since it usually requires a secure, and often cumbersome location to keep it. You can still receive funds easily, but not access them conveniently. Because this method of storage is removed from any network (computer or mobile device on the internet), it is the most secure. Technically, you could memorize a string of words or numbers, and walk across international borders with billions of dollars in your head.

Q: So if you use different exchanges with various balances, have numerous wallets and cold storage, how do you track the value of your portfolio and a summary of where you’ve made gains and losses?

A: I haven’t found a completely seamless way to do this, but have tried a few different methods. First I tried a mobile app, but inputting the transactions by phone touch screen was a massive pain in the ass. I since tried a few others and have settled on https://altpocket.io/. It’s a free tracker that uses the API of a couple exchanges for auto-syncing your accounts, but I just use it as a general ledger without the syncing to note the asset, price, date and notes (where I bought it) so that I can see my gains and losses as an aggregate and on a transactional level, all in one place. There is still the manual input aspect of it which could get overwhelming with medium to high volumes of trading. However, I’ve heard of lots of people using spreadsheets to do the same thing, which sounds even worse to me. Altpocked is also trying to build a community around crypto trading, so there’s the chatter of the feed in the dashboard view. There is the ever present issue of privacy, but theoretically it could just be used for paper trades anyhow. Which is also a cool thing you could do with the service.

*Update: Cryptocurrencies have started to turn the corner of being a much more legitimate and widely accepted asset class and as this progresses, tracking and analytics tools will become simplified and more widely available. For example, my Wealthfront mobile app has always connected to other accounts such as Bank of America and Ameritrade, but now also connects to Coinbase. The latter half of 2020 has included adoptions by payments giant PayPal and hedge fund mavens such as Paul Tudor Jones and Stanley Druckenmiller.

Q: What is an ICO?

A: An initial coin offering. There are now hundreds of cryptocurrencies or “coins” out there of which some will say are the next big thing, and others to deem as worthless. With an ICO, you are usually purchasing tokens that you then exchange for the currency once it goes out onto the blockchain.

Q: What is Ethereum?

A: It is another cryptocurrency which is more general-purpose than Bitcoin. One of the applications is the ability to build other smart contract applications on top of it. The downside is the increased vulnerability due to the flexibility of the program.

Q: What is a smart contract?

A: Any of these pieces of code replicated in the network that records and/or takes action around a recorded transaction. In essence, it is a way to formalize an agreement mathematically, as opposed to an enforcing third party or separate paper contract. This will eventually replace the traditional ways of dealing in prediction markets such as insurance, They will enable people operating in different countries to do what would traditionally be considered to be very sophisticated financial transactions such as futures and options.

Q: We’ve been using credit cards to transact digitally for quite some time now, and yet my cards have been hijacked several times now, and I’ve had to refute fraudulent charges with my bank. Isn’t the same thing going to happen with cryptocurrency transactions?

A: Credit cards were around long before the internet. In fact, we had to invent a whole set of very inadequate security subsystems in order to continue this method of payment for use in online transactions. With a cryptocurrency, you have a public key to receive payments, and a private key that you, and only you ever see in order to initiate a transaction. The payee never has access to your private key. In the case of credit card payments, you are in essence handing over your private key (your credit card number) to everyone you transact with. By doing so, you need to have complete trust in the vendor you are dealing with, all their employees, the security of the records they keep, and even the network you are transacting on. My guess is that in ten years we’ll look back in awe at what an insane system that is in the same way our kids will be amazed that we were allowed to freely blaze down the highway in gas powered non-autonomous vehicles.

Q: Is cryptocurrency a bubble?

A: Yes, but so is all currency. The concept of money has been called “the bubble that never pops”. The USD and Euro will fluctuate. If everybody suddenly stopped accepting your dollars, the bubble would burst, and the value would drop to zero. It is a very unlikely scenario, but the future is generally unpredictable. Anything like currency that is part of a network effect will eventually form a bubble to some degree.

Q: Why has Bitcoin been called a Ponzi scheme?

A: Likely because early adopters that mine and or/retain currencies growing in value will profit greatly, as those early into a Ponzi scheme. However, a Ponzi scheme requires founders (central entity) to convince investors(users) that they will profit, and in the case of Bitcoin, there is no central entity; just users building an economy. Ponzi schemes are a zero sum game where early investors profit only at the expense of late adopters. It is very likely that Bitcoin adopters will financially benefit from early adoption of coins that they hold, but late adopters will still benefit from the utility of the currency platform and ongoing increase in value.

Q: Because the “proof of work” for Bitcoin mining is so energy intensive, isn’t it all an immense waste of energy?

A: Mining coins is incredibly processor-intensive and consumes a massive amount of electricity to run. The security and scarcity extracted from the proof of work is actually far more efficient and socially scalable than the human capital that would be required to obtain such a system. It is likely that energy efficiencies will evolve over time with the protocol. The USD is probably the most widely accepted currency today, but still reaches <1B people. Cryptocurrencies can be exchanged by anyone with an internet connection (usually a mobile phone), to provide true social scalability, the current price of which is energy.

Q: Can any governments or institutes regulate or “shut down” Bitcoin and other cryptocurrencies?

A: Like the decentralized internet, decentralized cryptocurrencies can not be “shut down”. There are many thousands of copies of the complete Bitcoin ledger running on computers all over the world. Regulation happens at the level of the exchanges, such as New York driving out a lot of the innovation around the services surrounding cryptocurrencies, likely because it is seen as a threat to legacy Wall Street security exchanges.

*Update: Re the topic of Wall Street adoption, this is already starting to shift.

Q: Why is Bitcoin and other cryptocurrencies such a disruptive technology?

A: Over a longer arc of time, these currencies have a very high potential to make other currencies obsolete. In the early days of the internet, nobody would have predicted that a company like Netflix would push the 9,000 locations of Blockbuster Video into obsolescence. The internet also overturned countless numbers other companies in verticals like music, publishing and transportation (Spotify, iTunes, Amazon, Twitter, Facebook, Uber). The internet will also eventually turn the finance industry upside down. It seems very likely that the new finance industry will settle around the home of innovation for cryptocurrencies and smart contracts.

*Update: One of my favorite technologists and founder of Angel List, Naval Ravikant, spoke to cryptocurrency being analogous to email. Just like email is the postage letter for the internet, cryptocurrency is the money for the internet. Outside of nostalgia and personalization, writing and mailing a postage letter these days is largely inefficient. One day we may look back at our current method of exchanging value and feel the same.

Q: My banking system seems to be working fine for me. Isn’t that the case for the average consumer? Why does anyone really need another framework for currency and transacting?

A: To answer this, first we need to address who the average consumer is. It’s definitely not the quickly-shrinking middle class of the USA. Americans are less than 5% of the global population and represent the most privileged, with the greatest access to banking and financial services, and the least amount of constraints and controls, and is among one of the least corrupt governments. The Southeast Asian citizen is the “average” consumer and lives under a corrupt government, often a dictator, totalitarian systems, corrupt banks, bribery and mafias. Even our own privilege of FDIC insurance only holds up until there is a systemic failure.

*Update: With an attempted insurrection occurring in our country just two days prior to writing this, I couldn’t help but think of cryptocurrencies as a neutral store of value as it was all going down. While very sad, scary, and embarrassing, it was also reassuring that the charge on our capital was led by a shirtless, Viking-horned cultist known in that circle as the “Q’anon Shaman.” Prior to storming the capital, he was last seen screaming at shoppers at the Arrowhead Mall in Glendale, Arizona, claiming the spiral triangle symbols seen near the mall’s bathrooms are actually an “FBI pedophile code” which involves a more complex story including a secret society of lizard people and antisemitism. Wish I were making that up.

Q: Why is Bitcoin also politically interesting?

A: Money is currently a store of control. Financial service companies are under obligation by the government to adhere to certain protocols such as freezing and seizing assets in spite of due process. When money is used as a tool for surveillance and control, it begins to break down the core functions of a store of value, a medium of exchange, and a medium of account. When money is used as a store of control, there is a high likelihood of perversion of the core uses of money, and this combination often results in corruption. This is the reason why the separation of Church and State is necessary — because one will eventually corrupt the other. For the reason that these two are separated, money and State should also be separated so that money is neutral with rules only applying to commerce that have nothing to do with politics. The level in which governments are freaking out about losing this control is directly proportionate to their level of stifling freedoms of expression.

*Update: This last bit was very interesting to read again given the events of this week, three years after writing it.

Q: Isn’t an anonymous way to transact dangerous for society (illegal purchases, terrorism funding, etc)?

A. This topic got a lot of traction after the infamous Silk Road rose from the dark web and into mainstream news. Cryptocurrencies were the best anonymous way to complete these nefarious transactions. However, cash has also worked quite well for thousands of years as an untraceable peer to peer method of exchanging value for equally unsavory endeavors. There won’t be more people buying drugs or funding terrorism because of a new currency. Cryptocurrencies are just an improved medium or exchange for security and a multitude of other benefits.

Q: How is the growth of a transaction entity like VISA different than that of a cryptocurrency like Bitcoin?

A. VISA has been growing in a linear fashion for the last 50 years. Bitcoin is growing exponentially. With exponential curves, the growth looks incredibly slow at the beginning because although it is regularly doubling in size, the numbers are very small. But once it reaches the hockey stick part of the curve, things seem to happen overnight. Right now, Bitcoin is doing a near imperceptible fraction of the transactions that VISA is doing. But because of its exponential growth characteristic, some experts in the space predict that the day that Bitcoin achieves transaction parity with VISA will be only six months before it reaches 10x the transaction volume of VISA, and two years before it achieves 100x VISA. VISA’s architecture will keep it on a linear path, whereas Bitcoin’s scalability will not hold it to the same bounds.

Q: Oh crap! Bitcoin plunged over 60% just like that (early Feb 2018)! Why? Is this the end? If not, why is this happening?

A: It’s pretty unlikely that it’s over. It’s headed north again a week later but far from full recovery, and I’m sure the tumultuous ride isn’t over yet. If your angle is short term gains, you’ve got a stronger stomach than I do. The market has also taken a massive dump, but like crypto, I’m not a professional day trader and am instead here for the long game. Of course there’s always the lurking fear of needing to get partially out during a 2007 type of scenario, but those are long-arc investing risks. Right now there are many things driving the volatility. The latest is overseas regulation on exchanges such as the report released by a Chinese news source indicating that China would begin banning citizens from using overseas cryptocurrency exchanges. Although China had previously banned domestic exchanges, many customers found ways around this with overseas exchanges. The latest news is a much more of an aggressive position from the Chinese government. I think the motives there are pretty obvious. Additionally, Coinbase announced that cards issued by Capital One and Citi would also be prevented from making purchases. People get spooked by much less than this, so when you stack it all up, well…there you go — prices tumble. Integration is key to the long-term success of this protocol. Whether people like it of not, that includes regulation and China will either get on the bus or miss the ride, but my guess is that crypto will go on either way. I continued to buy BTC and ETH all the way to the bottom.

*Update: Well, not quite to the bottom. Okay, not even close. But boy do I wish I would have had the testicular fortitude to have gone in with everything since as of this writing, Bitcoin is trading around $43,200 USD a coin hours after Elon Musk announced Tesla’s $1.5B buy-in and the ability for the public to purchase one of their cars with Bitcoin. Even so, I don’t have the stomach for the ups and downs to time a cash-out anytime soon. Like any other retirement-type of fund, I try and adopt a set-it-and-forget-it mentality. It’s fun to watch the surges and hear about it in the news, but It’s very important to understand that it could lose 50% of its value (or more given the recent jumps) before it returns to another steady state. It was also interesting to look back at that news regarding the credit card companies. As of now, my wallets and exchanges are almost begging me to purchase positions right from my credit card (for a fee, of course) and PayPal is 100% in the game.

Looking at Bitcoin beyond an asset class, it is a bridge to a better transaction system and store of value. As a sustainability advocate, I was excited for the early versions of the Toyota Prius and was quick to buy in. However, in those first years of production, the lifespan of a Prius produced a larger carbon footprint when compared to a Ford F-150. How is that possible? The early production of those dual-drivetrain vehicles and legacy batteries resulted in a carbon output that was not recovered over the vehicle’s life of reduced emissions when compared to even larger non-hybrid models. With scale and production efficiencies, that obviously changed. But even more importantly, the fervent consumer adoption paved the way for companies like Tesla that are dramatically changing the transportation game when it comes to sustainability. It’s important to remember that we’re in the infancy years when it comes to this financial platform.

Do you have ideas or a project ready to take flight in Web3? DM me. We can help.