Crypto, Flim-Flam, and FTX

I mentioned in my I’m Back post that I’ve been fielding a host of questions from friends. The FTX case has been the hottest topic, but the question my astute colleagues have asked is actually bigger than FTX itself: Does the fall of FTX means that crypto is dead?

To recap: FTX was the third largest cryptocurrency exchange in the world. They recently imploded amidst clear criminal behavior, fleecing their best customers for something in the realm of three billion dollars. I will leave sorting that mess out to the U.S. Department of Justice and the courts, but it does seem clear to me that founder Sam Bankman-Fried is going to do jail time—and deservedly so, in my opinion.

Yes, crypto is dead. And no, crypto is not dead. It depends on what you consider “crypto” to be.

Full Stop for a History Lesson

Bitcoin was the first major cryptocurrency to get popular attention, and Ethereum was effectively the second. They are both built on a suite of technologies collectively called “the blockchain”, although they each have their own proprietary blockchain implementations. In technospeak, the blockchain is a globally available, crypto-protected, immutable data
store. In simple terms, it is super-secure, globally available, general ledger. That is an oversimplification, of course, but surprisingly accurate.

Here’s the real point: Planet earth has never had a globally available, trustworthy place to record transactions before. This is a Big Deal, especially if you have an imagination.

Governments cannot control it. Criminals cannot hack it—although they can be quite devious in hacking your access to it, which is a whole different enchilada. And corporations cannot manipulate it. FTX was able to commit their sins because, as an exchange, they held the keys to the cryptocurrencies on behalf of their customers. Let me emphasize this point: They did not hack the blockchain, nor were they hacked. Instead, they breached their fiduciary interest by siphoning off coin without permission to make risky investments.

It worked great—until it didn’t.

The pros and cons of a self-hosted wallet are beyond the scope of this already-lengthy essay, but suffice it to say that if you are in possession of your cryptocurrency wallet, you’re in no danger of anyone going all FTX on you. The technology did not fail here. Instead, untrustworthy people convinced major players with billions of dollars–as well as many smaller players–to “Just trust us.”

Back to the Future

Bitcoin’s blockchain and the Bitcoin cryptocurrency are highly coupled. In non-technical terms, this means that they so wrapped up in each other that you cannot easily tease them apart.

Ethereum’s blockchain, on the other hand, was designed for
extensibility and supports what are called “smart contracts”. In terms of potential functionality, Ethereum is much more interesting. It is so remarkably extensible that several other cryptocurrencies were built on the Ethereum blockchain.

The team of developers working on Ethereum were also able to convert the entire cryptocurrency from “proof-of-work” (by presenting a solution to a massive math problem), to “proof-of-stake”. The latter has to do with how transactions are validated and who gets to do the validation, but the important part is that Ethereum no longer requires massive
amounts of electricity to solve proof-of-work problems. Ethereum is now much more eco-friendly than Bitcoin.

That the Ethereum team could pull this off at all is a testimony to the quality of Ethereum’s original architecture. I would describe what they accomplished as the software equivalent of performing open heart surgery on yourself while out for a jog.

The point with this diversion is to be clear whether you’re talking about the Ethereum cryptocurrency or the Ethereum blockchain technology. They are related, of course, but are two entirely separate things.

A while back I mentioned other cryptos built on Ethereum… There are literally hundreds of other cryptocurrencies that have appeared since the debut of Bitcoin and Ethereum—remember Dogecoin mania? If you’ll forgive a rather rash, blanket statement: All the rest are get-rich-quick schemes with speculation as the primary objective. In-game tokens that allow the real and virtual worlds to mix might be an
exception; I’m of two minds about that.

Non-fungible tokens (NFTs) are just another object stored on a blockchain. Since their very name highlights the fact that they are not a currency, thus far their only utility seems to be speculation. I have been singularly amazed at how much money some folks have been willing to spend to acquire the rights to some bytes on a blockchain somewhere
“out there”, and all for bragging rights or the right to sell it to a greater fool.

As a technologist, my focus is Bitcoin and Ethereum: The former simply because it remains the granddaddy of all crypto, and the latter because it is interesting  technologically.

So, now that we know the names of the chess pieces, let’s revisit the game: Will the fall of FTX make Bitcoin and Ethereum useless and cause them to disappear?

The answer is a resounding “No!” because of the social value and utility of the technologies. But if you’re planning your retirement based on all the money you will make speculating on crypto… I hope you enjoy your job. You are going to be working for a long, long time.

There are really two crypto universes, which is why it is both dead and not dead. In one universe, crypto is (was?) an asset class valuable for speculation. Like the tulip mania in Holland a few hundred years ago, there has been no real reason for the price of various cryptocurrencies to skyrocket except that people wanted them to—and these same folks worked rather tirelessly to promote the frenzy that propelled the prices upwards.

I made a few thousand dollars on Bitcoin in the early days. It was fun and amusing, but I was careful not to invest more than I could afford to lose outright (which wasn’t much). I know one fellow who made enough from bitcoin to buy a big spread of acreage in Idaho and retire as a gentleman rancher. I doubt he fully understood the risk he was taking, however. He was lucky… very lucky. Speculative bubbles inevitably burst, and nobody can accurately predict the moves of a highly speculative, irrational marketplace. One hint of unanticipated bad news and you are left holding a bag of electronic nothings.

As a friend of mine aptly said when he hit a half-court, game-winner at the state basketball tournament: “Sometimes it is better to be lucky than good.”

A speculative asset class inevitably comes and goes, and this aspect of cryptocurrencies is certainly waning. I hope so, anyway. Crypto’s alternative universe—and more significant value to the world—is one in which cryptocurrencies are a tool with a valuable utility.

So, What is the Utility?

First and foremost, cryptocurrencies in general are a group of technologies that enable decentralization and some degree of freedom with respect to protecting economic value.

Through various means such as labor, investing, and even bartering, you and I accumulate economic “value”; maybe we call it “net worth”. Sometimes that value is in a physical asset like a house or car, and sometimes it is stored in other ways. Governments want us to store this value in the currency of the realm—which they control.

Unfortunately, throughout history governments have  exhibited a strong tendency to play rather dishonest games with the currency. Julius Caesar, for example, was supposedly the first to create price inflation by debasing the currency; he drilled out the centers of gold coins and replaced them with lead. The drilled-out centers were then reforged into new coins. Even in the Roman empire citizens were not suckers—prices went up accordingly.

In modern times, despotic regimes like Venezuela and North Korea not only print more cash than toilet paper, but also have laws and regulations that prevent the citizenry from holding other, more honest, currencies. More benign but incompetent governments do the same (Argentina, I’m looking at you).

Cryptocurrencies provide some degree of freedom and yes, even safety, by allowing us to squirrel away some of our net economic value anonymously into a digital currency. The cryptologic underpinnings of the technology make it virtually untraceable, and yet if you have your keys, you can access your stored value.

I do assume that you can find someone who will accept your chosen cryptocurrency as a store of value and will exchange them for something useful and/or valuable to you. This is also a huge additional reason why I choose to focus on Bitcoin and Ethereum: These two cryptos are surprisingly well-accepted on the internet and around the world.

Let’s pause… I jumped right into the deep end of the pool without a life jacket. Sure, residents of North Korea deserve all the freedom that technology can muster on their behalf, but don’t anonymous untraceable transactions enable the bad guys to do their evil deeds easier, too?

Yes, it does.

That is a tradeoff I’m willing to make. The reason is that the bad guys have always had this freedom. It is a cost of doing “business” for them. They hire a “mule” and use them to transport their valuables. Or they bribe government officials. Or worse.

Cryptocurrencies now provide a global infrastructure that levels the playing field for the rest of us.

So, we have the social values of decentralization and freedom established together as one of the pillars of the crypto value proposition. What else?

There’s transaction speed, and extremely low cost compared to bank transfers. But most important of all is simply potential, especially with Ethereum. I’m not talking speculative potential, but rather innovation potential. My company sees a future in which many important bits of your personal data are stored on the blockchain. This not only
frees them from political tyranny, but also the tyranny of proprietary software as well.

Remember that the blockchain is a globally available, immutable, highly-secure, and general ledger-like data store. I foresee storing all sorts of things there in a way that  multiple software applications can access them, but if and only if you give explicit permission.

Those permissions could be quite granular, too, so software app “A” can access something like your phone number, but software app “B” cannot. I’m not being highly visionary; the technology for this already exists at LifeID. I think we’re on the cusp of some big leaps.

So crypto is mostly definitely not dead. In fact, I think some of the most exciting innovations are still in its future—and I mean short-term future, too. Nevertheless, I don’t care what the price of Bitcoin or Ethereum happen to be as long as they are relatively stable. My advice to speculative investors is to look elsewhere: FTX did kill the crypto-speculation goose. At least I hope so.

I, for one, am not the least bit upset about cryptocurrencies falling back to earth. That’s where we really live, anyway.