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A quick look at crypto

Carl Capolingua Carl Capolingua 20/05/2021
A quick look at crypto A quick look at crypto
A quick look at crypto Carl Capolingua
If you've been watching the financial news sites and are a regular user of Twitter over the last week, you would no doubt have been inundated with items and tweets relating to cryptocurrencies.

Tesla boss, and world's second richest man Elon Musk, caused (another) explosion of interest in the space last week after he back flipped on the company's ongoing acceptance of Bitcoin as a form of payment. In February, Mr Musk caused an equally large stir in financial markets when he announced that Tesla had accumulated a US$1 billion holding in Bitcoin, which remains the largest cryptocurrency by market capitalisation.

Bitcoin chart vs Elon Musk Tweets timeline-1

So, what's all the fuss about!? And why the sudden turnaround in Mr Musk's view of Bitcoin? In this post, we thought we'd provide clients with a quick crash course on Bitcoin and investigate some of the reasons for Mr Musk's unexpected change of mind.


A bit (or two) on Bitcoin
In computing parlance, a 'bit' represents the smallest unit of digital informational input, essentially a 1 or a 0. A 'coin' as we know, is generally associated with a currency, which is simply a unit of exchange. So, 'Bitcoin' as the name so aptly suggests, is a digital currency. You'll never see a Bitcoin, because it's really just a bunch of ones and zeros that are stored in the memory of a computer (in actual fact, many thousands of computers called 'nodes'). But, as long as that bitcoin can be verified by its digital signature by all of the nodes on the network, it can be transferred between two cryptocurrency accounts, or 'wallets' as they are more commonly known.

Sound familiar? Well, it's not all that different from the money you have in your bank account right now. There are bunch of ones and zeros stored in your bank's computers in such a way as to represent each dollar you hold at the bank. You can ask the bank to communicate digitally with other digital nodes (e.g. the local coffee shop) to transfer some of your money for purchases and other uses.

The difference between the money in your bank account and Bitcoin, is that if you really wanted, you could ask the bank to swap some of your ones and zeros into physical currency, that is, the kind that jingles or folds. Also, this type of currency is issued by a central authority such as a government or central bank, and by ways of legislation and widespread acceptance, it is considered to be a store of value.

Bitcoin is not issued by any central authority, but rather its protocol was initially created by a mysterious computer programmer that goes by the pseudonymous name Satoshi Nakamoto. Nakamoto leveraged decades of previous research and failed attempts to create a totally self-sustaining digital currency to create the rules that control Bitcoin. There are and can only ever be 21 million Bitcoins. Each Bitcoin must be 'mined' by a node which cracks a sophisticated cryptographical algorithm. This occurs roughly every 10 minutes. Upon cracking the algorithm, the node collates the transactions which have occurred over the period into a 'block', encodes them with an identifier that represents all previous transactions, and adds those transactions to the ledger which contains the entire history of transactions. Because each block's digital signature contains the information of each block that came before it, we say that they are 'chained' together. This is why you may have heard cryptocurrencies referred to as 'blockchain' currencies.

Bitcoin mining and the blockchain-1

Bitcoin mining is expensive. Node operators, or 'miners' must make a significant investment in hardware, software, and electrical power in order to operate a node on the Bitcoin network. To compensate miners for this investment, and for their effort to set up and maintain their nodes, each time a new block is mined, the successful miner is rewarded with Bitcoin. This amount has varied over time because the protocol deems it will halve roughly every four years. Currently, miners receive 6.25 Bitcoin each time they add a new block of transactions to the ledger. In addition, miners also receive the transaction fees associated with the transactions contained within a block.

So, we can see that Bitcoin is not controlled by any government or central bank, but rather by the protocol which created it, and by the network of millions of nodes that are each simultaneously supporting and verifying its blockchain. Because really anyone can own a node, and because those nodes could be located anywhere in the world, we say that Bitcoin is a 'decentralised' currency. Also, many believe that Bitcoin's fixed supply is a major advantage compared to standard (or 'fiat') currencies which can be debased by excessive money printing.
Musk's revelation
In the interest of keeping this post brief (we'll no doubt investigate cryptocurrencies further in the future), let's skip to the reasons for Mr Musk's sudden about-face on Tesla's acceptance of Bitcoin as payment for Tesla products. As noted above, bitcoin mining requires a node to be switched on 24-7 in order to have the greatest chance of solving the cryptographical algorithm that will win them the Bitcoin reward. This means power consumption. And when you extrapolate this across the entire network of millions of nodes, this means a great deal of power consumption.

Bitcoin power consumption chart vs countries UC

In fact, if Bitcoin mining were a country, it would rank roughly 27th in terms of its power consumption. That's about the same as Sweden. Worse still, most economic think tanks believe that the majority of this power consumption comes from fossil fuels. So, Bitcoin has a massive carbon footprint. Many, including Mr Musk, are starting to realise that the benefits of a decentralised digital currency may not match the costs of maintaining one. Tesla has always positioned itself as a 'green' option, as a company that is part of the solution and not part of the problem. It follows, Mr Musk's sudden turnaround on Bitcoin usage is perhaps not surprising, albeit confusing with respect to the fact that Bitcoin's lack of green credentials was widely known before Tesla's initial investment back in February.
Adapt or die
Bitcoin's mining protocol is often referred to as 'proof of work'. In order to get your Bitcoin reward for verifying the blockchain you have to do the work. No work, no chance of reward. Because each node on the Bitcoin network is attempting to solve the same puzzle at the same time, many argue that mining Bitcoin is an extremely inefficient and wasteful process.

There are a number of other cryptocurrency projects that have sprung up more recently whose protocols aim to solve the issue of excessive blockchain energy use. An alternative protocol that is gaining significant attention since Mr Musk's comments is 'proof of stake'. Proof of stake involves existing owners of a cryptocurrency being chosen (either at random or as a result of the size of their holdings. i.e., their 'stake') as the next validator of the blockchain. Like the proof of work protocol, proof of stake rewards validating nodes with new cryptocurrency and the transaction fees associated with the new block. So, rather than constantly having to solve a CPU-hungry, and therefore an energy hungry algorithm, 'stakers' simply have to be connected to the network. This means that stakers can use regular computers like the one you're probably using now, instead of the energy-hungry dedicated 'mining rigs' most proof of work protocol miners require.

Perhaps the best performing of the major cryptocurrencies since Mr Musk's comments is Cardano (ADA)*. According to founder Charles Hoskinson, the Cardano cryptocurrency network consumes only about 6 GWh of power, which is about one-ten-thousandth of bitcoin’s energy consumption. Shortly after Mr Musk's comments, Mr Hoskinson tweeted (presumably to Mr Musk): "Are we finally going to have the Cardano conversation? Come to my farm . . . Got sweet tea and minidonkeys." So far, there's no word on whether the mini donkeys have met with the Tesla CEO!

Cardano price chart-1

Yesterday, the financial regulators in China announced that they would be applying further restrictions of the use of cryptocurrencies (including Bitcoin and Cardano) within the Chinese financial system. They also noted that they are progressing with the issuance of a digital version of China's currency, the Yuan. This news has further rocked the cryptocurrency world, and it has sent prices spiralling lower in an environment where investor sentiment was already on-edge after Mr Musk's comments.
Any opinions, news, research, analyses, prices or other information contained on this website is provided as general market commentary and does not constitute investment advice. ThinkMarkets will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.
Any opinions, news, research, analyses, prices or other information contained on this website is provided as general market commentary and does not constitute investment advice. ThinkMarkets will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.
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