On Episode 2 of The Edge of Innovation, we’re talking about cryptocurrency. We have to translate currencies because banks assign them value. But for cryptocurrency, you could say “I want to buy a bitcoin.” Well what’s it worth?

Show Notes

A New Alternative to Bitcoin
Link to SaviorLabs Assessment

Transcript

Sections

Intro to Cryptocurrency
Cryptographic Math
Bitcoin and Banks
Arbitrage Opportunities

Paul: This is the Edge of Innovation, Hacking the Future of Business. I’m your host, Paul Parisi.

Jacob: And I’m Jacob Young.

Paul: On the Edge of Innovation, we talk about the intersection between technology and business, what’s going on in technology and what’s possible for business.

Intro to Cryptocurrency

Jacob: So, Paul, I’ve heard a lot about this idea of cryptocurrencies. It seems like a lot of people have brought that category up, especially as it relates to Bitcoin. I’d be curious to know, what exactly is cryptocurrency. Can you explain what it is? What does it do?

Paul: Sure. First of all I think it’s important to take a step back and drop the word crypto and look at what currency is. If you go into your pocket and get some change or a dollar bill out, that’s currency. I’m speaking from the United States. If you’re in Europe, you might have euros or another type of currency.

But if I give you a piece of currency from another country, it sort of looks like a toy. You don’t understand what it is. You don’t understand its value. If I give you a yen, a bill, it it’s 1000 yen, you don’t know if that’s $1000; you don’t know if it’s $10. You don’t know if it’s a penny. And same thing: The dollar has a bigger penetration globally, and people tend to want to trade in it. So, we understand, certainly as Americans, the intrinsic value of a dollar.

Now, one thing that’s very difficult in currency as I just alluded to is the exchange of currency. You’ve been to an airport, and you can exchange your dollars for euros, and you’re sort of, “What does that mean?” Or dollars for Canadian dollars, or dollars for Australian dollars. I’m going to give you one euro for every $1.50 you give me. So, if I wanted to go buy a can of coke that’s $2 here in America, let’s say, that’s sort of like one and a half euros in Europe.

We’re not used to doing that translation in our head. And so that’s why it’s very difficult for anybody to be sitting there and saying I do that translation. Any new type of currency, whether it’s crypto, euros, whatever it might be is going to face the problem of how do you convert.

The reason why we convert is because the institutions that back those currencies put a value on them. And the world’s view of those institutions puts a value on them. It used to be that the United States had a currency that was based on the amount of gold it had in storage. And that was done away with. So, now we’re working on what’s called the full faith and credit of the United States. And the same thing with the euro zone. They back it, and they have a certain tie-in to value.

As we’ve heard in different discussions of late, different countries can change the value of their currency. And change how much goods are worth to the outside world so that they can make a trade advantage or disadvantage. So now, when we come to cryptocurrency, you say, “I want to buy a bitcoin.” Well, what’s it worth? There is no coin.

Cryptocurrency is based on the idea that is it a string of bits, ones and zeros, that is a large number that represents something. That basically represents a share of the amount of cryptocurrency that’s out there.

Well, why can’t I just make a new set of numbers? And write down a new random string of numbers? And that’s where the bitcoin or the cryptocurrency comes in, because there’s some strong math that has to be done to create those valid strings of numbers. When they’re issued, they’re recorded in a ledger. And they’re recorded in that ledger by more than one person, or really computer. And so, what you have is it’s very difficult to get the needed numbers of people that are out there to agree that this number has been issued.

It’s a little bit esoteric as I’m saying it. And it is esoteric.

Jacob: Yeah. You sort of lost me. So, you have to get people to agree to that number?

Paul: Yes. Exactly. So, if I go and write something in the ledger and say that Paul has $10. The people who control that ledger, because it’s a public ledger, all have to agree that yes, Paul has $10. Now, that sentence is easy for us as humans to understand. But it’s cryptographically significant. And what that means is that we use both private and public key encryption, a way to encrypt something that only the person that has the key can decrypt it.

These journal records are stored in something called the blockchain. The blockchain is really one of the coolest inventions of the past five or ten years, and is ways to record these and have everybody do the cryptographic work on these signings, and record them in the blockchain and say, “Yes, I agree with that.” “Yes, I agree with that.”

So, Paul said something in there with his cryptographic signature and then the other people calculate that and say, “Yes, I confirm that.” And you have to have a majority of people saying, “I confirm that.”

Now, if you’re thinking about that and we’re going at this very surface level because it gets very complicated very quickly… If I could convince more than 50% of the people that are verifying that blockchain to lie and literally take “Paul has $10” and say, “Yep, that’s valid,” I have effectively broken the trust of the blockchain. It other words, I’ve manipulated it. So, I didn’t have $10. I just said I had $10. And you could do that. There’s a thing in computers, never say never. There’s always ways to hack things. It would be hard, but it’s certainly not impossible.

It would be very hard because you’ve got them distributed all across the world and they’re all doing this work. And that’s what a bitcoin miner does. It validates those blockchain entries, among other things.

But the key thing is a person in business looking at bitcoin is to really start to think of it as a different currency. Now, if you’re in America, you probably don’t accept euros on your website. You may not accept Mexican pesos on your website. So, you say, “Why would I? Because the majority of the people that are coming here don’t use those currencies and they wouldn’t know what they are.”

And it’s important to note that our credit card system is not designed to deal with multiple currencies, because there has never been a motivation to do it. If you go down to the restaurant and you want to buy a bowl of soup, and it’s four dollars, you know what $4 of value is. The minute I say that’s one bitcoin, you’re like, “I don’t know. What is one bitcoin worth?”

And coupled with that, bitcoin has been relatively volatile. So, you have indications… Zimbabwe over the past couple of decades has had rampant inflation. So, a loaf of bread could have been a thousand bits of their currency, whereas yesterday it was at one unit of their currency. So, you understand that when you’re going through it, and it’s constrained.

In the whole Greece scenario… I have a friend who’s a developer there and sells his software internationally, and if he sells it with the Greek currency, there’s all sorts of problems. If he sells it in American dollars, that’s relatively stable. But you can check every day with the currencies, the conversion rates between Canadian dollars and US dollars and euros, and they fluctuate.

What’s that fluctuation caused by? That’s caused by the banks saying how much it’s worth and controlling that, and the governments make statements and the Federal Reserve, etc.

So, what controls bitcoin’s value? Well, it’s what anybody is willing to give you. That’s the ultimate judge of value. So, if you have a house you want to sell and you put it on the market for $10 million, and somebody comes along and says, “I’ll give you a dollar for it,” well, it’s worth a dollar. If somebody comes along and says, “I’ll give you $100,000,” well, now it’s worth $100,000. But that is the ultimate definition of what value is.

CryptographicMath

So, in the bitcoin world, what they’ve done is there’s a limited number of bitcoins that can be created through this cryptographic math. In the early days, the cryptographic math was very easy, because it was sort of like low-hanging fruit, the easy problems to solve. But as we’ve progressed, it becomes more and more difficult. It’s at the point now, where if you’re generating cryptographic bitcoins, the amount of electricity that you need to do it is very close to the amount of bitcoin value you would get out. So, if you run a computer for a year, and you say it costs me $10 to run that computer in electricity, you may get about $10 worth of bitcoins out.

So, all of these things coalesce to say what is bitcoin worth. Well, if you look at it, they’re about $450. Who knows what day they were recording this or what day you’re listening to this, and it changes wildly. We’ve seen fluctuations anywhere from…just huge fluctuations. That is fundamentally a problem with cryptocurrency, is that people don’t have a sense, or will not have a sense when they take it out of their pocket, or use their phone, of how much they’re actually spending.

If I could convince you to give me one bitcoin for this cup of soup, that doesn’t sound like a lot. Well, it’s worth about $450. So, now it’s like, “Wait a minute. How do I deal with micro-payments? I have to give you 0.0002 bitcoins.” Well, of course, we do this all on our phones or computers. So they handle all of that, sort of chopping it up into bits.

But you still don’t know what 0.0002 bitcoin is. You have no concept of that. Well, you say, “I’ll compare it to dollars.” So, that’s an intrinsic problem with cryptocurrency, is it doesn’t have any tie to the real world. And people…we’ve got thousands of years of dealing in the real world.

So, you could have the typical scenario where your kid goes on Amazon and buys all these things, thinking they’re all free, and it’s going on your credit card. They didn’t have a comprehension of how clicking the button changed to money. So, you look at it and say, “It’s only $2. Go ahead and do that.” The whole iPhone and iTunes store is spend a dollar. It’s no big deal. It really prevents you from putting that filter in to say, “Wait. That’s $10. I’m not going to spend that.” You don’t do the value calculation.

But now when we present it as a bitcoin or as other cryptocurrency, you’re going to be like, what does that actually mean?

So, there are some intrinsic things for it to overcome. One of the reasons people have felt that cryptocurrency would be good is because it’s hard to hack.

I don’t know that it is hard to hack. There has been a lot of high-profile people, examples where there have been hacks of people who owned bitcoin on behalf of other people. They broke in a stole it, the digital signatures that represent your bitcoin.

So, if you take an external hard drive or a memory stick and put this big, long cryptographic key on it in a text file and you put that through the wash and it gets destroyed, that’s gone. It can never be returned. Just like if it were a dollar bill and you shredded it, it’s gone. You can’t go back to the US government and say, “Well, I had a dollar bill. Here’s its serial number.” They’re going to say, “Tough.”

So, it has those same attributes. So, there’s no advantage there. But I will say, it’s probably more difficult for me to get your wallet out of your pocket and take the dollar bills out of it than it is for me to potentially hack in and get a file on your computer and copy that off and use those cryptographic keys.

So, there’s a lot to be figured out there. One of the use cases is – it’s really cool – you say, I have a phone. It has a fingerprint reader and I can spend bitcoins. Well, the only way it will let you spend the bitcoin is because you scan your fingerprint. Well, that’s good. I’d have to cut off your finger in order to steal the bitcoin or the cryptographic currency, which isn’t terrible. I could also take a scan of your thumbprint and maybe work around that. It’s got to be worth it. If you only have $10 is bitcoin, why waste my time?

So, there’s all of these challenges swirling around cryptocurrency. One of the other advantages that has been extolled is that it’s secret or private. That’s just patently false. The Silk Road prosecutions by the FBI used the blockchain to figure out who spent the money and traced it back. And the blockchain is basically a chain of blocks of information and you can follow them through to figure out who originated the money.

And if you go out and try to say, “I want to buy some bitcoin…” This is one of the things I try and play with is trying to figure out how to be anonymous. You cannot anonymously buy bitcoin. There is no way to do it. They want a credit card number. They want your social security number. They want everything you can. These are government mandated, or at least done in acceptance of government saying something like this needs to be done. Because they want to be able to come in and audit and say, “Who did you sell bitcoin to?”

So, if I go out there and go to anybody, I’ve got to prove who I am. I’ve got to send them a bunch of signatures. I have to send them a phone bill, something that’s got my address on it, that has my name on it… This is really things that I have to do. I can’t just take a credit card and buy some bitcoin.

In the future, we should have a talk about how to be anonymous and different options in there, because it’s a cool thought experiment.

Paul: What’s the advantage? Well, it is a one-world currency. I don’t know if that’s an advantage. There’s talk that the end of the world will be… Part of a one-world currency will be one of the things. Well, are we seeing that happen? I don’t know. But it is the idea that one bitcoin is worth $450 today, for example, here in the United States. And in Australia, at that some moment, it’s worth $450. Whereas, the minute I have to convert a currency, it’s the matter of how much somebody will give you for it.

Bitcoin and Banks

Jacob: In some ways, what you’re describing sounds a bit like the Wild West of currency, which I find interesting. I don’t know if that’s a correct application or analogy, but it does interesting to me that in light of all of those concerns and some of the positives of it, that you recently recommended an article about Bank of America and other large financial industry entities getting into cryptocurrency and trying to get into the blockchain dynamics of that. Can you talk a little bit about why they’re trying to do that and what advantages there are for big banks in doing that?

Paul: Sure. Well, all of these flaws…and there are other flaws which we haven’t talked about, about the scalability and the programming and all kinds of things like that, sort of the soft underbelly. Forget about all those. There’s a lot of money to be made in any new currency. So, any of those entities are going to want to invest and get their pieces of the pie. So, Bank of America… It was Bank of America, right?

Yeah, so they’re out there saying, “Somebody is going to make money on this. We want to have patents that say when you…” Let’s make up a silly patent. Every time you convert bitcoins to dollars, you have to do this lookup on the exchange, and you have to compare it with this exchange, and you may arbitrage some of those exchanges. Well, we’ll write a patent on that. And all the patent is, is a specific way of doing things, a methodology that isn’t generally obvious by just looking at. Like a door, it would be difficult to patent a door now, or a hinge that uses a door. But the first guy who figured out the hinge could have patented it because it wasn’t necessarily obvious by just looking at it.

So, as we develop patents, those things become obvious, and they want to stake their claim, and they certainly have the resources to do that. And this is sort of staking their claim, like the Old West, the gold claim. They’re going to go out there and do everything they can because they have armies of engineers who can think up idiosyncratic ways of doing things and then patent that.

Now, what will happen is they’ll patent things and they will get those patents awarded. And what will happen is people will then come back and say, “No. That’s an obvious application and shouldn’t have been awarded a patent.” So, our patent system is relatively broken in that way. But, of course, they would be doing that. And every big company is doing that.

So, one of the examples I’ve seen being around is it’s so difficult to buy bitcoins. Why don’t you have somebody buy them for you?

Well, there’s some regulatory problems there, but I could start an offshore organization that says I’m going to buy bitcoins for you and hold them for you. So, I’m never going to transfer them to you. So, I’m going to put a ledger together that I own that says, “This bitcoin belongs to Jacob. He has one bitcoin.” And I keep them in my bank.

And this is one of the problems that has happened is people have broken into those banks because they didn’t have good security and stole that ledger. And then I have some bad news for you Jacob. I know you have five bitcoins stored here, but I lost the money. I literally lost the bills. So, you can sue me, but usually these organizations don’t have a lot of assets.

Jacob: What are the ways in which you’ve seen entrepreneurs and startups engage cryptocurrency in their business model?

Paul: Well, right now, given it’s such an early stage, very Wild West, you have people that are primarily saying, “How do I get cryptocurrency? How do I take it? How do I accept bitcoin? How do I do that?” That’s where all the innovation is about right now. It’s nothing really sexy. It’s just a matter of…

Here’s the thing. You open a bookstore on the internet, Jacob’s Books, and you go out and find used books and rare books all over, and you list them on your site, and you say, “Here’s a first edition of this book. It’s $500 or 1.1 bitcoins.” If you got a check for $500, or you got $500 on your credit card, you’d feel fine. If you got 1.1 bitcoins, you would feel, “I better go cash it in right now.”

You see, you have a decision now. You can now be a currency trader. You can decide to be the arbitrage person that says, “Based on the indicators, I think bitcoin is going up this week.”

Jacob: Right. So, I can get that and say, “This 1.5 bitcoin does, for today, equate to $500. But I could hold onto this and this book that you would have sold for 500 USD, it could have make $1000, depending on how bitcoin goes up in two years.”

Paul: Yes. Or it could go down. So, you have a huge thing to think about. A whole mind share that you’re not designed, you’re not used to thinking about. You don’t arbitrage currency. You could do the same thing with the Canadian dollar or euros, is say, “Pay me in euros.” Because they’re going up. If you pay me Chinese currency, they’re devaluing their currency. So, if I gave you 100… I don’t even know what the Chinese currency is, but if I gave you 100 of their pieces of currency, and it was worth $10 today, there’s a good chance in six months it might be worth $8.

Well, you would feel bad about that, a 20% loss on it. What in the world am I doing here?

Jacob: So, is it advantageous for businesses to transition their primary currency over the cryptocurrency, where it’s not just static money, but it could in effect be a bit of a stock option/currency as well?

Paul: You could do that. I think that’s ill-advised because the forces that control the fluctuation in that are very Wild West. There could be a break-in on somebody that steals a bunch, and they’re very volatile. It could go down ridiculously.

Jacob: So then, what are the entrepreneurial future ideas for using cryptocurrency?

Paul: Well, just because it’s not a great idea to use it doesn’t mean people will be smart enough to not use it. It has a lot of pizzazz and appeal right now, and gee-whiz. So, I think building tools and allowing people to use cryptocurrency on your website are good ideas.

Now, if you have a website that sells to children, they’re probably not going to use cryptocurrency. So, you do have to evaluate that, and say where does it make sense. So, if you look at TigerDirect accepts bitcoin. Well, their clients are nerds. So, I buy from TigerDirect and I’m a nerd, so I can understand that.

Amazon doesn’t accept it yet. So, it hasn’t really moved into the mainstream. But that leading edge…it’s cool to do. I don’t think most of the people that are running websites or commerce websites out there are going to see a big uptick in conversion because they have added cryptocurrency to their website. But I could be wrong. It’s sort of an underwhelming situation.

Jacob: And would it be advantageous for organizations or companies that are more international, per se, rather than ones that are just domestic?

Paul: Well, it’s not a substitute for accepting local currencies. Because if you go and you say, “I’m going to expand to Mexico. I’m an American. I’m going to expand to Mexico. We only offer bitcoins and dollars.” That’s not a big market. That’s not a lot of people that are carrying bitcoins around or dollars. So in order for me to do that, I really need to still reach out.

Now, if you fast-forward 30 or 50 years, that may be different. And it more than likely will be somewhat different. The biggest thing with the cryptocurrencies and a proper iteration would be that they couldn’t be manipulated.

So, the scarcity of cryptocurrency is real. There is only a certain number of coins or cryptocurrency that’s available. And it is very much limited to that. Whereas, dollars are largely fictional. There is nothing stopping the US government from printing. If we had a million dollars in circulation, they could print another million dollars tomorrow. There’s nothing stopping them from doing that.

What does that do? Does it change the price of a cup of soup from $3 to $6 because we just diluted the money supply? It doesn’t because we’re not programmed that way as people. We interface with money and say, “It’s $3.”

Inflation has to happen. That’s a different thing where the costs change and expenses and values change. But when it’s dealing with just currency, I can print as much money as I want.

With a cryptocurrency, you can’t do that. So, I can’t manipulate the value of the currency relative to the world market. And that’s one big advantage to cryptocurrency. It can’t be manipulated as easily – I won’t say it can’t – as easily as a government backed…

Jacob: So, for businesses, it would seem to me that potentially for established businesses, it would be risky but worthwhile to explore the idea of cryptocurrency right now. Would it be better to wait for cryptocurrency to develop further?

Paul: No. I think you’re going to have to have some… This is the time where you start to look at it and say, “Do we want to do that?” The real question for a business is when you actually get a customer spending cryptocurrency, do you convert that to your local currency. Do you convert to dollars? That’s the crisis.

Now, you may say, “We’ve got one customer who has a subscription website, and it’s a few thousand dollars.” So, if somebody comes in and buys that in bitcoin, let’s say it’s 10 bitcoin, $4500. That’s what it’s worth today. Tomorrow it goes up to $500. They feel good. Let’s cash out. But tomorrow it goes down to $350. They’ve just lost $1000.

We’re not wired that way in our heads. So, you do need to make those decisions as when do you take and convert that money into fungible assets in your currency.

Jacob: So, it would be helpful for CFOs within a company to have a handle on how that stuff works

Paul: Absolutely.

Arbitrage Opportunities

Paul: I do think there’s a huge business opportunity there, is to be the arbitrage organization. And if you offer that with the proper insurances… So, you go and you get an insurance policy from Lloyd’s of London or one of the big insurance companies like that that says, “We will arbitrage. We’re buying currency, using dollars, and we’re buying bitcoin. Today we bought them at $450. Oh, we see it going down.” And they do their magic, and they know it’s going to go down the $350 tomorrow. Well, they would go out and buy a lot of it, because they also know that the next day it’s going to go back up.

Now, they make mistakes, but they do it in such volume that those mistakes are leveled out. Offering that arbitrage service to a small business or a business is a huge advantage. That doesn’t seem to exist right now.

Jacob: And it seems like another advantage for an entrepreneur asset in this area would be basically training and consulting for CFOs and the financial industry in ways that they don’t understand cryptocurrency.

Paul: Absolutely. I think there is an opportunity for that. But I think even more so, there’s an opportunity for these…somebody to offer. We’ll take that offer.

Jacob: I see. Not just consulting but just to take it away.

Paul: We’ll just do it for you. Because arbitraging only works when you have vast amounts of investments. So, if you’re good at that, why not offer that, broker that arbitrage?

Jacob: The Edge of Innovation is brought to you in partnership with SaviorLabs. SaviorLabs exists to help businesses mature and strategize for the future. Learn more about SaviorLabs at saviorlabs.com.

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Also published on Medium.