UB Insider #70: Decrypting Cryptocurrency
About this episode:
By this point, most people have heard about Bitcoin and other cryptocurrencies—if for no other reason than their skyrocketing values. But what are they and where did they come from? GPS Capital Markets‘ Brandon Parke tells all.
[The following has been edited for grammar and clarity.]
Lisa Christensen: Hello and welcome to UB Insider. I’m Lisa Christensen, online editor at Utah Business magazine. For the last few years, digital currency has quickly been gaining popularity. News organizations and tech firms have heralded it as the currency of the future. But what is it, and just what can it do? Brandon Parke of GPS Capital Markets is here to talk about just that. Welcome.
Brandon Parke: Thank you. It’s great to be here, Lisa.
Lisa Christensen: So give me just a brief overview of cryptocurrency – there’s Bitcoin, Lightcoin, and many other cryptocurrencies – but what are they as a collective thing?
Brandon Parke: At GPS Capital Markets we’re in the foreign currency business and we buy and sell currencies across the globe. As such, we only deal with corporate clients, not the mom and pop folks of the world. We help companies mitigate their foreign currency risk.
Over the last few years we’ve have a lot of clients calling us up because they want to know all about this cryptocurrency craze and what’s going on. Bitcoin is a big one. It’s become regular practice to turn on CNBC in the morning and see that Bitcoin is up another 100%. When everybody thinks about cryptocurrency, they tend to think about Bitcoin because they were the first to market. They have that advantage.
If you think back to 2009, you can remember the things that were happening when Bitcoin came out. We had just come off a big-time recession. The banks were in trouble. Lehman Brothers and Bear Stearns went belly up and that rippled through the debt markets. And so if you think about that, there were a lot of people that were upset about what the banks had done. They’d done a lot of unethical things as far as underwriting CDS’s which are credit default swaps. Everybody was buying a home back in 2004, 2005, 2006 and these banks were allowing people to buy homes with zero down or stated income and things like that. Banks were doing a lot of those types of things and it wasn’t right.
I tell that story because what ended up happening was in 2008, S&P and Moody’s slapped “A” ratings on all this debt and then all of a sudden the economy had a few hiccups and a lot of these banks were under water because those home loans were going sour. That put the economy in a tough spot. There’s a great book out there called Too Big to Fail by Andrew Ross Sorkin. You can read that to learn about what was going on with the banks at that time. But to keep a long story short, what happened was that the government came in and bailed everybody out. The government printed, a few trillion dollars to bail out all of the banks.
After all of that, there was a movement where a lot of people were upset about the bailout and so they started coming up with cryptocurrencies. Bitcoin was one of the first of those. It was designed by a man (they say it was man) by the name of Satoshi Nakamoto. Here in the United States that’s like being named John Brown. It was very anonymous. Nobody knows who really created Bitcoin and there’s good reason for that. So I tell that story to kind of give you a background as to what was going on with the economy in 2009 and why Bitcoin came to be.
Bitcoin is truly a digital currency for the digital age. Nobody controls it. Nobody can print it. In fact, there’s only 21 million bitcoins. Due to the Bitcoin protocol, there can only be 21 million bitcoins ever produced. So it’s kind of deflationary in that fact. If the U.S. runs out of money, what do we do? If our government runs out of money we pass a bill and we print more money. The Federal Reserve controls the money supply in the United States. You can’t print more bitcoins. And that’s why if you take a look at it on some of the most popular exchanges out there – Coin Base, number one, Crack, and a few others – you can see that Bitcoin has gone to around $5,000 per bitcoin in October from about $1,000 per bitcoin a year ago. Last month it bounced off $20,000 and now it’s sitting around $15,000-$16,000 per bitcoin.
Lisa Christensen: That’s an enormous amount of growth.
Brandon Parke: It is kind of crazy to think about it. But if you look at it, there’s no more supply to be had and everybody wants some. There are those out there who say it’s going to be $500,000 per bitcoin or a $1 million per bitcoin. Where is it going to be? Well Bitcoin, as I said, was put out there to be its own network and that’s how it works. It’s all based on blockchain technology which is this new technology out there. It used to be that currencies were valued on gold and silver and they were backed by that. We’ve been off the gold standard since 1971 when Nixon took us off of it. Bitcoin and the underlying blockchain technology is all based on mathematics and it’s a network. The Bitcoin protocol is based on this blockchain technology.
Now Bitcoin is not blockchain. But Bitcoin uses the blockchain technology to transfer digital coins of digital assets from one person to another. It’s its own payment process. There are some problems with that, but right now Bitcoin is a scarce digital asset and that’s why the price keeps going up. People think that it’s going to be digital gold. People think that you’re not going to be able to get them because there’s only going to be a finite amount that will be created. They want a piece of the action and everybody is rushing to do that now. They don’t even understand what it is but they want some because of what the news is calling FOMO – the fear of missing out – on the next crypto-craze.
Bitcoin was the first to market and there are now thousands of alternative coins or alt-coins. I checked last month and I think there are over 3,700 different cryptocurrencies out there that you can invest in. A lot of them are scams. Most of them won’t make it, but the thing is, in order to invest in an alt-coin, most of them require that you buy Bitcoin first. That’s the point. Your gateway to the cryptocurrency market most generally is through Bitcoin.
Lisa Christensen: So by being the first, it has accidentally become the standard?
Brandon Parke: Pretty much.
Lisa Christensen: Or maybe not accidentally?
Brandon Parke: Well what a blockchain is is a ledger. It’s a digital ledger and it’s open source so anybody can see it. It’s very difficult to hack.
Let’s say that I want to buy something from you with bitcoin. Well that’s put out there on the network and it’s called a block. Our transaction is called a block. Each block in Bitcoin is just a different iteration entry in a general ledger that’s out there on the blockchain and anybody can go in and see it and then it’s thrown out to the network.
The people that are on the blockchain network do what they call a proof of concept which are mathematical algorithms that they have to solve in order to confirm that the transaction is good. There has to be six of those to make a consensus. Once you get a consensus the transaction is validated and it creates what they call a hash. The next block has to have that exact same hash to create the next block in the blockchain. But once they come to a consensus and that blockchain has been validated, then the transaction goes through. That typically can take anywhere from 10 to 78 minutes.
I can transfer to you with very minimal costs, but the problem with that is Bitcoin is not nearly as fast as say a Visa or American Express platform. Just to put that in context, Visa has the capability to do 24,000 transactions per second. How many do you think that Bitcoin can do per second?
Lisa Christensen: A fraction of that if everyone takes 10-78 minutes?
Brandon Parke: Seven transactions per second right now. There’s a lot of issues right now with the blockchain technology and speed. Right now if you go and buy a cup of coffee with your bitcoin you have to sit around and wait for 30 minutes for the transaction to go through. As more and more people invest in Bitcoin and move bitcoins from one exchange to another the fees are going up and it’s going to get clogged and take more time.
Lisa Christensen: Is there any way to make the process any faster? I’m assuming there are some very smart people who would get paid very large sums to figure that out.
Brandon Parke: There is technology out there that’s being developed to increase the size of the block in the blockchain. I believe that right now a block right now that’s being validated has a cap of a couple of megabytes. They are looking at making that a gigabyte. There is new technology coming up, but because it’s not a centralized currency it has no real formal oversight.
In the United States we have the U.S. dollar as our functional currency. If we need more dollars or less dollars we have the Federal Reserve. The government controls that. When you have a decentralized currency like a cryptocurrency, the government doesn’t have any control over it. And that’s one of the challenges with Bitcoin that they have right now. The government is also there to protect us. There is no oversight of Bitcoin and there is no central Federal Reserve for cryptocurrency.
If there are to be changes in the Bitcoin world it has to be agreed upon by a consensus of all the miners. Miners are the those who validate the transactions on the blockchain. Another weakness of Bitcoin is that it requires an immense amount of computing power to validate these transactions and make sure that they are correct. They’re un-hackable and they’re secure, but a report came out last month that globally it costs $15 million a day to produce the energy on the electrical grid to mine Bitcoin.
Lisa Christensen: Oh, just in electrical costs?
Brandon Parke: Just in electrical costs.
Lisa Christensen: Wow.
Brandon Parke: Take a look at some of the stocks out there on the New York Stock Exchange that trade in U.S. dollars, like an NVIDIA or an AMD. You take a look at NVDA and their stocks have had a large bump up because they make the chips, the processing chips that most of these miners use. And so that’s been a big boon to them. There’s a large cost in it and a lot of people just say that there’s nothing behind Bitcoin. There’s not gold or silver – nothing. There’s no government standing behind Bitcoin therefore it’s not going to last.
To be honest with you, over the last four or five years, when I first started watching Bitcoin it was at about $200. And I watched it go to $1,200. And then one of the main exchanges, Mount Gox, out of Japan was hacked and over $300 million worth of bitcoin was stolen. That’s another weakness of Bitcoin. It could be hacked if you’re not careful. But then I watched it go up to $1,200 and then back down to $200 and that scared me to death. I said, “I can’t invest in this.” Obviously I probably should have now. But hindsight is 20/20, right?
One of the key factors of Bitcoin is in order to buy bitcoin you have to have your own digital wallet. New exchanges like Coin Base are creating those. One of the benefits in the past of Bitcoin has been that you could buy a bitcoin and transfer it and pay for something and get something and it’s totally anonymous. But now that Bitcoin has gone from $200 up to $20,000, do you think the IRS wants a part of that?
Lisa Christensen: Eh, maybe.
Brandon Parke: Yeah. In the systems in which we exist now we have anti-money laundering steps that we have to take as a brokerage. We have to make sure that we have a KYC, that allows us to know our customer. That’s what KYC stands for. It allows us to know everybody that we do business with. The problem with cryptocurrencies has typically been that we don’t know who the people are that we are trading with. In the past it has been for seedy things like buying drugs or selling things in the dark web, but now Bitcoin and cryptocurrencies are taking that leap forward into the mainstream and everybody wants to understand what it’s all about. They’re trying to learn what this blockchain technology is.
I was just out at a conference in San Diego a few months ago and they were all talking about blockchain technology, not for cryptocurrency, but how they can do things better in their backend services because it’s not hackable. They don’t have to protect it near as much. So there are a lot of challenges with Bitcoin and cryptocurrencies but it’s also going to be the future. If you take a look at some of the things that are going on in Zimbabwe or Venezuela, countries that have a high deflationary or inflationary currency, people want to know where they can put their money where they know it’s going to be worth something. They can’t buy dollars, but they can buy cryptocurrency like a bitcoin.
Lisa Christensen: Yeah, and speaking internationally, you guys do a lot of work with international trading and money. How does Bitcoin’s adoption and rise in popularity affect trading? I read recently that South Korea moved to limit cryptocurrency trading, for example. So what kinds of benefits and challenges do you face with that international market?
Brandon Parke: That’s a great question, and I don’t think we know the exact answer to that yet. Some countries have really moved to limit the use of cryptocurrencies like China and South Korea, just like you mentioned. South Korea hasn’t necessarily limited the buying of currencies, what they’ve limited is the ICO’s – the initial coin offerings. Those are new alt-currencies coming out that are looking to raise money, but a lot of them are scams. It’s unregulated. The government wants to regulate it just like in the U.S.
We have a lot of legislation and regulation in the United States and they’re trying to limit that because any time that a company goes public there are a lot of governmental regulations that go into effect. Any time you start dealing with financial markets the government has a fair amount of oversight. Whether you’re moving currencies or you’re trying to file an IPO to go public and trade on one of the exchanges, the government is involved. Cryptocurrencies are really mixing that up for investment bankers.
A lot of companies now will say, I’m not going to use an investment banker. I’m just going to sell a token, which is a digital asset created through the blockchain technology, and we can trade electronically. I don’t have to go through an exchange and I don’t have to do all these things. But the problem with that is that companies are not following any governmental standards. There is no AML. There’s no governmental oversight when you start dealing with cryptocurrencies. I think what will happen is the government will get a lot more involved in cryptocurrencies to make it investable for the general public.
Most people don’t know what Bitcoin or blockchain is. Or maybe they have heard about it and just want to get in for fear of missing out, but they have no idea what they’re investing. China has limited trading anything in cryptocurrencies because they control their own currency. I work in the foreign currency markets. Currencies like the U.S. dollar or the Euro or the Pound are all free floating currencies. You can buy those freely. But you can’t go out and buy a Chinese Renminbi off the market. It’s a controlled currency.
What has been happening is people in China will use their Chinese currency, the CNY, that’s the ticker on it, or the Renminbi, to buy bitcoin and then send that outside of their country. Bitcoin is a global payment process that you can move. There are no borders with Bitcoin. And that’s a good thing and that’s a bad thing. So the government in China realized that people were moving money outside of China unbeknownst to them and they couldn’t control it. So they just shut the whole thing down.
You’ve got countries and governments that are starting to worry a little bit as cryptocurrencies start to gain more and more traction. Those governments are going to start clamping down more and more or putting more regulation on them which creates costs. Typically when you look at a currency, the three ways you define a currency is medium of exchange, a store of value and a standard of value. The problem is that with bitcoin, one day it might be worth $20,000 and the next day it might be worth $2,000. When you go to your bank and you make a deposit, generally tomorrow you want to make sure you’ve got that same money in your account.
Lisa Christensen: It would be nice, yeah.
Brandon Parke: But people are thinking if I have $1,000 today and it might be $2,000 tomorrow, that’s good too. But that’s why it’s very speculative right now with wild movements.
Lisa Christensen: Yeah, and before we started recording you sort of compared this to the dot com boom and bust in the late 90s.
Brandon Parke: Right.
Lisa Christensen: So are there any lessons that we can learn from that cycle of people not understanding it, it getting wildly popular and then just kind of fizzing out? And then now evening out to something that is accessible for most people?
Brandon Parke: Again, I think that you have to take a look at each alternative currency. Bitcoin is probably here to stay in some form or degree. If not, then there will be something that takes its place. The popular one now, and we’re speaking on January 8th, is Ripple which is XRP, which is another blockchain technology. They’re rivals.
The way to track these currencies is on CoinMarket.com. You can go in and you can see all the cryptocurrencies right now – there’s about an $800 billion market cap. Bitcoin by far is the number one. It’s worth a couple hundred billion right now. XRP is worth about $100 billion. Then you’ve got Ethereum. Ethereum and XRP are bouncing back and forth in the number two and number three slot.
Your question was is this going to be like the dot com boom and bust? Well one of these technologies is going to win the day. Bitcoin was the first out of the gate technology. They’ve got the number one spot, but do they have the best technology? The number one spot doesn’t always have the best technology. Which one of these cryptocurrencies can play nice with the government? The reason Bitcoin came out was because they hated the government. They don’t want anything to do with the government. Therefore it has its own market.
Just last month futures came out on Bitcoin. Now you can trade and bet on cryptocurrency on the exchanges, on the CME, and on the futures exchanges. So what you need to do is follow each alt-coin and do a ton of research. I wish I knew which currency was going to make it. Then I’d be dumping all my money into it. But there are some ETFs, exchange traded funds coming out that will probably follow a lot of these cryptocurrencies. But be careful investing in them because the premiums you’ll pay will be high. Just be careful because some of them could be here today and gone tomorrow.
Lisa Christensen: So it seems that it’s going to take a few years for this to all even out.
Brandon Parke: I think so. A few years from now it will look a lot different than it does today. The reason Bitcoin remains popular is because it is called “digital gold.” Each of these alt-currencies has its own token which could be exchanged for some good or value. But right now it’s not very efficient to pay for things.
Last September, Seema Mody, who is an anchor on CNBC, tried to live on bitcoin for a week and you can see that it cost her 40% more to live for a week than it would have been just to use U.S. dollars. So if you’re paying for goods and services in bitcoin, it’s not very efficient right now. It just can’t compete yet with the current platforms like the Visas and Mastercards of the world that charge you 2-3%. Eventually that’s what some of these cryptocurrencies are trying to solve is removing the middle man, like a Visa or a bank, so you can just go peer-to-peer. And it’s coming. Pretty soon the technology will be free to you and I to exchange money because still to this point these things are costing money.
Lisa Christensen: Well I guess we’ll have to see what it brings.
Brandon Parke: No kidding.
Lisa Christensen: Well thank you so much for coming in today.
Brandon Parke: Yeah, you bet. It was my pleasure.
Lisa Christensen: Thanks also to Mike Sasich for production help. Make sure to follow UB Insider on Apple Podcasts, Stitcher, Google Podcasts or wherever else you get your podcasts. You can also follow us on social media at @utahbusiness and drop us a line at email@example.com. Thanks for listening.