Crypto

Do you have Bitcoin in your portfolio? How’s your collection of NFT’s performing? Maybe you’ve heard about DeFi financing or smart contracts. The Pancake explores.

Several Pancake readers have suggested over recent months that I address crypto, an evolving category of digital products and services that share the underlying use of blockchain. Wow, we’re in the weeds already.

I won’t touch crypto, as direct purchase of currencies like Bitcoin, in an Exchange Traded Funds (EFT) that tracks cryptocurrencies, in NFTs and certainly not meme coins. I’m not here to advise on what you should do. I will explain why.

Whether you view the various digital currency brands such as Bitcoin or Ether as a scam or NFTs (non-fungible tokens) as a rip-off, they all depend on blockchains, which is a legitimate and potentially helpful technology to assure the authenticity and security of digital data.

First, we must ensure we’re on the same page with our key terms. Cryptocurrencies and blockchain are closely related but distinct concepts:

What is Cryptocurrency?

This is a digital or virtual currency that uses cryptography for security. It operates independently of a central authority, like a bank or government. Examples include Bitcoin, Ethereum, and Litecoin, as well as the lesser-known Crypto Jesus Trump and Sunbeam. For some transactions in some venues, cryptocurrencies may be used as a medium of exchange or an investment asset.

NFTs are a form of crypto. They are unique digital assets tied to the blockchain, often representing art, collectibles, or even memes, like the recently introduced Trump “coin.”¹

In 2021 a JPG file made by Mike Winkelmann, the digital artist known as Beeple, was sold by Christie’s in an online auction for $69.3 million. The price was a new high for an artwork that exists only digitally, beating auction records for physical paintings by museum-valorized greats like J.M.W. Turner, Georges Seurat and Francisco Goya. Bidding at the two-week Beeple sale, consisting of just one lot, began at $100.

Beeple’s $69 million jpg

What the buyer received was a jpg file that looks identical to the one above (and yours gratis).² However, for the money, the buyer has enshrined in the blockchain that he, she, or they have the original provided by the artist. In one regard, this seems rather ephemeral. On the other hand, think of the many quality copies of the Mona Lisa worldwide, but the original at the Louvre still maintains its value.³

What is Blockchain?

Blockchain is the underlying technology that enables the existence of cryptocurrencies. It's a decentralized digital ledger that records transactions across a network of computers. Each transaction is grouped into a "block," and these blocks are linked together in a "chain," hence the name blockchain. Blockchain technology ensures the security, transparency, and immutability of the data recorded.

In summary, while cryptocurrencies are digital assets used for transactions, blockchain is the technology that makes these transactions secure and transparent.

Maybe this will help. Think of a bookkeeper with his green eyeshade huddled over his ledger books. He enters each sale and each payment for the goods received for his shop. One day a vendor comes in a claim he was not paid for some goods. Our bookkeeper opens the ledger and shows the vendor the payment entry. “But how do I know you didn’t just enter that without actually sending the money?” retorts the vendor. “Well, here in my files, I have a receipt showing “paid,” responds the bookkeeper. “And how do I know you didn’t just forge that receipt?” accuses the vendor. How indeed.

Moreover, what happens if there is a fire in the shop and those ledger books are destroyed? Now what?

Blockchain addresses these validation and security issues. First, when the modern-day bookkeeper pays a vendor with a digital currency, the ledger entry—the “block”—is quickly sandwiched between the entries of others who have made digital transactions at the same time. It becomes part of an unbroken chain. Moreover, rather than being encoded on a storage drive on one computer, the chain is propagated to thousands of servers globally. A fire at one has no impact on the chain. In addition, trying to tamper with the entry would require breaking the chain that the original entry was part of.

The notion of a continuous chain, in fact, harkens back to the method that was developed to ascertain the validity in infant days of written records. A digression:

The practice may date as far back as the 11th century, to the red, ribbonlike cloth that English clerks used to secure official documents. For hundreds of years, correspondence was tied with tape and the ends were sealed with melted wax, so that the contents couldn’t be read by anyone other than the intended recipient. The only way to access the documents was to cut the seal, which around the 18th century led to the common idiom “cutting through the red tape.”

Blockchain is a valuable technology. For example, it can be used for “smart contracts,” which are self-executing contracts with the terms written into the digital code and stored in a blockchain—thus ensuring it is secure and tamper-proof. So, let’s say a manufacturer does a deal with a buyer for a shipment of her goods. The terms are payment upon delivery. This agreement—the contract-- is entered into a blockchain. It cannot be altered or deleted.

Then, when the buyer confirms receiving the shipment, the payment, in the form of a digital currency, is automatically released. There is no need for lawyers or notaries to enforce the terms of the contract. It’s like a vending machine: that package of M&Ms is visible but protected until you insert the correct amount of money that the program requires, at which point it is released.

Back to crypto

Bitcoin is the grandfather of digital currencies but shares similarities with others. It was conceptualized in 2008 when an individual or group using the pseudonym Satoshi Nakamoto published a whitepaper titled "Bitcoin: A Peer-to-Peer Electronic Cash System." This document laid out the framework for a digital currency that could operate without the need for a central authority. On January 3, 2009, the Bitcoin network came into existence, and the first Bitcoin transaction occurred on January 12, 2009, when Satoshi Nakamoto sent 10 Bitcoins to computer scientist Hal Finney. This marked the beginning of Bitcoin's journey as a functional digital currency. At the time, it had no value.

Value of Bitcoin, January 2009-January 2025

A different category of cryptocurrency is “stablecoin,” a category in which Tether is the largest. Stablecoins are—as the name suggests—designed not to fluctuate in value. Instead, each Tether coin is tied to the U.S. dollar. One Tether coin=$1.00. Tether claims to be backed by dollar reserves. A buyer who wants $100,000 in Tether deposits that amount with Tether. Those funds can be used for transactions. Why not just use dollars? Tether has the advantage of blockchain security. It would allow for transactions using smart contracts. In countries with unstable local currencies experiencing high inflation, Tether would maintain its value of $1. Tether itself earns revenue from the interest it gets on the Treasury Notes it invests its cash in, as well as some small transaction fees.

Determining the value of crypto

The value of anything is ultimately what someone will pay for it. That said, most of what we buy has some tangible worth at its core. The house one lives in, the phone you carry, and the plane ticket purchased contain value as you get something for your payment. The accountant who does your taxes provides a service, but there is a quid pro quo for what is charged. The full faith and credit of the government backs the dollars we have in the bank or wallet. (Hopefully, that still means something). The value of stablecoins is the value of the currency in its reserves. On the other hand, cryptocurrencies in the Bitcoin model are backed by nothing—except what millions of individuals are deciding their worth at any moment.

The algorithm that creates Bitcoins caps the number at 21 million. About 20 million have been produced to date.

Should you invest in crypto?

Cryptocurrencies are a complex and often debated topic. Some people argue that certain cryptocurrency schemes resemble Ponzi schemes, where returns for earlier investors are paid with the capital from new investors. Others are convinced they are worse than a Ponzi. However, not all cryptocurrencies operate this way. Many legitimate cryptocurrencies are based on blockchain technology and have real-world applications and value. True, some early buyers have made a killing when selling to later buyers paying much higher prices. But in a Ponzi, there is no asset at all—it’s just shuffling incoming funds indirectly to existing marks until it topples from basic mathematics where there are too many Pauls and not enough Peters.

Crypto can have value if, over time, there are more buyers than sellers—more demand than supply.

Why Is Crypto So Risky?

As for whether cryptocurrencies are real investments, they may be, but they come with significant risks.

Extreme volatility, with crypto prices sometimes swinging wildly in a matter of hours. Bitcoin, for example, has seen its value drop by 50% or more multiple times over the years. This makes it a rollercoaster ride for investors, especially those who can’t stomach losing a significant chunk of their money overnight.

Lack of regulation because crypto operates outside traditional financial systems. And under the current administration, this is unlikely to change. This means fewer protections for investors. If your crypto exchange gets hacked or goes bankrupt (see Bankman-Fried and FTX), you might not get your money back.

Speculative nature, as much of crypto’s value is driven by hype, speculation, and FOMO (fear of missing out). Unlike stocks, which are tied to companies with revenues and profits, many cryptocurrencies have no intrinsic value. Their worth is based purely on what people are willing to pay for them.

NFTs are a unique risk, even more speculative than currencies. While some have sold for millions, the market is highly illiquid, and the value of an NFT can plummet if the hype dies down. Plus, there’s no guarantee that the digital art or collectible you bought will hold its value over time, though that applies to analog art as well.

Scams and fraud are a by-product of minimal regulation. The crypto space is rife with scams, from fake initial coin offerings (ICOs) to rug pulls (where developers abandon a project after taking investors’ money). Even experienced investors can fall victim to these schemes.

While some investors have made substantial profits, others have faced significant losses. There are hundreds of digital currencies that someone has bought, most worth little or nothing.

If I had a few million dollars in investments, I might accept a low five-figure bet on some form of crypto, in much the way I might put a few chips on the roulette table. I might win, but it won’t affect my future if I lose. For me, there are too many negatives to overwhelm a few positives. This isn’t like investing in Apple stock or even investing in a start-up venture with an uncertain outcome.

The Bottom Line

Crypto is exciting and innovative, and blockchain technology has considerable potential applications. However, crypto is also unpredictable, largely unregulated, and speculative. While some people have made life-changing money, many others have lost more than they could afford. So, before you jump on the Bitcoin bandwagon or buy that Bored Ape NFT, ask yourself: are you prepared for the risks? Because in the world of crypto, the only guarantee is uncertainty.⁴

---

What’s your take on crypto? Love it, hate it, or still trying to figure it out? Leave a comment!

1. Digital currencies like Bitcoin were created with the intent of being used for transactions like any other national currency. They are used as a substitute for dollars and Euros, particularly by criminals, as they can’t be traced and don’t enter the banking system. In practice, they are more often bought and sold to store value as an investment. Meme coins, on the other hand, are issued purely for collecting and have zero value other than what is created by supply and demand. On their first day, the price of the Trump coin was bid up from $10 to almost $75. On February 1, they were selling for under $20. Trump issued 200 million of the digital coins but created 1 billion, which they expect to release over the next three years. The proceeds from the original sales go to Trump. The value of its current “holding” of 800 million will fluctuate based on the price at any moment.

2. You can see some of the details within the full image here.

3. Granted, jpg copies are perfectly identical to the original, whereas a copy of a physical artwork can be identified as a copy.

4. For further explanations of cryptocurrencies, see this explainer from the Reserve Bank of Australia.