Bitcoin Decrypted: Cash, Code, Crime & Power

Meet the phenomenon worth trillions of dollars, that uses more power than Sweden, but that few understand...
06 April 2021
Presented by Phil Sansom, Eva Higginbotham
Production by Phil Sansom.


A bitcoin surrounded by data.


Meet the digital phenomenon that’s worth in the trillions of dollars, that uses more power than the nation of Sweden, but that very few people - including those involved - even understand. Cryptocurrencies are notoriously complicated, the best way to understand how they work is to understand where they came from. In this programme: the history, the technology, the economics, and the psychology. Plus, latest news from the crypto-world: NFTs and multi-million art sales, 'stablecoins' and financial misconduct, and finally - will the whole thing come crashing down?

In this episode

A physical coin imprinted with a Bitcoin logo.

01:01 - Bitcoin basics: where it's from, how it works

Bitcoin is the oldest and biggest cryptocurrency. Its underlying technologies come from unexpected places...

Bitcoin basics: where it's from, how it works
Yilmaz Yavuz; Finn Brunton, University of California Davis

Bitcoin is the oldest and biggest cryptocurrency. Understanding how it works requires understanding where it comes from, because the underlying technologies have come far from their original purposes. Phil Sansom told the story to Eva Higginbotham, with help from Yilmaz Yavuz and Finn Brunton...

Phil - I want to start today by introducing you to a guy called Yilmaz, who's a shopkeeper... but he's got this side hustle.

Yilmaz - You can trade between from a grand to 10 grand a day.

Phil - A grand to 10 grand?

Yilmaz - Yes, you can, yes. The best I've done is a six grand, and the worst I've lost is eight grand in 10 minutes. It's a good buzz man - very good buzz! It's like getting high, but it's nice. You should get on it, it's the future! The future is crypto.

Eva - What a rollercoaster.

Phil - Right? And he's not a millionaire or anything.

Eva - Just a regular guy; runs a shop; loses eight grand every so often, makes eight grand every so often...

Phil - I mean, he's not alone; he's one of millions of others like him out there. And the thing that they're trading, as he said, is 'crypto'.

Eva - Cryptocurrencies. So that's like Bitcoin?

Phil - Yeah. I mean, how much do you understand about this stuff?

Eva - I know a small amount, I would say. I have looked up things like Bitcoin, but it's one of those things that I've read about and heard about, but has not really settled into my brain in a way that I remember.

Phil - I think the best way to understand it is by kind of understanding where it comes; from specifically where the first of them that you mentioned, Bitcoin, comes from. So here is Finn Brunton, who is professor of science and technology studies at the University of California Davis, to take us through it.

Finn - What we think of as cryptocurrency is called 'crypto' because it's based in two primary technologies, both of which have to do in different ways with cryptography: the art and science of secret codes. Now, when we think of cryptography, we think of the idea of a cipher that you have the key to so I can send you the secret message; but there's another role that that cipher plays, and has always played through the history of cryptography, which is identification. If I can write something in a secret code that theoretically only I would have access to, then when you decrypt that, you can be fairly assured that I was the one who wrote it. This was on the minds of a lot of computer scientists in the 1960s and 70s, because they were beginning to realise that computers were going to be everywhere. And that posed this immediate problem, which is: how do you prove that you are who you claim to be over a computer network? And the solution that they came upon was a really ingenious one called 'splitting the key' into a public part and a private part.

Phil - The idea here in our technology number one, which is known as 'public key cryptography' is that there's these two keys that Finn is talking about: the public key and the private key. If you take your message and use one of the keys to then encode it, you can only use the other one to decode it.

Eva - It's like the key allows you to access the message in the code. How can there be two keys and two ways of understanding one code?

Phil - I have this analogy which is from cryptographer Sarah Mieklejohn, which helped me. It's kind of like if I said, "here is a safe," like a physical safe, "that I'm putting out publicly for anyone to use to send me a message." Anyone who wants to send me a message - say it's you - could write it down, and put it in the safe and shut the door. And the door locks when it shuts. Only I know the combination of the safe and so only I can open it. Anyone can encode, but only I can decode.

Eva - And so being able to close the door, that's the public key. And being able to open the door, that's the private key.

Phil - Exactly. The way they get there is obviously not with a physical safe; they get there with some extremely complicated maths. But the use of it that's important here is: in our safe analogy, it's like I've written a message on a wall, and beside it I've left my safe - which everyone knew was closed but is now open - and they go, "only Phil could have done that because only he has the code."

Eva - Okay. Yeah, I get it.

Phil - So technology number one, that's solving the problem of verifying your identity online.

Eva - And that's important in general?

Phil - In general. But so far nothing to do with cryptocurrencies! Back to Finn Brunton for technology number two.

Finn - Technology number two is kind of a related question when you think about it. You can think of question number two being, "how do I prove that something happened when I claim it happened?" If I can prove that I am who I claim to be, and then I, say, transact some money with you over the internet, how can I prove that I sent that money to you when I claim that I did? If you were to say, "well, no, that never happened," and then I produce the receipts, you can just say, "well, you could have made these in Microsoft Word!"

Phil - You know, who was really concerned about this stuff back in the early days of the internet?

Eva - Who?

Phil - Scientists! Scientists really want to be able to prove that they publish something first.

Eva - Mm, yes, that's true.

Finn - One of the solutions to this problem, and in many ways the most ingenious and sophisticated, is a technology called the blockchain. And we often talk about the blockchain as something that comes from cryptocurrency, but it significantly precedes it. A blockchain is a somewhat complex means for doing a very, very simple thing extremely well. And the simple thing that it does is to create a record to which information can be added, but never altered or removed; that can be shared, distributed, among some wide group of people who don't necessarily need to trust each other, there doesn't need to be a trusted third party that you're relying on to maintain the ledger. And it works like this. Let us say that we want to do something very simple and straightforward: we want to establish who wrote what when. We're all poets, so we want to publish our poems and not have people say that they wrote our poems instead of us. So we have a website where we post the first lines of our poem, and then the time and date on which we posted those lines. And then we create a hash of it. And a hash is a method in computer science for taking some blob of data of any length, and out of that, generating a short string of data which corresponds to it. You can just think of it as like a mechanism to produce a kind of very reliable word salad. We take our first line of our poem, our time and date stamp; we generate a hash of that; and then we post those things together. You can think of that as like a little block of data. The part that makes it into a blockchain is that the next person to post is going to post their time and date stamp, the first line of their poem, the hash of that data together, plus the previous hash in the chain; and then they're going to hash all of those together! And what that means is that as this keeps going forward, as each new post incorporates the hashes generated from the previous post, any change to any of the previous data in the chain is going to be immediately apparent. Which means that very, very quickly, as links in the chain keep getting added, you're going to find yourself in a situation where no one can alter the data that was previously entered without having to fake the entire thing.

Phil - Okay. And say, for example, I'm one of those poets, and I really hate that I used the word 'lily', and I want to change it to 'rose' in one of my poems, because it would just make it a lot better. What's to stop me just going in, and I go to two years ago in the blockchain and I change the word 'lily' to 'rose', and then in each of the little hashes I just change where it says 'lily' to 'rose' there as well, or change the corresponding bit?

Finn - The thing that would happen - and the reason why the blockchain is so robust - has to do with the mechanics of hashing itself. To change even a single bit of information in the data is going to completely alter the hash, which is going to completely alter the hash of the hash that is made in the next link in the chain, and so on down the line. So it will be absolutely and glaringly obvious that this whole chain has now been altered, including all of the subsequent activity.

Eva - It sounds really clever. So you're adding to it, and that means that by the end, if you were to try to make any difference, any change right at the beginning, it would be ridiculously difficult in order to do that for everything all the way through.

Phil - Yes.

Eva - What does the blockchain look like?

Phil - It looks like looking at the matrix, those numbers running down the screens, honestly.

Eva - I'm on board.

Phil - We've got our two technologies. Do you remember what they were?

Eva - The first one is about being able to identify yourself...

Phil - Public key cryptography.

Eva - Public key cryptography. The second is about being able to prove time online, and you do that using the blockchain. The blockchain is about time. I don't know how that's related to... how is that related to money though?

Phil - So far it's not! Because we're still back decades ago. The 'why' of cryptocurrencies comes from around the same time, and that includes movements like 'cypherpunks' and 'cryptoanarchists'.

Finn - And this is where we bring in the ideologies, which are quite distinct from the technologies and end up being rather awkwardly fused together with them in the form of cryptocurrencies. One core premise of most American libertarian ideologies is that money should, to some extent and in some way, be out of the control of states. The idea of sovereign central banks under the guidance of government issuing money is a danger, is a long-term threat; the promise of digital money was in many ways the opportunity to reinvent money in some new context. The challenge was always, "well, then what is the money to be?" Because of course, one of the best things that computers are good for is their ability to perfectly reproduce data. Which is kind of a problem if the data that you're transacting is supposed to be money, right? Like in the most obvious kind of seemingly ludicrous sense, why don't we just say, "this string of characters corresponds to money". Well, therefore I'm just going to 'control-c control-v' that money over and over again and spend it as many times as I like. And many different experimental projects to build new kinds of digital money foundered on this problem. And the solution was something that would be based on a blockchain. Because a blockchain provides a way for someone to say, "well, on the blockchain, I have the irrefutable right to this set of tokens and I can pass them over to you." And if someone were to try to cut and paste the rights to that money somewhere else, it wouldn't do anything, it wouldn't mean anything. All the money would do is exist on this closed ledger system.

Eva - So the benefit here is that you can trust that you've genuinely been given some tokens online which represent money, because they've used this blockchain to prove not only who gave you the money, but that the money actually happened in time - the money transfer actually happened at a certain time.

Phil - And the clever thing on top of that is that once you have that record, you don't even need the token - the money - physically, digitally, at all.

Eva - It's like one giant bank statement that says what everyone gave everyone at any time.

Phil - That's it! That's Bitcoin.

Eva - Boy. How hard is that to keep online?

Phil - There's a network of people that all keep copies of it. For now we're going to skip over a lot of history, because there's obviously decades of attempts at this digital cash; until all this stuff, the technology and the ideas, actually got brought together.

Finn - It got brought together late in the year in 2008. And the reason why that date is especially relevant is that that is right in the middle of the global credit crunch. And it happens to be in that context, in that exact moment, that a pseudonymous person whose identity is still not known - they worked under the name Satoshi Nakamoto, possibly a person, possibly a team - circulated a white paper on a mailing list devoted to cryptography which outlined how you could combine these different technologies together - combine public key, combine blockchain - to produce a system that they call Bitcoin: a peer to peer distributed anonymous system for producing digital money.

Eva - How much is a Bitcoin worth?

Phil - A Bitcoin at the time of recording is worth just over $55,000.

Eva - Oh my goodness gracious!

Phil - Whoever this Satoshi Nakamoto is - if they are even a person, and if they're even alive, and they can still access their Bitcoin - then they might well be the 27th richest person on Earth.

Lines of matrix-style green characters obscuring a hooded figure.

16:13 - How cryptocurrencies are linked to crime

Bitcoin and other currencies have been both a tool for cybercrime - and a target...

How cryptocurrencies are linked to crime
Eveshnie Reddy, University of South Africa

Bitcoin is not a criminal operation, but it has certainly been useful for criminals. Some of the first major adopters of Bitcoin were online black markets on what is known as the 'darknet'. Criminologist Eveshnie Reddy from the University of South Africa explained these interactions to Phil Sansom...

Eveshnie - Basically, buyers and sellers of illicit products and services such as weaponry, illegal narcotics, stolen databases, malware, typically rely on cryptocurrency because it helps conceal transactions. It is actually therefore not surprising that cryptocurrencies have become the payment of choice when it comes to electronic commerce on the dark web.

Phil - And how big do these darknet markets get?

Eveshnie - Really big. In monetary value it's millions of dollars of sales that are actually made on these darknet markets. And I think gauging how much money is actually made on the darknet is difficult because law enforcement is not really aware of it.

Phil - What other types of crime are cryptocurrencies linked to?

Eveshnie - The darknet offers services such as tumblers and mixers, and these are money laundering services available exclusively on the dark web. So they basically allow users to transfer their cryptocurrencies into a pool of existing cryptocurrencies, which are then mixed or tumbled, hence the term tumblers and mixers, to basically in inverted commas 'make their dirty money clean'.

Phil - Will these cryptocurrency have been used for some of the darknet stuff that you were just talking about?

Eveshnie - Absolutely. It could be used by anyone, any person or organisation, who was paid in cryptocurrency - Bitcoin in particular - and wishing to make the proceeds of their illegal activity appear legitimate.

Phil - What if you don't just want to use cryptocurrency to help you do whatever crime you were going to do anyway? What if cryptocurrency is the target of your crime?

Eveshnie - So basically then we move on to a different category of crime, and there are several methods that criminals can use to illegally obtain information as a means to steal cryptocurrency, because that's the basic aim. Several exchanges have been hacked. They could also use your traditional phishing attack, which is basically to deceive individuals or organisations into believing that they are communicating with legitimate established enterprises.

Phil - Eve, do you think this is a big part of what cryptocurrencies actually are, or do you think this is kind of like a fringe area, and the mainstream of cryptocurrencies is very legitimate and this is a very small, tiny piece?

Eveshnie - I wouldn't say it's a small, tiny piece. I would think it's quite a significant piece. But I must admit that I do not think that cryptocurrencies are all about criminal enterprises. That's not what they were created for. I really do believe that, if properly regulated, cryptocurrencies could become more legitimised in the sense where we move away from their use in criminal activities.

A stylised set of digital chains.

19:25 - Blockchains and privacy: tracing transactions

Companies like Chainalysis can trace people's money through the supposedly-anonymous Bitcoin ledger...

Blockchains and privacy: tracing transactions
Philip Gradwell, Chainalysis

While Bitcoin is reasonably private, it's not perfectly so. Your name isn't on the blockchain if you make a transaction - instead it's a random string of characters called an 'address' - but over the years, cryptographic researchers have developed tricks to de-anonymise these adresses and trace transactions. Chainalysis is one company set up to do exactly this. Phillip Gradwell is their chief economist, and told Phil Sansom and Eva Higginbotham how it works...

Philip - We're not actually trying to analyse what any individual is doing. We're not trying to name, "these are Phil Sansom's Bitcoin". But there is a need to actually understand how value moves on a blockchain. And if you're a cryptocurrency business, somewhere you might go to buy or sell Bitcoin, you need to do anti-money laundering checks in the same way that your bank needs to do that as money as sent in and out of them.

Phil - How do you actually do this? Because going from a random number to an actual person, organisation, thing... I have no idea how that's actually done.

Philip - Okay, so let's break it down. Whenever you make a transaction using Bitcoin or another cryptocurrency, you've got to tell the network that you're actually making that transaction. We can look at all of that data because all of those transactions are published into this big database that anyone can download. And I can actually show you what that looks like - if you go to our 'block explorer'...

Phil - Okay, you've brought up a website, and it looks like a table of a lot of numbers and stuff that I don't recognise.

Philip - So that's the source of the Bitcoin, the address that it's coming from; and it has the destination, the people that are receiving it. And some of these we've actually already identified, and there's some others that we haven't identified. And that's probably because they actually belong to private individuals.

Phil - You can identify the exchanges, but not the people?

Philip - Yeah, that's right.

Eva - Curious!

Phil - What they can do is effectively group a bunch of addresses into a group that they think is one source. And if they think that source is an exchange...

Philip - We'll actually have to go and send some Bitcoin to that business, and then we'll see the address that it gets deposited in. And that'll help us connect that address to all of the other addresses that that business controls.

Phil - Oh, sneaky. You're kind of infiltrating!

Philip - Well, we're just using it like any normal customer would.

Phil - The problem is though that you've still got these anonymous people. So how can you find that it's an illicit source in the first place?

Philip - Illicit sources, they often actually need to communicate their addresses, right? If you're a darknet market, you need to open up your platform to let your people come and buy and sell the goods that are there. And we can then, in the same way we interact with an exchange, we can go interact with that darknet market and map it in the same way.

Phil - And how effective is this? How much of this stuff are you catching?

Philip - Well, you never know how much you're catching, because you don't know how much you're not catching. But the stuff that we know is related to illicit activity is actually only around 1% of all the value that's sent on the blockchain.

Eva - Isn't that the opposite of what the point of it was though? The whole point of having your special public key is that no one knows it's you. It's not really 'crypto' anymore.

Phil - I mean, it's an excellent point.

Philip - There's been a lot of debate aruond this. My perspective is: if tools like this aren't available then the laws of the land can't really be obeyed. And then actually cryptocurrency doesn't grow, it doesn't become mainstream. Banks don't give bank licenses to cryptocurrency businesses, and normal people don't want to get involved in something that's kind of shady or murky.

Phil - And overall, today, cryptocurrencies like Bitcoin are much more mainstream.

Binary digits on a green computer display.

24:04 - Proof of work: how Bitcoin reaches consensus

How do you make sure everyone involved in a decentralised currency agrees with each other?

Proof of work: how Bitcoin reaches consensus
Mansoor Ahmed-Rengers, University of Cambridge

Previous versions of digital cash ran into the 'double spend problem'. How do you ensure everyone keeping a decentralised currency ledger agrees with each other, and avoid clashes where one person tries to spend their coins twice? The answer is a system called proof of work. The University of Cambridge's Mansoor Ahmed-Rengers explained how it works to Phil Sansom and Eva Higginbotham...

Mansoor - The creator of Bitcoin wanted something that was completely, what he calls, permissionless. And so anyone with a computer could be able to join the network. And the only thing that is sort of common between all computers is the ability to compute, right? Proof of work exploits that commonality. And what it does is it says, "okay, all of you computers in this network, we're going to do a puzzle. And what we're trying to find is a number which, when it is hashed with the previous block, gives us another number which has a certain number of zeros as its prefix." And this puzzle is going to determine who gets to be the next leader who decides what goes into the next block."

Eva - I don't understand. So who came up with this number that you add to it? Who's in charge deciding this is the way it works?

Phil - The underlying code of Bitcoin sets this criteria for what the eventual answer has to be, but who's in charge of finding out what the number you add to it is to get there: that's the puzzle! Right? Here's the puzzle: I try adding one, okay, that was wrong. I try adding two, that was wrong. I try adding three, that was wrong. On and on and on, until I try something and it ends up being right. You're basically doing this hashing over and over again with different values until you get the answer. And that is your proof of work - your proof that you have done the work.

Eva - Okay. Yeah. Like show your work. Yeah.

Phil - Show your working, yeah. Proof of work.

Eva - If you are a regular person who just buys some Bitcoin, you're not involved in any of this, this is just the people who are really into building the blockchain that controls everything?

Phil - Exactly. And the mechanics of the system mean that if you're one of those people, you're supposed to accept someone else's proof if it shows that they, quote unquote, 'won'.

Mansoor - The proof of work principle is that we accept the chain which is the longest,. So let's say that you and I both came up with the solution at the same time, which can happen. On an average half of the network will receive yours and half of the network will receive mine. And when, let's say Alice, receives my block, she'll start building her proof of work on top of that. Let's say Bob receives yours and he'll start building his proof of work on top of your block. Now the probability of another clash keeps going down. Now let's say Alice got there first. Alice's blockchain has one more block than your blockchain does at this point. So everyone who received your block will now abandon it and take Alice's, because we always go with the longest chain.

Phil - Okay. Mansoor does this work, does everyone actually end up agreeing?

Mansoor - In practice everyone does agree on the chain, let's say 10 blocks down from the most recent one and the transactions that are kind of set in stone.

Phil - I mean, that's kind of weird, right? That opens the door to a lot of messing around!

Mansoor - It is, you know! And one of the interesting thought experiments that I like to do with this is: we can imagine that there is a supercomputer which is more powerful than all the other computers in the Bitcoin network, and has already gone, let's say, a thousand blocks further than we are today. Now if the supercomputer suddenly decides to publish that blockchain to the network, we will all just have to accept it.

Phil - How powerful a supercomputer would I need?

Mansoor - It would have to be the most powerful supercomputer ever made.

Eva - What I don't understand is there must be so many people all over the world with computers who are doing this all at the same time. How on earth are they keeping track of every single Bitcoin transaction that's happening?

Phil - The hard part isn't collecting all the information of people sending Bitcoin transactions. I mean, computers are really good at using the internet to collect lots of that kind of information. The hard part is hashing and hashing and hashing until you find the right answer.

A bank of computer chips set up to mine cryptocurrencies.

29:12 - Bitcoin uses more power than Sweden

As Bitcoin gets more valuable, mining becomes more profitable - which takes huge amounts of electricity...

Bitcoin uses more power than Sweden
Michel Rauchs, Cambridge Centre for Alternative Finance

Bitcoin 'miners' have an incentive to do their computing: they get a reward for creating the next block, a certain amount of Bitcoin. And as the price of Bitcoin goes up, there's more and more incentive to do this mining. Faster technology doesn't make it easier, because the underlying code is set up such that the puzzle becomes harder the faster the technology gets. Today, mining operations are relatively centralised in vast banks of dedicated electronic chips that are drawing enormous amounts of electricity. Michel Rauchs from the Cambridge Centre for Alternative Finance told Phil Sansom and Eva Higginbotham that he's done the maths... 

Michel - Bitcoin currently uses about 15 gigawatts of electric power. That's about as much as Ukraine and Sweden consume in an entire year.

Phil - Ukraine and Sweden? Full countries?

Michel - That makes it look very large. Now you can also make it look a bit smaller. The yearly consumption of just stand-by home appliances in the US alone could power the Bitcoin network for nearly two years on their own.

Phil - Who exactly are these miners?

Michel - It used to be, really, hobbyists. Nowadays, since a few years now we would be talking about industrial scale operations all over the world; so we need big data centres that host tens of thousands of machines. Since 2012, you have specialised hardware called application specific integrated circuits; machines that have been specifically designed with custom chips to be good at one single thing, which is Bitcoin mining.

Phil - Is that how you figured out how they're taking up that much power? You could actually go to the places and ask them what they're using?

Michel - So that would of course be the ideal way, but unfortunately we do not live in a perfect ideal world. So we have to come up with a model that is based on certain assumptions. We essentially use a bottom up approach that starts from the energy efficiency of those different types of mining equipment, essentially calculates for each type of equipment whether it's still profitable based on a range of current factors, such as the Bitcoin price, mining revenues, and also the average electricity price.

Phil - Michel, all this energy is probably going to come with a pretty big environmental impact, no?

Michel - So that really depends on the energy sources that went into producing the electricity that miners use. We've essentially compiled the data sets, the estimates where most of those miners are being based. So currently we cover about one third of the entire network. China is clearly dominating with about 60 to 70% of all Bitcoin mining. But within China you see seasonal migration, where during the wet season miners are actually located or moving towards the Southern regions of Sichuan and Yunnan, where there is huge excess supply of hydropower that cannot really be stored or transported to demand centres. However, during the dry season, those miners then move north, where actually the majority of the power is being generated using brown coal.

Phil - Do you have an idea so far of what the carbon footprint of this stuff is? Or maybe how much of it is renewable energy, and how much is definitely not renewable?

Michel - So through surveys, we found out that miners used on average about 39% renewables, but that was based in 2019. So that might have changed quite a lot.

Eva - That is absolutely nuts. As much electricity as Sweden in a whole year. That is a lot. How much do you get for mining? How big is the reward?

Phil - The reward actually halves automatically every four years. Right now you get just over six Bitcoins for mining a block, but at today's prices, that's still more than $300,000.

A coin with the Ethereum logo.

34:51 - Ethereum: a computer in the sky

There's a whole world of cryptocurrencies out there - and Ethereum is the second biggest player...

Ethereum: a computer in the sky
Justin Drake, Eth2

So far in the programme we've talked a lot about bitcoin, but nowadays there’s a whole world of thousands of other cryptocurrencies out there. One of which Eva Higginbotham has bought, as she tells Phil Sansom - and which Eth2's Justin Drake explains...

Eva - I own £10 worth of Ethereum. My friend bought some Bitcoin and bought some Ethereum using this app, and I just got jealous of them talking about the highs and lows of watching it go up and down. I was like, "well, I'll put in £10". As we know from earlier on in this show, I don't really understand how it works; it was just kind of enjoyable to watch. So I can show you, I started with £10. I now have £14.22. And that is over quite... it's been a little while, I don't remember exactly when I got it, but at least a few months ago. And you can see it on a graph.

Phil - Oh yeah. There's a big climb.

Eva - It's gone way up. And I bought it at that point - see there, halfway up the big climb! So I should have bought it down here.

Phil - You probably made overall a good choice. Most cryptocurrencies are really small, don't last very long; you can think of them like penny stocks. Bitcoin is by far the biggest, it's got like two thirds of the market; but this one Ethereum, is definitely the second. And it's very different. I thought we probably wanted to explain it, and so here to answer some of your questions that you might have is Justin Drake. He's a researcher from Eth2, he works on this stuff.

Justin - Hi there. Thanks for having me.

Phil - Justin, I'm sure Eva has some questions. Eva, why don't you take it away?

Eva - To start with, what actually is Ethereum?

Justin - There's the network - and it's this computer which runs in the cloud, it's kind of a virtual computer - and then there's a second aspect to this computer, which is the financial aspect, and there's a token which is native to the blockchain called Ether. And this is what you own in your wallet.

Eva - So I have Ether. I don't have Ethereum.

Justin - That's exactly right. You own Ether.

Eva - And how is it different from Bitcoin then?

Justin - One of the key differentiators has been that Ethereum is programmable. You can also think of Bitcoin as a computer, but it's a very simple computer. You can almost think of it as like a calculator. It can do one thing and one thing very well, and that one thing is the transfer of funds from one place to another. On Ethereum, you can actually write very complex programs to create new and interesting financial schemes. So one very simple example is the idea of an exchange on the Ethereum blockchainl; there's an app called Uniswap which will swap one asset for another purely with code. And in that sense, there's this saying which is that 'code is law'. There's no concept of legal contract that comes into play. There's no concept of humans. It's purely automated with just machines.

Phil - Crucially Justin it's basically like the Bitcoin blockchain, and it uses the same proof of work, where everyone's spending all this power and computing power to create the next link in the chain.

Justin - Yes. So Ethereum today is using proof of work. The future version of Ethereum, which is going to use proof of stake, is meant to be purely digital, where the voting power is proportional to how many Ether do you own as opposed to how much electricity you're expending. This is better for the environment, but it's also better for the holders of the token, because we don't need to print as many Ether in order to reward the validators. There's been almost close to a decade of R&D to get to this point, and it has been a very difficult problem to tackle. The good news is that today, the proof of stake is live; and at some point in the future, in roughly 12 months, we hope to remove the proof of work component and replace it solely by proof of stake.

Eva - Isn't that risky in its own way though? Because couldn't I just buy all the Ether and then I just say, "well, and the next transaction was me getting even more Ether from everybody else"?

Justin - Yeah, that is a great question. It turns out that today, right now, there's about $6 billion of Ether at stake. So if you want to overwhelm the system, you need to match the $6 billion with another $6 billion.

Eva - Might be a little bit out of my league for right now!

Justin - But we have another cool, really cool, defense mechanism, which Bitcoin doesn't have, is that if for some reason you do perform this attack - and maybe you're a nation state, like the US government or China - well, it turns out that we can identify the attacker, penalise, and remove them from the system.

Phil - Just finally, Justin - what I know is cool about Ethereum is that you've got this Ether, but you've got this other layer, upon which there's this whole ecosystem of strange stuff like financial instruments, and weird things people are trading, that - am I right - is absolutely huge?

Justin - Right. We have basically a new internet of finance. Ethereum, when it came out, started with just Ether the asset. But because you have this programming layer, it turns out we have a lot of experimentation. And what we call this financial layer is DeFi, decentralised finance. And right now there's about $40 billion locked and participating in the DeFi ecosystem. And this is growing extremely fast.

Gold bar

40:42 - Are cryptocurrencies really currencies?

Economist Jon Danielsson questions what these digital tokens are really doing...

Are cryptocurrencies really currencies?
Jon Danielsson, London School of Economics

When Bitcoin was invented, its stated purpose was to provide a means of payment that doesn't rely on any person, state, or central bank to maintain it. But today, cryptocurrency investors buy the stuff in order to make money from speculation - far more often than they use it to pay for anything. As a result, economists are questioning what these digital tokens are really for. Phil Sansom and Eva Higginbotham discussed the subject, with help from the London School of Economics' Jon Danielsson...

Phil - Eva, I wouldn't blame you if all this is - economically - making your head spin.

Eva - It's just hard to imagine that all of this money - that doesn't exist in any sort of tangible, physical format - is also taking up not only a huge amount of energy, but there are whole organisations of people and researchers working on it. It's like a whole other world.

Phil - Yeah, and here's the thing: some economists don't even think it's money. There's actually a great example because when you showed me your Ethereum graph, you were like, "look how much I bought here, but I should have bought it here." That's not the function of money, is it?

Eva - No, you have money and then you buy stuff with it. You don't buy money with your money.

Phil - And here's the thing. Most people are not buying things with this cryptocurrency. They're buying it, to have it, to make money with it. Economist Jon Danielsson is the director of the London School of Economics' Systemic Risk Centre; he's been looking into this stuff. He told me he struggles to find a reason himself.

Jon - You can't take a Bitcoin, go to the pub and buy a beer, can you? You can't go to the supermarket. You're not paid in Bitcoin, you can't pay your taxes. And if you can't do any of the things you normally do with money, it's not a currency. It's something else.

Phil - I guess that's true. But I can't do that with like a Euro here in the UK either, and that's because the Euro has its place; and does Bitcoin have its place, which is the internet?

Jon - You can certainly buy things online, but that's highly restricted. You can buy a Tesla car with Bitcoin, but it has a high transaction cost, it takes a long time, and the fee you pay is much, much, much higher than you would pay by using your regular pound notes.

Eva - Well, I do know that if I want to take out my £14.44 of Ether, it's going to cost me money. And so, yeah - true.

Jon - If you buy stuff on the internet with Bitcoin, you end up paying so much for the privilege of doing it, that you're only doing it to show off - to show you can do it.

Phil - Are people actually using stuff like Bitcoin to pay for limited types of things, or is it just not getting used?

Jon - It is really hard to ascertain, but it's a tiny, tiny fraction of the overall volume of transactions. A lot of it is illegal, of course, but in the legal domain, it is so small it's almost negligible.

Phil - Is there a risk that we're coming from kind of a privileged country, you and I, Jon - or a privileged couple of countries - and if you're someone who's lived somewhere where you've seen a couple of political regimes come and go, that you think, "hang on a minute, this money that they're saying we should use doesn't seem all that reliable to me, I want my cryptocurrency"?

Jon - The example these people like to mention most often is Venezuela. And of course, what ends up happening in a place like Venezuela or Zimbabwe - another country with a badly managed currency - is that the US dollar ends up being effective currency. The US dollar is universally understood, universally known; everybody knows what it looks like. If you tried to explain to your mother what Bitcoin is, she might not get it. You tell her what the US dollar is - she knows.

Phil - So why on earth are people buying Bitcoin?

Jon - Because if you see something going up in price, you expect it to go up in price. It makes sense to stay at the party and enjoy the ride, keep on buying Bitcoin, keep on speculating, so long as you think you're really smart and can sell before all the other losers. Get out early and you'll make some money. I think that is all most people care about.

Phil - This is a really cynical view of cryptocurrency.

Jon - I might be cynical, but every time I have a conversation with one of these cryptocurrency enthusiasts, I always seem to get mysticism or politics. And economists like to see something real behind it. There is no real economic activity underpinning Bitcoin. And one thing that you often hear which I think is fairly dumb is a comparison with gold; you hear that Bitcoin's the new gold. Well, we know what gold is. I mean, our ancestors knew what gold is. You trust it because of 5,000 years of written history of using gold. Bitcoin is 12 years old. There is no comparison.

Eva - We can also touch gold. It actually exists in a tangible way.

Phil - Yeah.

Eva - Real mining.

Phil - This is why some economists and a lot of people prefer to call these 'cryptoassets' instead of cryptocurrencies.

Financial imagery - a young man with glasses behind a rising graph.

45:17 - Bitcoin: the psychology of getting rich

Are cryptocurrencies really about the technology? David Gerard doesn't think so...

Bitcoin: the psychology of getting rich
David Gerard, Cryptocurrency Journalist

Many are sceptical about the benefits - and the functions - of cryptocurrencies. Phil Sansom and Eva Higginbotham heard from cryptocurrency journalist David Gerard...

David - A lot of it is based on contradictory ideas that make no sense. So you hear how it works and people go, "oh, that's stupid. You must be explaining it wrong." No, a lot of it is actually quite silly. Bitcoin is not a technology story. It's a story about psychology. And then the psychology it's a story of is getting rich for free. If you tell someone that they could possibly get rich for free, they will do anything, say anything, believe anything if they'll get that goal.

Phil - There's all this technology underlying it though, there's various cryptographic types of algorithm, and you've got your blockchain technology and all this stuff.

David - Yeah, some of that stuff's impressive and interesting; none of it's new. The Bitcoin market or crypto markets in general, they work like thinly traded commodity markets, right? Where you have, say, a rare metal or something. There's supply and demand, but there's also people who basically own that market and manipulate it, regulators might have a hard time regulating it, and so on. Except there's no use case for Bitcoin except trading it. It's just the digital token that you can try to get someone to give you money for. It doesn't do anything. All of this stuff is a smaller version of stuff that happens in the world of real trading as well. And now the regulators are finally sort of catching up to it a bit.

Phil - When you sort of cast your eyes away from Bitcoin, do you see a world of ways of doing decentralised finance and having control over the way you govern organisations, that kind of thing? Or do you see more of the same, but just on a smaller scale?

David - So a lot of the ideals were a bunch of promises that were made to Bitcoin early on that didn't really work out for Bitcoin. Promises of "trustless", "decentralised", and "be your own bank". You don't want to be your own bank. Why the hell would I want to be my own bank? Who thought that was a good idea? It's a really, really stupid idea! I'm not able to run a bank; I pay a bank to do that for me! You know, it's civilisation, it's division of labour.

Phil - This is kind of a bitter pill to swallow if you're a big crypto enthusiast.

David - None of this stuff makes sense on so many levels! The only consistent ideology I've seen is “number go up”.

Phil - Number go up.

David - Number go up. It's the driving force. Now this is understandable. In finance there is no more interesting story than number go up. I mean fine, it's called business. But it doesn't go with all the other ideals.

Eva - Number go up. It's certainly an interesting story. One thing I'm still not too clear on: apart from the fact that there are people mining it, where does it actually come from?

Phil - Oh, that's a great question.

Eva - Did we start with one, and now we have five? Do you know what I mean?

Phil - In the paper that Satoshi Nakamoto first wrote that defined all this stuff, he said there is going to be 21 million that will ever exist. And this mining process will generate new ones. The first block gave him the first 50 Bitcoins, and once we've reached 21 million, that's it.

Various coins with cryptocurrency logos.

49:16 - Crypto-news: NFTs, Tether, and a Bitcoin bubble

Multi-million art sales, financial misconduct, Facebook money... and are we in a cryptocurrency bubble?

Crypto-news: NFTs, Tether, and a Bitcoin bubble
Frandes Coppola, Finance and Economics Writer

The rest of this programme discussed the phenomenon of cryptocurrencies, from the tech and the cryptography to the economics and the energy use. And now that we've reached the present day, we can start to understand some of the bonkers headlines headlines coming out of the crypto-world: NFTs and multi-million art sales, financial misconduct, Facebook money... and are we in a Bitcoin bubble? Economist and finance expert Frances Coppola joined Phil Sansom and Eva Higginbotham...

Eva - So Frances, there's been some news about the digital artist known as Beeple who achieved something remarkable when he turned his artwork into what's known as an NFT...

It's the first NFT ever sold at auction, and one of the 20 most expensive works of art period ever sold at auction. The online auction for Beeple's the first 5,000 days just wrapped up at Christie's; final sale price: $69.3 million. That's more than most Picassos, Monets, or Warhols...

Eva - Frances, what is an NFT?

Frances - It means 'non-fungible token'. And it simply means that this is something that is unique; there's only one of it in the whole world. It's a digital token that can't be copied or reproduced.

Phil - This is something that usually runs on a blockchain like Ethereum, right?

Frances - Yeah.

Phil - Why on earth is it related to a huge art sale?

Frances - What they're doing is they're tokenising art. So Beeple has been producing digital art for the last 13 years or so; he put all of his artworks together into one digital artwork, created a token based upon it, and sold the token. The token is a unique representation of that artwork which is cryptographically secured, which should give somebody the right to... well, what? To that token. It doesn't actually give them the right to the artwork. And that's the whole weird thing about this: that in a way, the token becomes the artwork and what people have bought is the token, not the art.

Phil - Is that why it's worth so much money? Are people trading these and turning them into another speculative thing?

Frances - Yes, absolutely. This is another speculative bubble. We've had some very weird things: somebody made an NFT out of a fart and sold it for $85.

Phil - How strange!

Frances - We also had the famous example of Jack Dorsey selling his first ever tweet. The thing is though that he hasn't sold the tweet, he sold an NFT based upon the tweet, but the tweet is still up! You can still look at it, you can still retweet it, you can still copy it. What you buy when you buy an NFT is not the art, it's the token. I mean, really, they're not real. They're just odd.

Phil - Meanwhile in this world, we've been hearing about some large scale actual legal action...

Crypto exchange Bitfinex and stablecoin issuer Tether have reached an 18 and a half million dollar settlement with the New York Attorney General's office. Bitfinex and Tether have admitted no wrongdoing.

Phil - Bitfinex, that's a cryptocurrency exchange, and Tether I think is a kind of cryptocurrency. So what's going on here?

Frances - Back in about 2016, I think it was, Bitfinex got hacked and lost rather a lot of its customers' money. So it borrowed some money from Tether. Now the problem with this was that the money it borrowed from Tether was the money sitting in Tether's reserves. It was meant to be backing the Tethers. So for a period of time, Tether was not fully backed by reserves, but it said on its website that it was. So the New York Attorney General took exception to this. They had a fine, and we shall see what they come up with by way of "these are our reserves and this is the audit to prove it."

Phil - So Tether, unlike Bitcoin - which is just sort of a digital thing - Tether's supposed to have dollars in its account somewhere that are equal to the amount of Tether coins that it's put out?

Frances - Absolutely. It's called a stablecoin. And rather than it being a cryptocurrency like Bitcoin, which is a thing in itself, it is a digital asset in its own right, Tether is supposed to be: one Tether equals $1 at all times.

Eva - You can see why it's called Tether now; it's tethered to a specific currency. What's the point though, if you could spend dollars or euros or whatever themselves, why would anyone bother going to buy some Tethers, which sounds potentially risky?

Frances - Well, I think the reason for that is that it's actually quite difficult to use fiat currencies on many crypto exchanges. And some crypto exchanges don't actually use fiat currencies at all. So Tether is used by a lot of offshore exchanges in the decentralised finance world, where it's really being used as a proxy for the US dollar because these exchanges just don't have any means of getting fiat currencies.

Eva - It sounds very meta and multifaceted getting into the different levels! And you can actually see now why then the New York Attorney General got so annoyed.

Frances - It's changed its terms and conditions somewhat since its original claim that it had actual cash dollars backing every one of its Tethers, because we now know that it didn't, and possibly still doesn't. It now says that its reserves could include other things like third party loans and whatever they decide to put their reserves into, which could include cryptocurrencies or almost anything really. It could be that what they've got is a whole load of cryptocurrencies and shares and other kinds of dodgy investments. So you may think you're holding US dollars, but you may never actually get US dollars.

Eva - We also heard from a cryptocurrency journalist earlier, David Gerard, and he's been writing a book about a currency that's called Libra from everybody's favourite social media company...

David - Facebook proposed to have a sort of Facebook-based money used by maybe 2 billion people in the world. They said they were going to do it in 2020, then they said it'd be 2021... unlike with cryptocurrency, regulators looked at it really closely.

Eva - So Frances, do you think we're going to get Facebook money?

Frances - I'm sure Facebook, despite all its protestations, would really quite like us to. To be fair, it's not meant to be Facebook money. They've set up this independent foundation that's located in Switzerland, which is meant to be issuing the money and running the reserve. It's a bit like a stablecoin in that it's meant to be backed by currencies, fiat currencies. And the backing is meant to be one for one. So it's going to have this mammoth fund. One thing that people haven't been talking about too much is that in order to use this thing, you need a wallet. And the main wallet is called Novi and it's produced by guess who? Facebook.

Phil - Finally, we better figure out what's actually going to happen with all this stuff. I was speaking to economist Jon Danielsson about whether we're kind of in a Bitcoin bubble or a cryptocurrency bubble that's going to burst - he told me yes...

Jon - I think it's a huge bubble. And one day - not today, not tomorrow, but someday in the future - the little boy will yell, "the emperor has no clothes," and the whole edifice will come crashing down and all the Bitcoins will become worthless.

Phil - But I did also speak to economist Thorsten Koeppl from Queen's University, and he told me that he thought mainstream investors getting involved might actually make it stabilise.

Thorsten - Bitcoin may survive, but less as a payment instrument, more as a new asset class, a new investment.

Phil - Frances, what do you think? What's the future of this stuff going to look like?

Frances - It's very early days, isn't it? And I mean, we are in a digital transition generally, not just in money. So it kind of makes sense that there should be some kind of digital money and digital assets that kind of underpin the digital marketplace that we are moving to. I'm not convinced that this is quite it; I think this is just like an early stage of evolution. I find it a little bit disturbing that even now we've got Bitcoin maximalists attempting to set it in stone and saying, "this is this and there can be nothing else," because that's not what technology is like. Things become obsolete, we have ridiculous bubbles that blow up and then everything crashes, and what grows out of that is something different. That's happened a couple of times in the Bitcoin history already. I think it's probably going to happen again.


Great episode. More information like this needs to get out.

The reason I'm commenting is that I was surprised that two common misconceptions were not mentioned.

The first is that, regardless of cryptocurrency, when studying economics and monetary systems, it's important to become perfectly clear on the fact that all forms of money, including gold, only have value because of human agreement. Gold is valuable only because you and I agree that it is. There's nothing valuable about anything, physical or digital, except that we agree that it has value.

The second point is the passing comment that "it's just an entry in a ledger somewhere." Pamphlets available in every US Federal Reserve Bank explain how the system works. Only about ten percent of the US dollars in circulation in the world are actually printed. The other 90 percent are "just entries in a ledger somewhere."

Best regards and please keep up your excellent podcasts. I listen to every one.


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