A couple weeks ago I asked for resources on cryptocurrency for my EFL personal finance course in this post, and some of you kindly provided me with links to resources. I looked at many of these, but most of them were far too complicated for my students to understand, so as one user suggested, I wrote my own article. Here is a copy the the article I have written, sans some of the graphs due to the nature of the way Reddit posts work. I would appreciate any constructive feedback you might have about my article. Please note that (1) I'm not a cryptocurrency expert. I'm just summarizing what I've read after doing many, many hours of research. (2) This article is meant to be used by my EFL students, who are intermediate-advanced English learners. Therefore, some concepts and terminology have been simplified to ease understanding. Anyway, without further adieu, here is the article I wrote:
What you need to know about cryptocurrency
If you’ve spent any time at all on the internet, you’ve probably seen the terms “bitcoin” and “cryptocurrency” being thrown around. It seems like there is an entire army of people promoting this stuff online, telling you to “BUY! BUY! BUY!” What exactly is cryptocurrency though? Is it a good investment opportunity, or a dangerous scam? In this short article, we will explore what cryptocurrency and Bitcoin are and some of the major issues and challenges facing cryptocurrencies as a legitimate currency and investment tool.
What is cryptocurrency and Bitcoin anyway?
Essentially, cryptocurrency is a decentralized digital currency that can be transferred between people over a computer network. Every time a transaction occurs between people, a record of the transaction is listed on a special ledger called a blockchain, and this blockchain lists every transaction that has ever been made across the entire cryptocurrency. The blockchain is decentralized, so no one person or institution is capable of altering the transaction records. As a result, governments and institutions are not able to control or have any oversight over the transactions that happen between users.
Any cryptocurrency you have is accessed through a “wallet.” There are several kids of “wallets,” but they all require a special password (a “private key”) to operate them. In theory, this helps keep your cryptocurrency safe. Cryptocurrency can be traded, bought, and sold through special websites called “exchanges.” So for example, you can trade your dollars or yen for varying amounts of cryptocurrencies or vice versa, and some exchanges even function as banks in that you can store your cryptocurrency in them.
The supply of cryptocurrency is gradually increased over time through a process called “mining.” “Miners” can “mine” cryptocurrency by using their computers to do extremely difficult math problems called “proof-of-work problems” which validate groups of transactions (“blocks”) on the blockchain. If a miner is successfully able to do this, they are rewarded with some units of the cryptocurrency. This slowly adds more cryptocurrency into the supply, although there is usually a limit to the total amount of cryptocurrency that can be made. Anyone can become a miner if they want to. All you need is special computer hardware that is capable of doing the proof-of-work problems.
There are over 19,000 different cryptocurrencies in existence today, but by far the most popular cryptocurrency was also the first one to be invented, the Bitcoin. Bitcoin was created by a shadowy figure calling himself Satoshi Nakamoto. The identity of Satoshi Nakamoto is still unknown today, although there are many theories about his true identity. Nakamoto envisioned Bitcoin strictly as a currency that would allow people to secretly exchange goods without interference from governments or corporations. However, after its release, many people started viewing Bitcoin not as a currency, but as an investment, and people started buying bitcoin with the hopes that its price would increase in the future, at which time they hoped to sell it and make huge profits.
That’s basically cryptocurrency and Bitcoin in a nutshell. So should you think about investing in cryptocurrencies like Bitcoin in the future? Well before you consider exchanging all your yen for cryptocurrency, there are a number of challenges and hazards that you need to be aware of first.
Cryptocurrency problems
1. It’s Terrible for the Environment!
What do the Netherlands, Argentina, and North Korea all have in common? They all consume less energy than Bitcoin does. Take a look at this graph:
(See graph at https://www.forbes.com/sites/niallmccarthy/2021/05/05/bitcoin-devours-more-electricity-than-many-countries-infographic/?sh=2891194641a6)
Why is this? Well as described earlier, the way most cryptocurrencies validate the transactions that are being added to the blockchain is by having miners do complicated proof-of-work problems on their computers. One unfortunate consequence of relying on proof-of-work problems is that it requires a massive amount of energy. In fact, each bitcoin transaction requires electricity equal to 1.57 times the average American family's daily energy consumption. The end result is that Bitcoin consumes 142.59 terawatt-hours of electricity each year, which is more than the consumption of 169 different countries! Since over 75% of electricity is created by burning fossil fuels, it seems extremely unwise to rely on cryptocurrency when traditional currencies and investments require far, far less energy.
2. The Transactional Bottleneck
Another massive problem for cryptocurrency is that its transaction speed is significantly worse than traditional currency transactions. A typical credit card or cash transaction takes just seconds to perform, but cryptocurrency transactions typically take between 5 and 20 minutes to go through. Due to its reliance on proof-of-work problems to validate transactions on the blockchain, the bitcoin network can only process 4.6 transactions per second. In comparison, Visa does around 1,700 transactions per second on average. [2] Is cryptocurrency really viable as the currency of the future when its performance is undeniably worse than what it is supposed to replace?
3. It’s not a stable currency
One key aspect of a viable currency is that it’s value stays the same or almost the same over time. If the yen’s value doubled tomorrow, and then decreased by 25% the next day, followed by a 300% decrease the next day, it wouldn’t take long before stores stopped accepting yen and insisted that you paid them with something more stable like dollars. Yet that is the exact situation we see with Bitcoin and other cryptocurrencies. Here is a graph showing Bitcoin’s price over time:
(Omitted in this Reddit post, but you can see any number of these graphs online)
If you look closely at the data in the last two years of this graph, you will see this:
October 2020: 1 BTC ≈ $10,000
} 500% increase!
April 2021: 1 BTC ≈ $60,000
} 48% decrease!
June 2021: 1 BTC ≈ $31,000
} 110% increase!
October 2021: 1 BTC ≈ $65,000
} 69% decrease!
June 2022: 1 BTC ≈ $20,000
You can quickly see why cryptocurrency isn’t accepted by any legitimate store today. The price is just too unstable and fluctuates widely.
4. What is cryptocurrency used for then?
Today, cryptocurrency is primarily used for two things: criminal activity and speculation. One of the dirty little secrets about Bitcoin is that 40% of Bitcoin transactions are used for criminal activity. [3] Online black markets that sell drugs and weapons use Bitcoin as their currency of choice to conduct their transactions due to the fact that it can be done anonymously online. Most ransomware usually involves paying the hackers in bitcoin. Even some terrorist groups have used cryptocurrency to fund their operations.
The other 60% of transactions, on the other hand, has primarily been related to cryptocurrency speculation. This has caused other problems.
5. What gives cryptocurrency its value?
In order for a currency or investment to possess real long-term value, it needs to have an underlying asset or application which gives it value. Gold is valuable because it has many applications in the jewelry, dental, and electronics industries. A stock’s value is based on the performance of its corresponding company. The yen is a fractional representation of the entire GDP of Japan, which is based on the work that Japanese people do to produce products and provide services. But what is the underlying asset of cryptocurrency? Essentially, nothing. It’s not based on work, or useful applications, or a company’s performance. A cryptocurrency’s value is derived solely from what other people are willing to pay for it. But what happens when people don’t want it anymore? The results can be catastrophic.
6. The losses can be huge!
As you know, the 100-year average growth of the US stock market (i.e. the S&P 500) has been 10% every year. That doesn’t mean that every year will see 10% growth, as some years will involve a decline, but if you invest for a long enough period, you can expect that your investment will grow at an approximate rate of 10% a year. However, as previously demonstrated, cryptocurrency is not stable at all. When the cryptocurrency goes up, it’s great for investors, but when it goes down, it hits investors hard, and it’s extremely common for cryptocurrencies to crash to $0. According to one 2021 research paper by Bedil Karimov and Piotr Wojcik that used machine learning to identify scam cryptocurrencies, 47% of the 305 cryptocurrencies in the study had gone to $0 and were dead. [4]. In May 2022, the fourth largest cryptocurrency, TerraUSD, along with its sister coin Luna, crashed to $0. $45 billion dollars was lost. People’s life savings were destroyed. This was the biggest cryptocurrency crash ever, but it was far from the only one. There is no reason to think this couldn’t happen to any other cryptocurrency, including Bitcoin, and it could easily happen in two different ways:
7. The Greater Fool Theory
The fundamental reason cryptocurrencies have seen so much growth in recent years is due to a social phenomenon sometimes called the Greater Fool Theory. This phenomenon occurs when someone buys overpriced assets with the hope that they will be able to sell those assets to an even greater fool for an even higher price. When this happens, the trading price of the assets gets higher and higher, but the true value of those assets remain unchanged, and a massive bubble emerges. The problem with this chain of events is that eventually you run out of greater fools, and people realize that the actual value of the asset is much lower than its trading price. When this happens, people stop buying the asset, the bubble bursts, and the price of the asset drops. We saw the Greater Fool Theory in action during the US financial crisis in 2008 (“Lehman Shock”) with sub-prime mortgages. The Greater Fool Theory also explains why we have seen Bitcoin rise to such insanely high valuations in recent years and why its price has plummeted since October 2021.
8. Government Regulation
Within the past few years, more and more governments have begun to recognize that cryptocurrencies pose a danger to their own economies and are beginning to regulate or even ban them. While they will likely be unsuccessful in banning cryptocurrency outright (since it is decentralized), they do have the power to stop cryptocurrency mining and to eliminate the exchanges. If enough governments outlaw cryptocurrency, then 1) the ban on mining will mean that new transactions won’t be able to be added to the blockchain, and the cryptocurrency will no longer function, and 2) the elimination of the exchanges will make it impossible to convert Bitcoins to dollars and yen, and the value of Bitcoins will drop to 0. It’s not an accident that the price of Bitcoin started rapidly declining right after China announced it was banning all cryptocurrencies on September 24, 2021. Since that time, most cryptocurrency mining has been moved to the US, but if the US ever decided to follow China’s lead and ban cryptocurrency, it’s hard to say whether cryptocurrency would be viable at all.
9. User protections
One of the reasons it’s generally safe to keep your money in the bank or the stock market is because these institutions are heavily regulated by the government, so you always have legal recourse to get at least some of your money back if disaster strikes. The problem with cryptocurrency is that it is completely unregulated by the government, so if something happens to your cryptocurrency, you have no way to get it back. Let’s look at a few example scenarios to make some comparisons:
If your bank runs out of money:
Banks are required to have insurance for this situation. In the US, all bank accounts are insured by the FDIC for up to $250,000 each.
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If your cryptocurrency exchange runs out of money:
It is not illegal for the exchange to cut off users’ access to their accounts and take their money. This happened recently when the crypto exchange Celsius Network stopped letting users access their accounts on June 13, 2022, and it is looking quite likely that they are not going to give their customers’ money back.
If someone illegally gains access to your bank account through hacking or other means:
You don’t have to pay anything. It is the bank’s responsibility to protect your money, and they must financially compensate you if there is a theft.
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If someone gains access to your cryptocurrency wallet or account through hacking or any other means:
Your money is gone, and there is no way for you to get your money back. This has happened too many times to count. For example, in February 2014, it was discovered that Mt. Gox, the biggest crypto exchange at the time, had been hacked, and the thieves had stolen 740,000 bitcoins from users’ accounts and 100,000 bitcoins from the company itself, for a total equivalent value of $460 million. This contributed to the closure of Mt. Gox. To date, not a single user has gotten their money back. [5]
If you forget or lose your bank account password:
The bank has methods for you to regain access to your account.
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If you lose your bitcoin wallet or wallet password:
Your money is gone. There is no way to recover your bitcoin without having the original password. There are two particularly infamous incidents where this happened. In 2011, A San Francisco software developer named Stefan Thomas put 7,002 Bitcoins on an IronKey USB stick wallet, which gives you 10 attempts to input the correct password before the wallet destroys itself. Thomas later forgot the password, and has unsuccessfully tried putting in the password 8 times. His money is likely lost forever. In another case, a man in the UK named James Howell threw away an old laptop, but he forgot that he had left his wallet containing 7,500 Bitcoin on the hard drive. Howell tried asking the local government to let him search for the wallet in the landfill, but they refused to do so, so Howell’s millions are likely lost forever. [6] It has been estimated that 20% of all Bitcoin has been lost in this manner and will never be able to be recovered. [7]
10. Price Manipulation
One of the more disturbing pieces of news to come out about cryptocurrency is that it has been particularly vulnerable to price manipulation. What this means is that a small number of people have been able to disproportionately influence the price of cryptocurrency to change in their favor. In the stock market, such behavior is highly illegal. In the US, public companies are heavily regulated by the Securities and Exchange Commission (SEC), whose sole purpose is to stop market manipulation. No such regulations exist for cryptocurrency, however, which has led to all kinds of bad behavior. For example, in 2017, the price of Bitcoin surged from less than $1,000 per bitcoin at the beginning of the year to nearly $20,000 in November 2017 before crashing back down to $3,000 in the next few months. Research by University of Texas professor John Griffin and Ohio State University professor Amin Shams has shown that over half of the transactions contributing to Bitcoin’s massive increase in value during this time came from a single person on a single exchange. The researchers concluded that these transactions were so radically different from normal trading patterns that the only possible conclusion they could make was that these transactions were attempts to manipulate the market. [8]
Another person who has demonstrated a profound influence on the price of cryptocurrency has been the world’s richest man, Elon Musk. Elon Musk famously announced in March 2021 that people could now buy Tesla cars with Bitcoin, causing the price of Bitcoin to surge to $58,000. In April 2021, Musk had Tesla sell part of its bitcoin holdings. In May 2021, he announced that Tesla would no longer allow people to buy their cars with bitcoin due to Bitcoin’s negative environmental impact. By the end of the month, the price of bitcoin had plummeted to around $35,000. In June, Musk tweeted that Tesla would accept Bitcoin in the future if it’s environmental impact could be mitigated. The price of Bitcoin subsequently surged. Here is a graph showing a basic timeline:
(See graph at https://www.vox.com/recode/2021/5/18/22441831/elon-musk-bitcoin-dogecoin-crypto-prices-tesla)
Musk’s influence on cryptocurrency has not just been confined to Bitcoin either. For example, Musk short tweet of, “One word: Doge” on Twitter on December 20, 2020 caused the price of the joke cryptocurrency Dogecoin to increase by 50% within the next 24 hours:
With traditional investments like stocks, influencing the price of stocks in such a way would be considered illegal, but since cryptocurrency is not regulated, cryptocurrency investors like Elon Musk are fully within their rights to advertise for various cryptocurrencies they hold and influence the prices to their advantage. One has to wonder how wise it is to invest in an industry that this so prone to this kind of price manipulation.
11. Scammers and Con Artists
Why is it that there are so many people advertising for cryptocurrencies online, sometimes in alarmingly pushy ways? One big reason is due to “pump and dump” scams. The basic idea is that a scammer will “invent” a new worthless cryptocurrency and then market it in such a way that many people start buying it with the hopes of selling it to someone else for even more money. As people continue trading their dollars for this new cryptocurrency, the price of the cryptocurrency rapidly rises. Then, “POOF!” The scammer sells all the cryptocurrency they have, and then they suddenly disappear. The scammer makes millions, and everyone else is left holding a worthless cryptocurrency that does nothing. This has happened so many times that it is becoming the norm, not the exception. As mentioned earlier, 47% of the 305 cryptocurrencies that Karimov and Wojcik looked at in their 2021 study had gone to $0, and almost all of these were suspected to be scams. Two infamous cases of this were the Onecoin and Bitconnect scams, which ended up stealing $25 billion and $4 billion dollars respectively from investors. [10] And just in case you think that Bitcoin is somehow safe from this phenomenon, just remember that Satoshi Nakamoto has a wallet containing 1.1 million Bitcoin in it. He has yet to touch this Bitcoin stash, but if he ever decided to sell it, the price of Bitcoin would crash dramatically. [6]
12. Fear Of Missing Out
If cryptocurrency has so many problems and challenges, why in the world are there so many people investing in it? The answer is simple: Fear Of Missing Out (FOMO). Essentially, people are afraid of missing out on a potential opportunity to make millions of dollars. It’s easy to see why. There have been some periods where cryptocurrencies have had incredible growth, as in 500% in six months! Some people have become millionaires or even billionaires overnight, and it’s tempting to try to imitate these people’s success. However, while indeed there have been some people who have gotten very rich from cryptocurrency, there have been plenty of people who have lost everything they had due to foolish cryptocurrency investments. There is zero evidence that cryptocurrency is a safe, long-term investment, and there is a lot of evidence showing that the opposite is true. Fear Of Missing Out is not a rational reason for buying anything.
Conclusion
Cryptocurrency certainly is an interesting and novel new technology. Unfortunately, it has been overpromised by its supporters as the future of both currency and investments, when in fact it performs worse than traditional currencies and investments by almost every measure. Now certainly there are some people who have amassed large fortunes through cryptocurrency investments, but this does not seem to be the norm, and there are lots of people whose investments in cryptocurrency have led them to financial ruin. Looking at the information we have available to us about cryptocurrencies, buying crypto seems to be more akin to gambling than investing. Some people are able to get rich from gambling, but this is most often due to sheer luck rather than skill, and most gamblers lose money. Don’t gamble away your future with “Get Rich Quick” schemes like cryptocurrency and NFT investments. Instead, remember the principles that we have learned in class about how the key to retiring comfortably is to “Get Rich Slowly.”
References:
[1] Bitcoin Devours More Electricity Than Many Countries, Niall McCarthy
[2] The Blockchain Scalability Problem & the Race for Visa-Like Transaction Speed, Kenny L.
[3] The Case Against Bitcoin, Michael W. Green
https://www.commonsense.news/p/the-case-against-bitcoin?s=r
[4] Identification of Scams in Initial Coin Offerings With Machine Learning, Bedil Karimov and Piotr Wojcik
https://www.frontiersin.org/articles/10.3389/frai.2021.718450/full
[5] What was the Mt. Gox Hack? Jordan Tuwiner
https://www.buybitcoinworldwide.com/mt-gox-hack/
[6] The Top 5 Biggest Lost Bitcoin Fortunes (That We Know About), Michael Brown
https://www.cryptovantage.com/news/the-top-5-biggest-lost-bitcoin-fortunes-that-we-know-about/
[7] 20% of All BTC is Lost, Unrecoverable, Study Shows, Nathan Reiff
https://www.investopedia.com/news/20-all-btc-lost-unrecoverable-study-shows/
[8] Is Bitcoin Really Un-Tethered? John M. Griffin and Amin Shams
https://papers.ssrn.com/sol3/Papers.cfm?abstract_id=3195066
[9] When Elon Musk tweets, crypto prices move, Rani Molla
https://www.vox.com/recode/2021/5/18/22441831/elon-musk-bitcoin-dogecoin-crypto-prices-tesla
[10] The 10 biggest crypto scams on record – and the lessons we can learn from them, Ebony Ximines-Parke
