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Money From Nothing

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For those who are new, my name is Jeremiah. I’m not a cryptocurrency expert. Nor am I an economist. I
 

The Block

November 22 · Issue #2 · View online
Weekly curated #cryptocurrency news and commentary.

For those who are new, my name is Jeremiah. I’m not a cryptocurrency expert. Nor am I an economist. I am an enthusiast who believes that cryptocurrency and its attendant technologies are the prelude to a Cambrian explosion of innovation in “real/cyber-space,” where the digital and physical worlds meet.
This is a weekly email digest comprising commentary on a topic within the crypto-space I find intriguing, followed by a manageable collection of curated links.
If you know anyone who’d be interested in this kind of content, they can subscribe here. I’ll be playing around with the format from week to week to see what I like best, and I love feedback, so don’t hesitate to email me

Money Is a Delusion But At Least We All Share It
Have you ever thought about why we hand people little pieces of green paper when we want to buy something? Or why we swipe a little plastic card across a black electronic device? Or why we write checks to landlords or babysitters? It’s really weird when you think about it long enough. None of these things has any value on its own. Something else allows buyer and seller to both agree that this ritual of giving and taking of non-valuable objects entails a concrete and objective value exchange. So what is it?
At its root, the government promises that the money we exchange is the value printed on it, and that it won’t ever change, and it is divisible (down to a fraction!), and there is a limited supply of it in circulation. And because we trust the government, we trust the promise on the paper. (Even if we don’t have any trust in the government.)
It’s really a shared delusion, a collective belief that something that has no intrinsic value has inherent value bestowed on it by a large, abstract entity that is itself made up of…us. Kinda freaky, right?
So how does cryptocurrency fit into all this?
I’m about to get into some monetary theory, which was not the original intent of this issue, but I think anyone who is interested in cryptocurrency ought to also be interested in what gives cryptocurrency its value, because if cryptocurrency does have value as both a store of wealth and a utility for conducting transactions, then it has incredible implications for society. And if it doesn’t, that would be good knowledge to have before deciding whether to invest in it.
But determining all that is a little like mapping an undiscovered country by first checking an existing map. It can be somewhat reductive, as the question which prompted this little detour demonstrates.
Someone asked me the following: “I want I know where the original amount of money that people used to "transact” came from… chicken and egg?
The first Bitcoin was mined by its creator, Satoshi Nakamoto. That Bitcoin was initially worth practically nothing. Indeed, it was worth nothing until other users began to see the possible utility of the protocol, began using it themselves, at first to mine but later to also transact exchanges, and convinced others to do the same. Once the protocol and its currency began to be used widely, it gained utility, which drove its perceived value. 
But you have to remember that Bitcoin is really just a encrypted public ledger. Each transaction is just a note in the ledger, and everyone on the network has a copy of the ledger. When a user sends Bitcoin to another user, they are not physically exchanging Bitcoins (no more than banks today send physical dollars from one account to another). Instead, a note in the ledger is made, indicating a deduction from one account and an increase in another account. Like all modern currencies, these ledger entries are backed by the community’s shared use of the protocol as measured against the total supply.
This exposes the challenges that cryptocurrencies have in overcoming institutional understanding of market value exchange. We are all used to asking, "What does this cost?” and think of the answer in terms of dollars, or euros, or yuan, or ruble, or some other national fiat currency. Because we see cryptocurrencies also valued in terms of fiat currency we expect their value is also somehow tied to that currency. But that’s misleading at best. Yes, we do place a dollar value on a particular cryptocurrency since, like any commodity or asset, we believe that it has value within the existing monetary system.
But, cryptocurrency has its own stored, inherent value, which is that it is worth what the people who use it believe it is worth. With Bitcoin specifically, 21 million coins will have been “mined” once the last block is sealed (sometime next century). This limit is called scarcity, and is one of the underlying characteristics of money.
Since bitcoins are just mathematical tokens, controlled by the network against counterfeit and theft, and are limited to a set supply, the Bitcoin community, in using them for transactions to exchange value, asserted that the value of the coin could be found in its utility, its scarcity, its fungibility and its divisibility. Because of these factors and the fact that it can be exchanged nearly instantaneously across the globe, Bitcoin carries its own internal value. 
On an open exchange you can see Bitcoin’s value in terms of itself when measured against other cryptocurrencies, but you could just as easily compare the dollar’s value against a Bitcoin, instead of the other way around. We don’t normally do this only because of institutional inertia and the fact that in terms of lifespan, Bitcoin is still an infant compared to the dollar. 
Because Bitcoins (and other cryptocurrencies) are ascribed value by their users, they only need to be accepted by anyone else who agrees to that same system of value or backed by an authority (central or decentralized) to succeed as a “currency,” in much the same way bartering or local currencies work. 
But, this may not be the answer to the original question posed. Allow me to rephrase the question to bring to mind a different answer.
How did Bitcoin first come to have value as a medium of exchange if no one was using it as a medium of exchange?
This is the chicken/egg problem implied by the original question, and this is a well-known problem in money theory. There is a response to this, known as Misesian Regression Theorem of Money, which states:
We can trace the purchasing power of money back through time, until we reach the point at which people first emerged from a state of barter. And at that point, the purchasing power of the money commodity can be explained in just the same way that the exchange value of any commodity is explained. People valued gold for its own sake before it became a money, and thus a satisfactory theory of the current market value of gold must trace back its development until the point when gold was not a medium of exchange.
In short, the price of money (value) is determined by utility of money today, and the utility of money is determined by yesterday’s prices. This seems circular, until you introduce the element of time. 
In order for money to emerge from a barter economy, it must have a pre-existing commodity value, either as a good or service, or–and this is important–as a means of money
This arises from demand for the potential money in terms of direct consumption. This value seeds future estimates of the value of money as a medium of exchange. 
Once an economy has been monetized and the pricing ratio for goods and services has been established (and the original memory of those goods and services barter exchange has been eliminated), money can lose its direct market commodity value and still be used as a medium of exchange. In other words, once the medium of exchange has been set, first from barter, then from memory of the barter value, then money prices continue to be set as long as that value holds for its users.
This is the principle that underlies all fiat currencies. Bitcoin initially served (and still can serve) as an intermediary for any national fiat currency, but with the perceived utility (anonymity, decentralization, cryptographic trust and encrypted transactions, predetermined rate of growth, built-in deflation, and low transaction fees (in theory!) inherent to the network, it’s easy to see why it can serve as its own currency, since it provides a common medium of exchange with its own internal value separate and distinct from any national fiat currency.
There’s lots of great books on the history and utility of money, its underlying mechanisms, and monetary theory (which I’ve only touched on here). I encourage you to check them out. Some good ones below:
Altcoins: What Are They and Why Should We Care?
What are altcoins and why do you need to know about them?
Altcoins are, in some ways, the descendants of, but also alternatives to, Bitcoin. The creation of Bitcoin and its underlying protocol, the blockchain, spawned an entire ecosystem of crytpocurrencies, all of which share common characteristics, but most often serve different purposes.
Generally people refer to altcoins as any coin with a lower market capitalization than Bitcoin. They are further broken down by “major alt” or “minor alt,” with the major alts comprised of coins with top 10 market caps. There are thousands of altcoins currently in existence, with more being born almost every day. Here’s a list of all altcoins along with their market capitalizations.
In general, altcoins work on similar principles as Bitcoin, but often are created to address a particular need, or correct a perceived problem within Bitcoin, or to offer a new good or service.
Some altcoins are scams (sometimes called scamcoins or shitcoins) created for the express purpose of making their creators money until the user base discovers no underlying value or purpose to the coin. Hence the need to research any coin you are interested in investing into.
In truth, most altcoins are little more than clones of Bitcoin, with different transaction speeds, hashing mechanisms, and distribution methods, and often a different circulation amount. Not all altcoins are clones, and many offer unique features that Bitcoin does not have.
Tokens and ICOs
Ethereum is a special case, and warrants its own dedicated issue, so look for that in the coming weeks. But in order to briefly discuss tokens and ICOs, I have to first talk about Ethereum.
Ethereum is what I refer to as an altcoin that isn’t really a altcoin, but is instead a global decentralized computer that happens to use cryptocurrency to fuel itself. Imagine a computer, but instead of it being a single box in your home, it exists as a collective set of computers all connected on the same network, programmed to perform tasks given to it by the users on the network. That is Ethereum. It uses “ether” to fund transactions; it is the currency of Ethereum, but everyone pretty much refers to it as Ethereum.
It is not a clone of Bitcoin. It is built on its own unique blockchain, has its own features and most importantly, its own computer language, which programmers can use to write software that performs specific tasks on the Ethereum network. These tasks can range in complexity. Some can be as simple as, “Send X from A to B.” Others are far more complex.
These tasks are referred to as smart contracts, and they are one of the most exciting aspects of the Ethereum protocol. I can’t get more into them in this issue, but I recommend doing some reading on them if you’re curious.
One other aspect of smart contracts is the ability to issue your own “tokens” or currencies that use the Ethereum protocol for verifiability, anonymity, etc. These tokens can then be used by their creators to fund future development. And this is done through the process of an Initial Coin Offering (ICO). ICOs are like IPOs, in which a company will offer tokens / shares to the public at a given price.
A lot of companies have created billions of dollars through ICOs. Speculative investors will buy into an idea or the possibility of a need being met by purchasing tokens issued through the Ethereum blockchain. Those tokens then have a value, which investors hope will increase if the company succeeds. 
Some ICOs are legitimate. Others are scams designed to fleece investors of their money. And all are highly speculative. Even legitimate companies offering a legitimate business plan and roadmap can fail. It is for these reasons that I urge caution before embarking in any investments in cryptocurrency.
Investing in Cryptocurrency
Everyone who looks into cryptocurrency eventually lands on this question: Should I invest? It can be exciting to watch the value of a currency increase two- or three-fold, but it can also be scary when a currency loses half its value in a matter of minutes. Like any investment opportunity, it behooves you to do your research. Part of that process involves gaining a solid understanding of the technology, the protocols, the mechanisms, and the underlying foundations of the ecosystem in order to make as informed a decision as you can.
You also may want to familiarize yourself with how the technology works! That means creating a paper or digital wallet, funding the wallet by purchasing some of the coin you are interested in, conducting transactions, and just getting used to the mechanics of using the blockchain. It can be daunting at first, but learning by doing is the best way forward. Start with small amounts that you won’t mind losing if something goes wrong.
If you do decide to invest, look at coins that seem to have an interesting, practical application with long-term possibilities. A healthy cryptocurrency has a strong, supportive online community with engaged users, a healthy and high liquidity, and an active (and open) development team. CoinGecko has a good breakdown of top coins based on these metrics.
It should not need to be said, but invest at your own risk. Cryptocurrencies are inherently volatile and value fluctuations can often be catastrophic if you’re not prepared to either ride it out or accept a loss. Even a well-known entity like Bitcoin can be volatile. 
The altcoin market is especially prone to market manipulation. So-called “whales” will either buy or sell a huge amount of currency in order to swing the price one way or another, to induce panic selling or FOMO (fear of missing out) buying. This is referred to sometimes as “pump and dump.” This is where doing heavy research can pay off. Gravitate toward coins that are the least susceptible to these kinds of manipulations and are more focused on creating true value versus short-term profit taking.
Like stock or ETF investing, never invest more than you can stand to lose, and remain objective and keep emotion out of it as much as you can. Avoid hype. All investors have agendas, so anything you read online about a particular coin, don’t take at face value. Always do your research. Making ill-informed investing decisions is an easy way to lose money.
If you want to get started with Bitcoin or one of the two major altcoins (Ethereum and Litecoin), sign up for a free account on Coinbase. Once you buy or sell $100 or more of digital currency, you’ll get $10 of free Bitcoin.*
Links of Note
How to talk about cryptocurrency at the holiday dinner table
100 cryptocurrencies described in four words or less
Cryptoeconomics In Context
We already know blockchain’s killer apps
Why Smart Contracts Will Bring Blockchain to the Masses
This Cryptocurrency Miner Says It Solved Bitcoin’s Power Problem
CME Group Announces Launch of Bitcoin Futures
Bitcoin is Growing on Jamie Dimon
Top Six Most Ridiculous Altcoins
Wrap up
That’s all for this week. Thank you again for reading. Please send me any articles you think would be good for future newsletters. If you have any questions you’d like addressed, feel free to contact me. I do respond to everyone who writes me.
* This is a referral link, so I’ll also get $10 for any eligible signups. 
Full disclosure: I have investments in Bitcoin, Ethereum, Litecoin, and Ripple.
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