Think Bitcoin™ Issue #7
Bitcoin makes the world greener; Coinbase in SEC crosshairs; intro to Bitcoin wallets
Hey friends, welcome back to Think Bitcoin™. As always, if you’re brand new or relatively new to Bitcoin and looking for some education on the basics, feel free to scroll down to the “For the new and new-ish” section and work your way up.
In this issue:
Content Round-up: 2 articles, 1 film, 1 video, 1 podcast
Headlines/News: Gensler testifies, MicroStrategy buys more BTC, Dalio says governments will “kill it,” El Salvador update
For the new and new-ish: How wallets work
As always, if you find this newsletter interesting or useful, please share it with others who might find it interesting or useful!
Content Round-Up
1. “This Machine Greens,” a 38-minute documentary film that explains Bitcoin’s energy use and, most importantly, puts it into historical, anthropological and geopolitical context. It was just released last Tuesday, and I cannot recommend it highly enough. In fact, if you go no farther in this newsletter and consume only 38 minutes of Bitcoin or finance-related content this week, let it be this film.
There’s so much missing in the mainstream polemics against Bitcoin’s energy consumption, making it more and more important for Bitcoiners, especially new Bitcoiners, to understand how the network’s energy consumption works and why it works.
This film explores how the Bitcoin network incentivizes use of the cheapest and most efficient forms of energy, which are renewable forms of energy. Fun fact from the film: 39% (and growing) of the Bitcoin network’s energy usage is from renewable sources, while only 11% of general energy usage in the world is from renewable sources.
The film also asks the question that conveniently gets left out of many mainstream discussions around energy, Bitcoin, and the United States dollar: “Because it ties the interests of the United States to oil, the petrodollar system may well have functioned to preserve not only the dollar, but also oil production itself, one of the most polluting forms of energy. Would we have evolved away from the oil industry faster were its interests not entwined with those of the U.S. dollar?”
As Meltem Demirors, Chief Strategy Officer at CoinShares, points out:
“We have central bankers going on television saying they are concerned about the ESG footprint of the crypto mining ecosystem when they are flying around the world on private jets and using taxpayer dollars to subsidize a highly-developed, multi-trillion dollar oil and gas industry in order to maintain the petrodollar status quo. Those two things are ideologically incompatible.”
As Caitlin Long, CEO of Avanti Bank and Trust, notes:
“More than two thirds of the energy produced in the world is waste energy because it’s produced during the hours of the day when there’s not demand to consume it, and it’s also produced in a place where there’s not transmission to move it across space and time. And so that energy goes unused and wasted. It is a misnomer that Bitcoin is using all the energy of a country like Switzerland, for example. That may be technically true, but that’s not the real story. You have to peel one layer of the onion back and realize that a lot of the energy that the Bitcoin network is consuming is waste energy that otherwise was not available to be consumed.”
For those who have seen hyperbolic, doomsday articles in various mainstream financial publications about Bitcoin’s energy use, this is a must-see film. For those concerned about the environment and looking for ways to fundamentally change the structures and systems of societal organization in order to promote better uses of energy (instead of just cosplaying ESG), this is a must-see film. WATCH IT.
2. “Fighting for Financial Literacy in Congress,” an episode of the Bitcoin Magazine Podcast with Aarika Rhodes. Rhodes is a Democratic candidate running for California’s 30th Congressional District against incumbent, Brad Sherman. Sherman, a politician heavily funded by big banks and insurance companies, has come out strongly against Bitcoin. Rhodes, on the other hand, did her research, got in touch with folks in the Bitcoin community, talked to them, read books, and, most importantly, spoke extensively with her constituents, a majority of whom were invested in Bitcoin. All of this due diligence led her to become a Bitcoin supporter. In this podcast, she discusses her Bitcoin journey and discusses how some of her constituents use Bitcoin, including the story of a formerly homeless constituent (and a veteran) who told Rhodes at a diaper drive that Bitcoin lifted her out of poverty.
Rhodes is a strong advocate for financial education in schools to promote financial literacy at a young age. She also stands against big corporate money in politics. She believes there should be a Bitcoin Caucus in Congress and firmly stated, “we can’t stifle innovation.”
Her website is here.
3. “Bitcoin, Voting Blocs and the Effect on Bipartisanship,” an article by Ulric Pattillo. I like this article because it explores an idea I think and write about a lot myself, which is the idea that Bitcoin presents a unique opportunity to transcend our current political paradigms and coalesce around common values (pro-environment, anti-war, pro-financial access, anti-inflation, etc.).
4. “Bitcoin: ‘A Weapon for Us to Fight Oppression,’” a 6-minute video about Fodé Diop, a Senegalese app developer. Diop recounts his own journey to Bitcoin and explains why he thinks Bitcoin is a tool for African nations to throw off the oppressive weight of monetary colonialism.
5. “Crypto Isn’t the Cause of Ransomware. It Might Be the Cure,” an article by Ari Redbord. This piece addresses a very common criticism of Bitcoin (and crypto, generally), which is that it’s primarily a tool for hackers to extract payments from companies and for money launderers to evade the law. Redbord argues that the open, transparent nature of the blockchain makes it much easier, in fact, to track illegal flows of cryptocurrency than cash.
Headlines/News
Gary Gensler testifies before Congress, suggests Coinbase is offering unregistered securities
On Tuesday, SEC Chair Gary Gensler testified in front of the Senate Banking Committee. Crypto was, as you’d expect, a hot topic. Gensler repeatedly asserted that many digital assets, including many of the ones listed on Coinbase, are investment contracts under the Securities Act, and therefore securities. If you tuned in, you heard a lot of talk about the Howey test and the definition of a security, which we’ve been discussing a lot here in the newsletter.
Gensler essentially said that, in his mind, the law is pretty clear with respect to what falls under the definition of a security, though Congress could obviously change the laws. Senator Warren cited gas fees on Ethereum (whether she actually knew that this is what she was citing was unclear) as evidence that crypto, as a whole, does not advance financial inclusion. She also cited the flash crash on September 7 and the subsequent temporary outages of popular exchanges like Coinbase as evidence that crypto, as a whole and in all circumstances, is no improvement on the traditional financial system.
TAKEAWAYS:
Coinbase is squarely in the SEC’s crosshairs. My personal opinion is that it’s only a matter of time before the SEC brings an enforcement action against the exchange, whether for the “Lend” product or for listing unregistered securities. Last week I wrote lengthily about the Wells Notice Coinbase received from the SEC relating to their forthcoming Lend product. What became abundantly clear in this hearing, though it had been growing increasingly clear in Gensler’s recent speeches, is that Coinbase is also on the SEC’s radar for listing what the latter very explicitly views as unregistered securities.
I don’t think the question is whether the SEC goes after Coinbase. I think the important questions are on what grounds do they choose to go after Coinbase, what will the result be for Coinbase, and what will the result be for the majority of coins traded on Coinbase, many of which the SEC views as securities. If Coinbase is told they have to become a registered exchange, how does that affect the crypto ecosystem? In other words, what’s the endgame here?
One way this could shake out is Coinbase eventually becomes a registered exchange with the SEC and is forced to de-list all tokens deemed to be unregistered securities (assuming the SEC starts naming names, so to speak, on this front). In this way, traditional finance sort of blends with and merges into crypto in a way that’s acceptable to regulators (though undoubtedly not to crypto users and advocates), at least in the short-term.
BUT, what would this mean for all those coins that get de-listed? Would other exchanges similarly de-list, in order to avoid SEC ire? These are big questions and big unknowns.
Democrats and Republicans seem to have completely different views of investor protection. One view, typified by Sherrod Brown and Elizabeth Warren, is that no retail investor or non-professional investor should ever be at risk to lose any money in the market. The other, typified by folks like Tim Scott, is that retail investors now enjoy the easiest access to the stock market they’ve ever had. With trading fees at zero or near-zero on most trading platforms, various easy-to-use trading apps, and a wealth of free educational information, the retail investor has never had more frictionless access to the stock market. This new level of access, Scott and others argue, should not now be curtailed or eliminated, because it gives more Americans an opportunity to benefit from investing. On the other hand, Warren and Brown are hyper-focused on eliminating any and all risk to the non-professional investor, and they view the unprecedented access to markets that retail investors now enjoy as a morass of predation, exploitation, and dangerous, game-ified risk-taking.
The divergent views here are based on similarly divergent views of markets, writ large, and the role of governance. On one side, there’s the idea that a free market coordinates economic activity far better than any government central planner ever could, and that investment in the market (as opposed to savings in a bank account) will always involve some level of risk. The market rewards risk well-taken and punishes ill-advised risk. That’s how capitalism works.
On the other side, there’s the idea championed by Warren and Brown that the market can and should be engineered and policed by regulators and lawmakers in such a way that the risk of loss is near zero. The consequences of this view, historically, are that we have walled gardens for accredited investors (investors who meet a level of wealth specified by the SEC). Accredited investors get access to investment opportunities, often the best and most potentially lucrative investment opportunities, well before retail investors. Accredited investors get to invest in start-ups before they go public (think every big successful tech company), and other opportunities that are exempt from SEC registration. The reasoning behind these rules is that accredited investors are “sophisticated” because they’re wealthy and, therefore, can better appreciate the risk they’re taking with their capital. This may be true, but the real-life effect is that they always get the best investment opportunities. With many start-ups choosing to stay private for longer before going public, these accredited investors lock in immense gains that aren’t available to the retail investor.
Meanwhile, we have no problem allowing and even encouraging these “retail” investors to take on mortgage-level debt at 18 to acquire an exorbitantly expensive higher education that, increasingly, does not guarantee the ability to quickly or efficiently pay back the debt once completed.
In sum, the Warren/Brown/Gensler view of capital markets and investing, though sold as “investor protection,” manifests in many cases as simply protecting retail investors out of the best investment opportunities because they involve risk, which is a dirty word to the aforementioned folks. Crypto has turned this dynamic on its head because, despite being the best-performing asset class of the last decade, retail investors have been able to front-run the institutional investors and have, in many cases, enjoyed enormous gains.
The corollary to the paternalistic view of investor protection espoused by Warren/Gensler/Brown is the impulse and desire to intervene often, rather than allow the market to arrive at a solution. As NLW pointed out on his podcast, Warren cited multiple examples of what she viewed as shortcomings in the crypto market that ought to be resolved, corrected, or disallowed by regulators, each of which was or is currently being actually solved by the market itself, without any such intervention.
First, she cited high gas fees on Ethereum as a problem for investors. This problem is currently being addressed by the market itself via the ever-growing number of competitors to Ethereum (Cardano, Solana, etc.), all of which seek to fix Ethereum’s high fees. Second, Warren cites instances of exchanges being temporarily down as a problem for those investors who, having incurred some paper losses in a bout of market volatility, need to be able to log-in quickly and sell to lock in those losses (I’m not kidding, this was actually her example). Warren is correct that exchanges being down from time to time is a problem that needs to be fixed. But it’s a problem that the market itself is already fixing. When exchanges go down, users move to other exchanges. Exchanges that are down frequently tend to lose users and provoke their very public ire.
Lastly, Warren cited the flash crash on the day of El Salvador’s adoption as evidence that all investors should be protected from Bitcoin and crypto, neglecting to mention that, despite local spells of volatility, Bitcoin is the best-performing asset of the last decade.
The crux of the debate between folks like Warren or Gensler and folks on the other side, is that the former essentially think risk is a categorically negative thing to be guarded against at all costs, in all scenarios, for all people. I think this is misguided and ultimately a net-negative for precisely the folks it purports to protect. It’s also a boon for those already-rich investors who will, if Warren has her way, continue to have access to the best investment opportunities, while retail investors are excluded from them for their own “protection.”
Sure, we should be aggressively going after actual scams, the predatory and fraudulent projects seeking to dupe investors into forking over their money. But we should not be preventing investors from taking risk altogether. That’s precisely what investing is about - managing risk (not, as the famous Benjamin Graham quote goes, avoiding it). There is no reward without risk.
It’s worth repeating that Bitcoin and crypto has been the best retail investing opportunity in recent memory (and maybe ever). And let’s remember that retail investors over the last 20 years have had to deal with two recessions, while carrying student loans, and now are looking at rising inflation, debasement of the currency, and general geopolitical uncertainty. Now, on top of and in the midst of all this, Elizabeth Warren wants to keep you from buying Bitcoin, growing your purchasing power, and investing early in one of the most profound technological transformations to date. Which really begs the question: is this really about investor protection? Or is it just about control?
MicroStrategy purchases more bitcoin
MicroStrategy, the business intelligence company helmed by CEO Michael Saylor, announced this week that they purchased another 5,050 bitcoin, bringing the total amount of bitcoin held by the company to approximately 114,042. They made their first purchase in August of 2020 and have continued to add to their stack ever since.
Saylor, for his part, has become a vocal bitcoin evangelist and advocate. In February of this year, he organized “Bitcoin for Corporations,” an event designed to educate companies on how and why to add bitcoin to their respective corporate balance sheets.
For those interested in how Saylor arrived at his conviction in Bitcoin, why he thinks it’s the best money ever created, and how he sees it in historical context, I highly recommend his many-part, many-hour series of interviews with Robert Breedlove on the latter’s What Is Money Show podcast.
Ray Dalio says if bitcoin is successful, regulators will eventually “kill it”
This week, in an interview, Ray Dalio said, “I think at the end of the day if it’s really successful, they will kill it and they will try to kill it. And I think they will kill it because they have ways of killing it.” He also said “government doesn’t want it to succeed.” He still owns some, though, and considers it a good alternative to cash.
At the risk of sounding like a broken record, I want to reiterate that no government can “kill” Bitcoin. Unless the internet is shut down globally, which will not happen, the network will continue to exist. All governments can do is ban things like mining, ban exchanges from operating, and generally make it hard or illegal to acquire and transact with Bitcoin. But, as we’ve seen recently with China banning mining, the network just moves elsewhere.
There’s game theory involved here, too. Unless every country agrees to crack down on Bitcoin, there will always be incentives for countries to encourage and promote its use to attract business and stimulate commerce.
So, while I think Dalio is correct in the sense that some governments will see Bitcoin as a threat and attempt to regulate it into nonexistence, I wholly disagree that it can be “killed” by any such government. As Brian Brooks, former acting Comptroller of the Currency and former Chief Legal Officer at Coinbase, said this week, “there has never been a $2 trillion activity that’s been killed by the government.”
El Salvador update
El Salvador continues to be a mixed bag, due primarily to the authoritarian tendencies of President Bukele. I am obviously not on the ground there speaking with people or observing firsthand how Bitcoin adoption is (or is not) progressing.
Alex Gladstein is on the ground in El Salvador, though. And he published a great piece on the situation this week titled “The Village and the Strongman: The Unlikely Story of Bitcoin and El Salvador.” For a thorough overview of the dynamics within the country, as well as the import of its recent history, I highly recommend this piece.
For the new and new-ish
After a week off, we’re back with some more Bitcoin fundamentals. This week I want to discuss wallets and keys.
Remember, we’re running a decentralized network here, with no trusted intermediary to, among other things, keep track of everyone’s identity. In our normal, day-to-day transacting, we log in and out of our accounts, almost entirely on our phones. The log-in information is confirmed by an intermediary, the job of whom it is to make sure we are who we say we are and have rightful ownership over the account with which we’re transacting.
With Bitcoin, we don’t have this trusted intermediary keeping track of every user’s identity, ensuring network actors are who they say they are, etc. Instead, the Bitcoin network uses a pair of digital keys, one public and one private. An important initial point of clarification here is that one’s keys do not hold bitcoin. Think of your bitcoin as existing in a mailbox or a locker on the network’s blockchain. Your keys allow you to access your mailbox and send or receive bitcoin from or to it. A “wallet” is just a device that holds your keys.
Your private key is the most important because it’s what allows you to control your bitcoin. If you do not hold your private key, or if you lose it, you no longer control your bitcoin. Your public key is sort of like a username, while your private key is more like a password. Or, you can think of your public key as like an email address that people are allowed to see, while your private key is the password to your email account that only you see, which allows you to access your email.
What’s the relationship between one’s private and public keys? Well, first off, they allow for asymmetric encryption (remember, we’re using cryptography here, i.e. “cryptocurrency”). What the hell is asymmetric encryption? It just means you can encrypt with one key and decrypt with the other. This means you can send a coded message by encrypting it with one key, and that message will only be able to be read by someone who has the other key with which to decrypt it. The person who decrypts it will know it’s you who sent the message, and not someone else, because only you will have had the key to encrypt it (unless of course someone stole it from you).
This is how transactions work on the Bitcoin network. If I want to send bitcoin to you, I encrypt the transaction with my private key. And don’t worry, this is not happening manually with each transaction. You don’t have to be Alan Turing or some super-hacker computer genius every time you send bitcoin to someone. Your wallet is doing this for you. But anyway, back to our hypothetical. I want to send bitcoin to you. I broadcast this transaction to the network by saying hey guys, I want to send bitcoin to one of my readers. I also reveal my public key, which, you’ll recall, is like revealing the address to the mailbox on the network from which I’m going to send coins. I encrypt the message with my private key.
The point of this is NOT to actually reveal my private key. I do not want to do that. That’s bad. I just want to prove that I hold the private key. I do this by encrypting the message with my private key because only people with the corresponding public key can decrypt that message. If the corresponding public key doesn’t work, you know I don’t have the private key and the transaction isn’t valid. If it does work, you know I have the private key. This is why you keep your private key private, and why you allow people to see your public key. By doing so, you can encrypt transactions with you private key, which acts as a signature that can be confirmed by someone who has your public key.
So I’ve now encrypted the transaction with my private key, which proves I own the private key to the mailbox from which I’m sending bitcoin. Other network users can confirm this by using the public key I’ve revealed to decrypt my encrypted transaction. But to whom am I actually sending the coins? I send the coins to another public address, meaning someone else’s public key. The holder of the private key that corresponds to this recipient public key, is able to access the coins once the transaction has been approved.
So, to sum it all up in simplified terms, here’s how a transaction goes. I want to send Alice some bitcoin. Alice gives me her address, which is a hash of her public key (again, your wallet is doing this - you are not doing this manually). I announce my transaction to the network, i.e. that I want to send some bitcoin to Alice. I encrypt it and reveal my own public key. Nodes on the network confirm that I have access to the coins I’m trying to send by using my public key to decrypt the transaction that has been encrypted (think “digitally signed”) by my private key. If it works, they know I’ve used the corresponding private key (i.e. that I’ve “signed” it). The network validates the transaction and the coins are sent to Alice’s address. Only the person with the corresponding private key to that address can access those coins. Assuming Alice holds her private key, she can then access the coins.
Some takeaways here. First, it’s vitally important that you do not lose your private key. Your private key is what allows you to send and receive bitcoin. If you lose it, or someone else gets access to it, they can now send bitcoin from your account. There are no chargebacks in bitcoin. It’s not like a credit card transaction that takes many days to finally settle. Bitcoin transactions are settled immediately, once they’re published to the blockchain. So if someone gets your private key and sends bitcoin from your wallet to theirs, those coins are gone. You can’t get them back.
Second, you may have heard the popular bitcoin maxim, “not your keys, not your bitcoin.” This means that if you do not possess your own keys, you do not actually own your bitcoin. Someone else does. For example, if you hold your bitcoin in a Coinbase account or on any other exchange, they hold your keys. You do not. You don’t own your keys until you move your bitcoin off an exchange and into a wallet that you possess. Holding your coins on an exchange introduces a layer of counterparty risk, meaning that if something happened to the exchange on which your coins are held, you are exposed to a range of possible negative outcomes.
Now, there are two main types of wallets: software wallets and hardware wallets. The former are sometimes called “hot” wallets because they’re online. This creates extra risk because we all know how compromised our devices and our information are these days. Hardware wallets, on the other hand, are offline. Storage in hardware wallets is often called “cold” storage. Popular hardware wallets on the market are Ledger, Trezor, and the Cold Card.
Bonus/Miscellaneous
The newest issue of the Economist features this cover:
Pointing out that much, though not all, of DeFi is not actually very decentralized, @tip_nz shared this video about how Bitcoin is the real, proverbial rabbit hole:
As always, thanks for reading! If you enjoyed it or found it useful, share this newsletter widely and freely!
“Civilization is in a race between education and catastrophe. Let us learn the truth and spread it as far and wide as our circumstances allow. For the truth is the greatest weapon we have.” -H.G. Wells
See you next week,
Logan
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DISCLAIMER: I am not investment advisor and this is not investment advice. This is not, nor is it intended to be, a recommendation to buy or sell any security or digital asset. This newsletter exists for educational and informational purposes. Do your own research before making any investment decisions.
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