What Are Crypto Assets?
The easiest way to answer the question of what cryptoassets are and why they are important is to think about a simple transaction, like giving someone $1 million.
In a world where we all carried cash, this was simple. If I want to give you $1 million, I simply give you $1 million. The transaction is unambiguous and instantaneous—as soon as I hand you the cash, you have the money. What’s more, I can’t give the cash to multiple people. The transaction doesn’t require a trusted third party to verify it. Everyone in the world can agree, instantly, that I had the cash at one moment and that I then gave it to you.
But the cash transaction has its flaws. First, it’s inconvenient. Who carries around $1 million in cash? Second, it’s not secure.
The more likely scenario, if I want to send $1 million to you, is to use a trusted third party to handle the transaction (as opposed to, say, handing you a briefcase stuffed with cash).
In this example, we both have a bank account at a single bank—let’s call it Wells Fargo. I call Wells Fargo or enter a form online telling them to send you $1 million. On the back end, the bank will verify that I have the money, deduct $1 million from my account in its ledger and send $1 million to you, possibly subtracting a small fee for the service.
If we have two different banks, it’s a little more complicated. First, my bank will debit my account. Then, it will have a shared account with your bank, and it will transfer $1 million to your bank. Then your bank will credit your account. At each step, banks will check their work and make sure that the money is really where it should be.
A Common Financial Transaction
Sometimes, it can get more complicated. If I’m wiring money to you in, say, South Africa, I’ll have to tell my bank, which may have to tell a large money center bank in the U.S., like Bank of America, because my small community bank may not be connected to any banks overseas.
That money center bank may not have a relationship with banks in South Africa, so they may wire it to a large money center bank in Europe—Deutsche Bank, maybe. Deutsche Bank will translate my funds into euros and then transfer the money to its partner bank in South Africa. That bank will exchange the money into Rand, and then transfer the money to your local bank, where you can withdraw the money.
At every step, these banks are doing work, so they may charge you a fee.
This is a generalization, but it’s not uncommon. To take just one angle, Americans sent $138 billion in remittance abroad last year. They paid an average fee of 8% to do so, and settlement took on average three days. To put those numbers in perspective, that’s $11 billion in fees. Alternately, 8% is roughly equivalent to 1/12, meaning workers spend one month each year working just for Western Union— sacrificing all of January just to pay the fees to send this money to their families abroad.
International commercial transactions are a multi-trillion dollar market, and while fees are lower, they’re still significant and settlement times are still slow.
These are among the markets crypto is aiming to debate.
Crypto Allows for Digital, Peer-to-Peer Transactions Without a Central Authority
Crypto allows you to send value over the internet, safely and securely, without the need for a trusted third party to verify the transaction. That’s why some people call crypto “the internet of money” or “the internet of value.”
So, for example, rather than forcing money to daisy-chain its way around the world from one bank to another, taking hours or days to settle, you can just send it where you want it to go —peer-to-peer, like an email.
The magic that makes this all happen is called the “consensus protocol,” which is a fancy phrase for a mathematical way that a bunch of different computers can agree (or come to consensus) about who owns what and where it’s been. This process that allows this to happen is the much ballyhooed “mining” that you read about in the media.
Mining: What It Is and Why It’s Important
In crypto, mining or other consensus protocols are how a distributed blockchain synchronously updates the account of who owns what. It is also the way that crypto networks eliminate the risk of double-spending: people who, say, try to send the same $1 million to two different people. This double-spending problem is important; a lot of what banks do, after all, is make sure that if you send someone $1 million you actually have it, and you haven’t sent it to multiple people.
To show how it works, let’s go back to our original example of me sending you money. To initiate that transaction, I would send a message into the network saying I want to send you that $1 million in bitcoin.
All the computers that are keeping track of the bitcoin ledger —effectively, the spreadsheet of who owns what in the bitcoin network—take my proposed transaction and a bunch of others and combine them with other proposed transactions into what’s called a block. Importantly, these computers—colloquially known as “mining rigs” and operated by “miners”—can only combine valid transactions. So if I tried to send that same $1 million to two different people, a miner would have to choose which of my transactions to take.
Once a group of valid transactions is combined into a
block, a miner will race other miners to solve a really hard math problem. The problem is so hard that it doesn’t actually matter how smart you are, only how much computing power you can throw at it, effectively randomizing who solves it first.
The first miner to solve the problem broadcasts the solution to the network, along with the block of validated transactions. Other miners then check to see if the proposed solution to the problem is correct and the transactions are valid. If they are, that block is added to the chain of previous blocks, the transactions are “settled,” and everyone updates their copy of the blockchain to the new official state.
The miner that solved the puzzle first is rewarded with some amount of the cryptoasset as compensation for keeping the network up to date. Then, the process starts all over again, with a new block, more transactions, and a new puzzle. Importantly, the next math problem is built on the information in the past block. Therefore, you can’t solve the next puzzle if you change any of the past data.
This process has multiple positive effects. First, it solves the double spend problem, because miners can’t make a block with invalid transactions, creating digital scarcity for the first time ever. Second, it makes the database incredibly secure. Because each subsequent block contains all of the information of previous blocks, you can’t go back and falsify records without invalidating everything that follows. It breaks the chain. That’s why, despite holding $120 billion in bearer wealth, the bitcoin blockchain has never been hacked.
But most importantly—and the reason it has implications outside of just sending money— it negates the need for rent-seeking middlemen we previously had to rely on in order to process our transactions. And the ability to replace trusted intermediaries with something better, faster, and cheaper means we can rethink major systems, where the reliance on a third party to process transactions was once a foregone conclusion.
Summary:
We are bullish on Bitcoin, but not as an investment just yet. The SEC (Securities and Exchange Commission) says that Bitcoin is not a security. Because we’re registered with the SEC, we only use 40 Act products that are registered by the SEC under the Investment company Act of 1940. We can’t advise clients to go to Coinbase or invest in Bitwise. We don’t have that ability and are limited with our firm.
However, because it is now 10 years old, it’s a $200 Billion-dollar market, the Bitcoin itself is about 40% of that total. It is obviously here to stay.
There are massive amounts on investments going into the Blockchain and crypto assets. It’s obvious that advisors do not fully understand this category no more than their clients do. Therefore, advisors can’t effectively give advice to their clients that they need. Should I consider buying a crypto asset like Bitcoin or another one? If so, how much? How do I do it? And many other questions to consider. My mission is to educate investors and advisors so they can be a better advocate.
Crypto assets are an asset class like gold, technology or energy, but and we need to listen to and applaud the SEC with their efforts to understand their concerns for investors and advisors.
Will an ETF be available soon? I don’t know, maybe in 3 months or in 2021, who knows, but right now, raising your knowledge and education of these crypto assets is priority #1.
If you would like a deeper discussion about Crypto Assets please email us at info@crosspointwealth.com
