Understanding cryptocurrencies, the value of Bitcoin and what happens ‘under the hood’.

Q: What is a cryptocurrency?

A: Cryptocurrency is a misnomer for what is really a ‘digital asset’.

Q: Why then is it called cryptocurrency?

A: The first cryptocurrency (Bitcoin) was invented to solve money problems, and to use cryptography to achieve the objective.  The name cryptocurrency just stuck.  However, looking at Bitcoin after over a decade since its creation, it is not used as currency but more as an asset.

Q: What was the problem with money that people were trying to solve with cryptocurrencies?

A: A group of programmers felt that there was always a danger for money to be abused by a central authority (gov’t).  For instance, think of overprinting of money in the countries that see hyperinflation.  The fact that it was controlled by a ‘central’ authority was also seen to be a problem.

Q: How does cryptography solve those problems?

A: Cryptography is only a small part of the solution.  The major innovation brought by Bitcoin and other digital currencies/assets is the use of a blockchain – it is both secure and brings the promise of ‘peer to peer’ usage.

Q: What is a blockchain?

A: Blockchain is a type of ledger (or record) that exists on multiple databases. The ledger is not edited when transactions occur. Rather, when transactions occur, they are added to the ledger in ‘blocks’.  Over time, more and more blocks are added, forming a ‘chain’.

Q: What is so great about the promise of ‘peer to peer’ usage?

A: It allows Bitcoin or other crypto to be ‘permissionless’, meaning there is no need for a trusted third party to transact.  You don’t need a bank to approve the transaction.  You don’t need a central authority that can abuse it’s power to print more money or even make mistakes.

Q: If there’s no central authority, how will you transact?

A: You can interact directly with the blockchain.  All you need is to send your transaction into the blockchain for verification, using your private key (this is the cryptography part).

Q: What is a private key?

A: It is a randomized code given to you when you create your wallet.  Anyone with the private key can use the bitcoins in your wallet.

Q: How do you create a wallet?

A: You can create a wallet by interacting with the chain using an app on your iphone or android phone, or even a web browser.  You can also use ‘hardware wallets’ such as a Trezor.

Q: The wallet will be on my phone, computer or harware?

A: Not exactly.  One can only control bitcoin using the private key.  That private key can be kept on your phone, computer or hardware.  Many don’t even keep their keys.  There are institutions and crypto exchanges (Centralized Exchange or CEX) that hold people’s keys for them.

Q: How do I transact or send bitcoins to a friend or particular person?

A: You simply need to ask them for their public key, which can be expressed in the form of a code of letters and numbers or, something more familiar and easy to use: a QR code.  Then using your chosen app, or harware wallet, you authorize the transaction to your friend’s wallet (indicated by the public key).

Q: Wait, I need to ask them for the key? Won’t that give me control over their wallet?

No.  There are two keys: private and public.  The private key is what gives you control, so the private key must always remain a secret.  The public key is like your address, you can give it out to your friends and family because it allows them to send you packages or mail.  The public key is what people need to know to be able to send you bitcoin.

Q: So Bitcoin is just a bunch of keys?  Isn’t that the same as passwords for email, etc. Cryptography has existed already. What’s so good about Bitcoin?

A: It’s really the use of a blockchain that is truly innovative.  Since the ledger (record of who owns how much Bitcoins) exists on multiple databases, which are called nodes, it’s extremely difficult to make fake or double transactions.  It’s practically impossible for a regular user to counterfeit bitcoin.

Q: Ok.  So no fake Bitcoins.  What else is so good about it?

A: Remember that the only way to control it is through the private key.  This is one of the best and also dangerous things about Bitcoin.  First, as long as the private key remains private, nobody can access your coins – not even the government.  They can, however, theoretically force you to turn over your keys.  That’s another conversation altogether.  Second, the danger is that if you lose your private key, nobody can retrieve it for you.

Q: Ok. Is that it?

A: Well, one unique thing about Bitcoin is that it was programmed with a maximum number of 21 million.  So, there’s some built-in scarcity.

Q: Why is that good?  Why is scarcity good?

A: From a demand and supply perspective, it’s great for those who want to treat it like an asset.  For the same reason that rare metals or stones are valuable, rare crypto assets are theoretically better at holding value than assets that are aplenty.  This is believed to be a way to solve the inflation problem in regular currencies.

Q: Why do people buy bitcoin?

A: Some see it as a speculative purchase (hoping it will grow in value), others believe it can store value for generations, some others want to use it to move wealth easily across borders (i.e. Ukrainians fleeing the war – it’s much easier to carry your private key than to carry bars of gold as you flee the country.), and others use it to protect them against hyperinflation.

Q: Ok, suppose I invest in Bitcoin? Who gets the money?

A: When you buy bitcoin, you are buying is from another person or entity.  Think of it like buying gold or real estate.

Q: Who decides what the price of Bitcoin is?

A: The price of Bitcoin really depends on what anyone is willing to pay.  Since there are many crypto exchanges, most people choose to buy and sell there.  The price on the exchanges is determined by the daily bids and offers for buying and selling, very similar to a stock market.  However, there are some institutions that allow “over the counter” transactions.  The price will there will be determined by the negotiations of the buyer and seller.  One popular story is that the first recorded Bitcoin transaction is when someone paid 10,000 Bitcoins for two pizzas back in 2010.

Q: Are there Philippine laws, rules and regulations on Bitcoin?

A: The Banko Sentral ng Pilipinas (BSP) regulates local cryptocurrency exchanges.  The Securities and Exchange Commission (SEC) also has regulations on cryptocurrencies and ‘Initial Coin Offerings’.  We expect more rules and eventually laws to regulate cryptocurrencies and digital assets.

The BSP primer may be accessed at:

https://www.bsp.gov.ph/Media_and_Research/Primers%20Faqs/VC.pdf

Q: What are the other other cryptocurrencies?

A: There are hundreds. Another well known cryptocurrency is Ethereum (ETH) – developed to host ‘smart contracts’.