Speaker 1: This is Bloomberg Crypto, a daily Bloomberg I Heard podcast,
Speaker 1: and I'm Stacy Marie Ishmael, Managing editor of Crypto for
Speaker 1: Bloomberg News. Let me cut to the chase. Matt Levine,
Speaker 1: my colleague on the Bloomberg Opinion side of the house,
Speaker 1: is perhaps the greatest finance blogger ever to do it,
Speaker 1: and in what is both a flex and a service,
Speaker 1: He's just written tens of thousands of words on the
Speaker 1: subject of crypto for a special issue of Bloomberg Business Week.
Speaker 1: Matt's gone deep into the blockchain to break down its origins,
Speaker 1: it's possible, futures, and the current state of a technology
Speaker 1: that's showing up everywhere in industries ranging from finance to
Speaker 1: shipping too, of course video games. And we're going to
Speaker 1: be bringing his exploration to you in audio form thanks
Speaker 1: to the talents of Bloomberg editor and professional voice actor
Speaker 1: Mark Ledoff. You'll get weekly chapters of the special Crypto
Speaker 1: issue of Bloomberg Business Week. Welcome to the third chapter
Speaker 1: of the special audio edition of the Bloomberg Business Week
Speaker 1: Crypto issue, written by Matt Levine and narrated by Mark Leadoff.
Speaker 1: Mr chapter. You can find previous episodes right here in
Speaker 1: the Bloomberg Crypto podcast feed Part two. What does it mean? Okay, then,
Speaker 1: I've described in some detail the workings of the thing
Speaker 1: bitcoin That'satoshi Nakamoto invented. But let's take a step back.
Speaker 1: What exactly is it that he invented. The simplest answer
Speaker 1: is that he invented bitcoin. Bitcoin is a big thing.
Speaker 1: At its peak, the total value of bitcoin in the
Speaker 1: world was more than one trillion dollars. There are thousands
Speaker 1: of articles about it. It has lots of investors and
Speaker 1: fans and believers. Some of these people are called bitcoin maximalists.
Speaker 1: They believe the only really interesting and valuable thing in
Speaker 1: the world of crypto is bitcoin. Those people could stop here.
Speaker 1: I guess there. It is Bitcoin here, though, I want
Speaker 1: to keep going. I want to talk about different ways
Speaker 1: that you might generalize Satoshi's invention. There are different ways
Speaker 1: to interpret what Setoshi was up to and what he accomplished,
Speaker 1: and each interpretation points you to a different direction. For crypto,
Speaker 1: a a store of value. A minimal generalization of bitcoin
Speaker 1: is something like Satoshi invented a technology for people to
Speaker 1: send numbers to one another. That's not nothing before Setoshi
Speaker 1: I could have written you an email that said one
Speaker 1: thirty two point fifty one, but you'd have no way
Speaker 1: of knowing whether I had the one thirty two point
Speaker 1: fifty one on my computer, or whether I had already
Speaker 1: sent the one thirty two point fifty one to someone else.
Speaker 1: And you'd have no way of proving to other people
Speaker 1: that you now add the one thirty two point fifty
Speaker 1: one on your computer and could send it to them.
Speaker 1: I realized that paragraph sounds very stupid, because it is
Speaker 1: you definitely have one thirty two point fifty one on
Speaker 1: your computer, as well as every other conceivable number. Computers
Speaker 1: can generate numbers arbitrarily and more or less for free.
Speaker 1: Open a spreadsheet type two point fifty one, and there
Speaker 1: you go. In a sense, the technological accomplishment of bitcoin
Speaker 1: is that it invented a decentralized way to create scarcity
Speaker 1: on computers. Bitcoin demonstrated a way for me to send
Speaker 1: you a computer message so that you'd have it and
Speaker 1: I wouldn't to move items of computer information between us
Speaker 1: in a way that limited their supply and transferred possession.
Speaker 1: But the technological accomplishment is not the whole story, arguably
Speaker 1: not even the most important part. The wild thing about
Speaker 1: bitcoin is not that Satoshi invented a particular way for
Speaker 1: people to send numbers to one another and call them payments.
Speaker 1: It's that people accepted the numbers as payments. There's nothing
Speaker 1: inherent in the technology that would make that happen. People
Speaker 1: might have read the Bitcoin white paper and said, huh,
Speaker 1: this is a cool way to send payments, but your
Speaker 1: problem is that you aren't sending dollars. You're sending this
Speaker 1: thing you just made up, and who wants that? Well
Speaker 1: most of them did say that initially, but lots of
Speaker 1: people eventually decided that bitcoin was valuable. That's weird. Satoshi
Speaker 1: was like, I have invented a payment system that works great.
Speaker 1: The only problem is that instead of getting paid in dollars,
Speaker 1: you get paid in this thing I just made up.
Speaker 1: Is that cool? And enough people were like, Yeah, that's
Speaker 1: cool that now crypto is a trillion dollar business. That
Speaker 1: social fact that bitcoin was accepted by many millions of
Speaker 1: people as having a lot of value might be the
Speaker 1: most impressive thing about bitcoin, much more than the stuff
Speaker 1: about hashing shit coins. Here's another extremely simple generalization of bitcoin.
Speaker 1: One you can make up an arbitrary token that trades electronically. Two.
Speaker 1: If you do that, people might pay a non zero
Speaker 1: amount of money for it. Three worth a shot. No.
Speaker 1: As Bitcoin became more visible and valuable, people just did that.
Speaker 1: There was a rash of new cryptocurrencies that were sometimes
Speaker 1: subtle variations on Bitcoin and sometimes just lazy knockoffs. Shit
Speaker 1: coins is the mean name for them. To software engineers
Speaker 1: through together a cryptocurrency and gave it a logo of Doge,
Speaker 1: the talking sheba e new meme. They called it doge coin,
Speaker 1: and it was a parody of the coin boom. It's
Speaker 1: worth a eight billion dollars today. I'm not going to
Speaker 1: explain that to you. Nobody is going to explain that
Speaker 1: to you. Certainly the guys who invented doge coin don't
Speaker 1: understand it. One of them has taken to Twitter to
Speaker 1: say he hates it. It's just like, if you're making
Speaker 1: up an arbitrary token that trades electronically, and you hope
Speaker 1: people will buy it for no particular reason, you might
Speaker 1: as well make it fun, slap a talking dog on it,
Speaker 1: give people stuff to make jokes about online. Incidentally, here's
Speaker 1: a fun argument that was made against bitcoin early in
Speaker 1: its life. One, there's a limited supply of bitcoin. Two,
Speaker 1: but the Bitcoin software is open source and can be
Speaker 1: cloned trivially. Three, So if the price of Bitcoin gets above,
Speaker 1: you know, a hundred dollars, someone will just invent blit coin,
Speaker 1: which will be an exact copy of Bitcoin. Four. Bitcoin
Speaker 1: is arbitrary and blit cooin is arbitrary, so there's no
Speaker 1: reason that blit coin should trade at much of a
Speaker 1: discount to bitcoin. Five. This will dilute the value of
Speaker 1: bit coin. Any sensible person would rather pay ninety dollars
Speaker 1: for blit coin than a hundred and five for Bitcoin,
Speaker 1: since they're the same thing, but one is cheaper. Six. Therefore,
Speaker 1: there's an infinite supply of Bitcoin or things that are
Speaker 1: exactly like it, so the value of bitcoin cannot get
Speaker 1: too high. This argument turned out to be mostly wrong. Socially,
Speaker 1: cryptocurrency is a coordination game. People want to have the
Speaker 1: coin that other people want to have, and some sort
Speaker 1: of abstract technical equivalence doesn't make one cryptocurrency a good
Speaker 1: substitute for another. Social acceptance, legitimacy is what makes a
Speaker 1: cryptocurrency valuable, and you can't just copy the code for that.
Speaker 1: That's a revealing fact. What makes bitcoin valuable isn't the
Speaker 1: elegance of its code, but it's social acceptance, another advantage
Speaker 1: that Bitcoin has over a hypothetical copycat more minors. A big,
Speaker 1: diverse pool of miners keeps a cryptocurrencies blockchain more secure
Speaker 1: than a small concentrated pool, But that security is just
Speaker 1: an instantiation of its rodder social acceptance. All the Bitcoin
Speaker 1: miners could quit and become blitcoin miners, they just don't.
Speaker 1: A thing that worked exactly like Bitcoin but didn't have
Speaker 1: Bitcoin's lineage, didn't descend from Satoshi's genesis block and was
Speaker 1: just made up by some copycat would have the same technology,
Speaker 1: but none of the value. Two an uncorrelated asset. Here's
Speaker 1: another generalization of bitcoin. One Satoshi made up an arbitrary
Speaker 1: token that trades electronically for some price. Two the price
Speaker 1: turns out to be high and volatile. Three the price
Speaker 1: of an arbitrary token is arbitrary. This may not sound
Speaker 1: that great to you, but it's very interesting as a
Speaker 1: matter of finance theory. Modern portfolio theory demonstrates that adding
Speaker 1: an uncorrelated asset to a portfolio can improve returns and
Speaker 1: reduce risk. Big institutions will invest in timberland, or highway
Speaker 1: tolls or hurricane insurance because they think that those things
Speaker 1: won't act just like stocks or bonds, that they'll diversify
Speaker 1: their portfolios, that they'll hold up even in a world
Speaker 1: where stocks go down to the extent that the price
Speaker 1: of bitcoin. One mostly goes up, though with lots of
Speaker 1: ups and downs along the way, and two goes up
Speaker 1: and down for reasons that are arbitrary and mysterious and
Speaker 1: not tied to like corporate earnings or the global economy,
Speaker 1: then bitcoin is interesting to institutional investors. There are variations.
Speaker 1: For instance, one, bitcoin is not just uncorrelated to regular
Speaker 1: financial stuff. It's a hedge to inflation. If the Federal
Speaker 1: Reserve is printing money recklessly, the dollar will lose value,
Speaker 1: but bitcoin is in limited supply and will maintain its
Speaker 1: value even as the dollar is inflated away. Two. Bitcoin
Speaker 1: is like gold, but more convenient. The value of gold
Speaker 1: is also somewhat arbitrary and mysterious, but it's a store
Speaker 1: of value that's not tied to corporate earnings and central
Speaker 1: bank policy. Investors who like gold should buy bitcoin. Well,
Speaker 1: those are some things that people said in practice, it
Speaker 1: turns out that the price of bitcoin is pretty correlated
Speaker 1: with the stock market, especially tech stocks. Bitcoin hasn't been
Speaker 1: a particularly effective inflation hedge. Its price rose during years
Speaker 1: when US inflation was low, and it's fallen this year
Speaker 1: as inflation has increased. The right model of crypto prices
Speaker 1: might be that they go up during broad speculative bubbles
Speaker 1: when stock prices go up, and then they go down
Speaker 1: when those bubbles pop. That's not a particularly appealing story
Speaker 1: for investors looking to diversify. You want stuff that goes
Speaker 1: up when the broad bubbles pop. Three game stop. I'm
Speaker 1: not going to dwell on the meme stock phenomenon here.
Speaker 1: I dwelt on it in this publication last December. But
Speaker 1: one important possibility is that the first general realization of bitcoin,
Speaker 1: that an arbitrary tradeable electronic token can become valuable just
Speaker 1: because people want it to permanently, broke everyone's brains about
Speaker 1: all of finance. Before the rise of bitcoin, the conventional
Speaker 1: thing to say about a share of stock was that
Speaker 1: its price represented the market's expectation of the present value
Speaker 1: of the future cash flows of the business. But bitcoin
Speaker 1: has no cash flows. Its price represents what people are
Speaker 1: willing to pay for it. Still, it has a high
Speaker 1: and fluctuating market price. People have gotten rich buying bitcoin,
Speaker 1: so people copied that model, and the creation of and
Speaker 1: speculation on pure, abstract, scarce electronic tokens became a big business.
Speaker 1: A share of stock is a scarce electronic token. It's
Speaker 1: also something else, acclaim on cash flows or whatever. But
Speaker 1: one thing that it is is an electronic token that's
Speaker 1: in more or less limited supply. If you and your
Speaker 1: buddies online want to make jokes and invest base on
Speaker 1: those jokes, then depending on your sense of humor and
Speaker 1: which online chat group you're in, you might buy either
Speaker 1: dogecoin or GameStop corps stock, and for your purposes those
Speaker 1: things are not that different b a distributed computer. Here's
Speaker 1: another very different generalization of bitcoin. In its sharpest form.
Speaker 1: It's mostly attributed to programmer Vitalic bou Terran, another colorful
Speaker 1: character whom we won't discuss. If you're curious, there are
Speaker 1: two books by former Bloomberg journalists about the early days
Speaker 1: of Ethereum, in which Vitallic is the star but by
Speaker 1: no means the only important player. Camilla Russo's The Infinite
Speaker 1: Machine and Matthew Lisn's Out of the Ether. Bu Terran's
Speaker 1: sketch of bitcoin goes like this. One. Look, this thing
Speaker 1: you made is a big, sprawling computer. The blockchain is
Speaker 1: doing the functions of a computer. Specifically, it's keeping a
Speaker 1: database of bitcoin transactions. Two. This computer has some fascinating properties.
Speaker 1: It's distributed. The computer's data aren't kept on any one
Speaker 1: particular machine, but spread out among lots of nodes. The
Speaker 1: blockchain creates a mechanism to make sure they all agree
Speaker 1: on what the database says. It's decentralized. Different people run
Speaker 1: the database on their own separate machines. It's secure and
Speaker 1: final because of how transactions are encoded into blocks. It's
Speaker 1: more or less impossible for someone to reach back into
Speaker 1: the database and change a transaction from last week. And
Speaker 1: it's trust less and permissionless. Anyone who wants to can
Speaker 1: download the blockchain or mine bitcoin. The mining mechanism gives
Speaker 1: people incentives to collaborate and compete with one another to
Speaker 1: keep the database secure and up to date. Three. But
Speaker 1: it's not a very good computer. Mostly it just keeps
Speaker 1: a list of payments. We'll be right back with more
Speaker 1: from Bloomberg Business Week. Special crypto issue written by Matt
Speaker 1: Levin a narrated by Mark Leadoff. Four. Let's do the
Speaker 1: same thing, but make it a good computer. One. Ethereum,
Speaker 1: the computer that Vitallic invented. Like Setoshi, Vitallic Buterian is
Speaker 1: widely referred to in the crypto world by his first name,
Speaker 1: is generally called Ethereum or the Ethereum Virtual machine. It's
Speaker 1: a virtual computer distributed among thousands of redundant nodes. Each
Speaker 1: node knows the state of the computer, what's in its memory,
Speaker 1: and each transaction on the system updates that state. Ethereum
Speaker 1: works a lot like Bitcoin. People create transactions, they broadcast
Speaker 1: them to the network. The transactions are included in a block.
Speaker 1: The blocks get chained together, everyone can see every transaction, etcetera.
Speaker 1: The currency of the Ethereum blockchain is called I don't know.
Speaker 1: It's common to call it ether, though sometimes people say
Speaker 1: ethereum and often they just write E T H. Similarly,
Speaker 1: Bitcoin is sometimes written BTC in conversation. It's mostly shortened
Speaker 1: to but whereas Bitcoin transactions are mostly about sending payments,
Speaker 1: that's an exaggeration. There is a scripting language in bitcoin,
Speaker 1: and some ability to write programs. Actions on Ethereum are
Speaker 1: conceived of more generally, Ethereum is a big virtual computer,
Speaker 1: and you send it instructions to do stuff on the computer.
Speaker 1: Some of those instructions are send ten ether from address
Speaker 1: X to address why one thing in the computer's memory.
Speaker 1: Is a database of Ethereum addresses and how much ether
Speaker 1: is in each of them, and you can tell the
Speaker 1: computer to update the database. But you can also write
Speaker 1: programs to run on the computer to do things automatically.
Speaker 1: One sort of program might be send ten ether to
Speaker 1: address why if something happens. Alice and Bob might want
Speaker 1: to bet on a football game, or on a presidential election,
Speaker 1: or on the price of ether. Alice and Bob, by
Speaker 1: the way, are stock characters and discussions of crypto, not
Speaker 1: interesting characters, though they might write a computer program on
Speaker 1: the Ethereum virtual machine to do that. The program would
Speaker 1: have its own Ethereum account where it could keep ether,
Speaker 1: and it's programming logic would say something like, if the
Speaker 1: Jets win on Sunday, or if Joe Biden wins the election,
Speaker 1: or if either trades above on November one, then send
Speaker 1: the money in this account to Alice. Otherwise send it
Speaker 1: to Bob. Alice and Bob might then each send one
Speaker 1: Ether to the account, which would whirr along for a
Speaker 1: bit checking the football scores, or the election results or
Speaker 1: the ether prize. How would it check. The standard solution
Speaker 1: in crypto is called an oracle. It's a program that
Speaker 1: will periodically query some company or website that tracks the
Speaker 1: relevant information election results, football scores, whether, etcetera, and post
Speaker 1: the answer to the Ethereum blockchain. An oracle is essentially
Speaker 1: a way to bring information from the outside world, the
Speaker 1: real world, or just the Internet, onto the blockchain. When
Speaker 1: the program had an answer to its question who won
Speaker 1: the game or the election or is ether above, it
Speaker 1: would automatically resolve the bet and send to ether to
Speaker 1: the winner. Or you could have a program that says,
Speaker 1: if anyone sends one ether to this program, the program
Speaker 1: will send them back something nice. Something nice is pretty
Speaker 1: hazy there, and frankly it's pretty hazy in actual practice,
Speaker 1: but in concept, anything that you can put into a
Speaker 1: computer program could be the reward here. So send me
Speaker 1: one ether and I will send you back. A digital
Speaker 1: picture of a monkey would be one possible program. And
Speaker 1: I guess it sounds like I'm joking, but for a
Speaker 1: while digital pictures of monkeys were selling for millions of
Speaker 1: dollars on ethereum. Or there's a thing called the Ethereum
Speaker 1: Name Service, or e n S, which allows people to
Speaker 1: register domain names like Matthew Levine, dot et h and
Speaker 1: use them across various Ethereum functions. You send ether to
Speaker 1: the e n S program and it registers that name
Speaker 1: to you. You send in money, and it sends you
Speaker 1: back a domain. The standard analogy here is a vending machine.
Speaker 1: A vending machine is a computer in the real world
Speaker 1: where you put in a dollar and you get back
Speaker 1: something you want. You don't negotiate with the vending machine
Speaker 1: or make small talk about the weather while it wrings
Speaker 1: you up. The vending machine side of the transaction is
Speaker 1: entirely automated. It's programming makes it respond deterministically to you
Speaker 1: putting in money and pressing buttons. In the crypto world,
Speaker 1: these programs are called smart contracts. The name is a
Speaker 1: bit unfortunate. A smart contract is a computer program that
Speaker 1: runs on the blockchain. Some smart contracts look like contracts.
Speaker 1: Alison Bob's bet on the price of ethereum looks a
Speaker 1: lot like a financial derivative, which is definitely a contract.
Speaker 1: Some smart contracts look like vending machines. They sit around
Speaker 1: in public waiting for people to put money in, and
Speaker 1: then they spit out goods. A vending machine is not
Speaker 1: exactly a normal contract, but it is a transaction, and
Speaker 1: people who are into philosophizing about contracts like thinking about
Speaker 1: vending machines. But some smart contracts just look like, you know,
Speaker 1: computer programs. The concept is more general than the name.
Speaker 1: In the Ethereum white paper, Vitallic Bouterran wrote, note that
Speaker 1: contracts in Ethereum should not be seen as something that
Speaker 1: should be fulfilled or complied with. Rather, they are more
Speaker 1: like autonomous agents that live inside of the Ethereum execution environment,
Speaker 1: always executing a specific piece of code when poked by
Speaker 1: a messenger transaction, and having direct control over their own
Speaker 1: ether balance and their own key value store to keep
Speaker 1: track of persistent variables. There are limits. Ethereum is a
Speaker 1: distributed computer, but it doesn't have a keyboard and a monitor.
Speaker 1: It would be hard to play call of duty on
Speaker 1: the Ethereum virtual machine. But ethereums blockchain and smart contracts
Speaker 1: can serve as sort of a back end to other
Speaker 1: types of programs. Developers build dapts or decentralized apps on
Speaker 1: Ethereum and other block chain. These are computer programs that
Speaker 1: mostly run on the web, perhaps on some centralized or
Speaker 1: cloud server, but keep some of their essential data on
Speaker 1: the blockchain. You play a computer game, and your character's
Speaker 1: attributes are stored on the blockchain. A normal program on
Speaker 1: the game company's servers renders the character's sword on your screen,
Speaker 1: but the fact that she has the sword is stored
Speaker 1: on the blockchain. One other limit is that it's a
Speaker 1: slow computer. The way Ethereum executes programs is that you
Speaker 1: broadcast the instructions two thousands of nodes on the network,
Speaker 1: and they each execute the instructions and reach consensus on
Speaker 1: the results of the instructions. That all takes time. Your
Speaker 1: program needs to run thousands of times on thousands of computers.
Speaker 1: Computers and network connections are pretty fast these days, and
Speaker 1: the Ethereum computer is fast enough for many purposes, such
Speaker 1: as transferring ether or keeping a database of computer game characters.
Speaker 1: But you wouldn't want to use this sort of computer
Speaker 1: architecture for extremely time sensitive, computation intensive application. You wouldn't
Speaker 1: want like a self driving car running on the Ethereum
Speaker 1: virtual machine. You wouldn't want thousands of computers around the
Speaker 1: world redundantly calculating how far you are from hitting someone
Speaker 1: before you could break two proof of steak. This distributed computer,
Speaker 1: the Ethereum Virtual machine, takes its basic design from Bitcoin.
Speaker 1: There are blocks, everyone can see them. They are chained together,
Speaker 1: Transactions are signed with private keys, everything is hashed, etcetera.
Speaker 1: It's just that, in addition to sending money to people,
Speaker 1: you can send computer instructions to the blockchain and the
Speaker 1: blockchain will execute them. What that means is that there
Speaker 1: are thousands of computers each running nodes of the Ethereum network,
Speaker 1: and all those computers will agree about what happens on
Speaker 1: that network, who sent money to whom, and what computer
Speaker 1: instructions executed when. The fact that Ethereum is a distributed
Speaker 1: virtual computer means that all those actual computers can come
Speaker 1: to a consensus is about what operations executed when. And
Speaker 1: the reason this was possible is that Bitcoin showed how
Speaker 1: a decentralized computer network could reach consensus. The stuff with
Speaker 1: the hashing and the mining and the nonsens and the
Speaker 1: electricity that is Bitcoin's consensus mechanism, proof of work, or POW.
Speaker 1: Until last month it was also Ethereums. There were some
Speaker 1: technical differences, but the basic mechanics were pretty similar. Miners
Speaker 1: did a bunch of hashes of block data, and whoever
Speaker 1: found the right hash first mined the block and got
Speaker 1: a reward. Because this was expensive and wasted a lot
Speaker 1: of resources, it demonstrated a commitment to the Ethereum ecosystem,
Speaker 1: but the waste itself was bad, and so on September,
Speaker 1: after years of planning, Ethereum switched to a new consensus mechanism.
Speaker 1: Ethereum now uses something called proof of steak or POS.
Speaker 1: The basic ideas remained the same. People do transactions and
Speaker 1: broadcast them to the Ethereum network. A bunch of computers.
Speaker 1: In POW they're called miners. In POS, they're called validators
Speaker 1: work to compile these transactions into an official ordered list
Speaker 1: called the blockchain. Anyone with a computer can be a
Speaker 1: minor validator. The protocol is open to everyone, but the miners.
Speaker 1: Validators have to prove their commitment to the system to
Speaker 1: mine or validate blocks in POW. The way you prove
Speaker 1: that is by using a lot of electricity to do
Speaker 1: hashes in pos The way you prove that is by
Speaker 1: having a lot of ether oversimplifying a bit. The general
Speaker 1: mechanics are one. Anyone can volunteer to be a validator
Speaker 1: by staking some of the network's currency depositing it into
Speaker 1: a special smart contract. The staked currency can't be withdrawn
Speaker 1: for some period on ethereum. You need to stake thirty
Speaker 1: two ether currently forty dollars or so to be a validator.
Speaker 1: Two Validators get transactions as they come in and compile
Speaker 1: them into blocks. No. In fact, there is a division
Speaker 1: of labor in ethereum, where there are specialized companies called
Speaker 1: block builders that compile blocks for validators to validate. Three
Speaker 1: at fixed intervals, say every twelve seconds, one validator is
Speaker 1: randomly chosen to propose a block, and some other set
Speaker 1: of validators is chosen to review the proposed block and
Speaker 1: vote on it. Four, the randomly chosen validators agree on
Speaker 1: whether to add the block to the chain. If everyone
Speaker 1: is doing their job honestly and conscientiously, they'll mostly agree
Speaker 1: and the block will be added. Five the validators get
Speaker 1: paid fees in ether. Six If a validator acts dishonestly
Speaker 1: or lazily, if it proposes wrong blocks, or if it
Speaker 1: fails to propose or vote on blocks, or if someone
Speaker 1: turns off the computer running the validator, it can have
Speaker 1: some or all of its stake taken away as a penalty.
Speaker 1: I mean, that's the concept, but when I write it
Speaker 1: out like that, it sounds more manual than it is.
Speaker 1: Nobody is sitting around reviewing retransaction and agonizing over whether
Speaker 1: it's legitimate. The validators are just running the official open
Speaker 1: source Ethereum software. It is all pretty automatic, and you
Speaker 1: can run it on a laptop with good backup power
Speaker 1: and a solid Internet connection. The big outlay maybe forty
Speaker 1: dollars to buy ether. It's not hard to contribute to
Speaker 1: the consensus. It's hard to override it, but being an
Speaker 1: honest validator is pretty easy. When we discussed proof of
Speaker 1: work mining, I said that cryptosystems are designed to operate
Speaker 1: on consensus among people with an economic stake in the system.
Speaker 1: POW systems demonstrate economic stake in a cleverly indirect way.
Speaker 1: You buy a bunch of computer hardware and pay for
Speaker 1: a lot of electricity, and do a bunch of calculations
Speaker 1: to prove you really care about bitcoin pos systems demonstrate
Speaker 1: the economic stake directly. You just invest a lot of
Speaker 1: money in ethereum and post it as a bond, which
Speaker 1: proves you care. This is more efficient in two ways. First,
Speaker 1: it uses less electricity, burning lots of electricity to do
Speaker 1: trillions of pointless math calculations. A second, in a warming
Speaker 1: world seems dumb. Proof of steak uses to a first
Speaker 1: approximation no electricity. You're simply keeping a list of transactions,
Speaker 1: and you just have to compile the list once, not
Speaker 1: two hundred quintillion times. The transition to POS cut Ethereum's
Speaker 1: energy usage by something like second POS more directly measures
Speaker 1: your stake in the system. You demonstrate your stake in
Speaker 1: ethereum by one owning ether and two putting it at
Speaker 1: risk to validate transactions. One risk is slashing. If you
Speaker 1: do nefarious things and other validator's notice, they can slash
Speaker 1: your steak and take away your ether. Conceptually, the bigger
Speaker 1: risk is that the value of your ether will fall
Speaker 1: while you have it locked up. If you do things
Speaker 1: to undermine confidence in ethereum, then the value of your
Speaker 1: stake will drop. To take control of the POS system
Speaker 1: and abuse it for your own nefarious purposes you to
Speaker 1: own a lot of ether, and the more you own,
Speaker 1: the less nefarious you'll want to be. Proof of Steak
Speaker 1: can buy something like twenty times more security for the
Speaker 1: same cost, the Talec has argued. Coming up next, you'll
Speaker 1: hear more from Matt Levin's special crypto issue of Bloomberg
Speaker 1: Business Week, narrated by Mark Leadoff staking Here's how a
Speaker 1: bitcoin minor makes money. One spend dollars to buy computers
Speaker 1: and electricity to use the computers and electricity to generate bitcoin.
Speaker 1: Three sell the bitcoin or hold them and hope they
Speaker 1: go up. Here's how an ethereum validator makes money. One
Speaker 1: bye ether to lock it up. Three get paid fees
Speaker 1: in either that are roughly a percentage of the ether
Speaker 1: you've locked up. Currently fees are around four. There's still
Speaker 1: some computer hardware involved. You have to run software to
Speaker 1: compile and check transactions, but not much of it. Again,
Speaker 1: it can be a laptop. The capital investment isn't in computers,
Speaker 1: but in the relevant cryptocurrency. The transaction is very close.
Speaker 1: To invest a lot of cryptocurrency and then get paid
Speaker 1: interest on that cryptocurrency. You can make it even easier
Speaker 1: on yourself. Instead of downloading the software to run a
Speaker 1: full ethereum validat or node and depositing thirty two ether,
Speaker 1: you can hand your either over to someone else and
Speaker 1: let them be a validator. It doesn't need to be
Speaker 1: thirty two either. If you have one either and thirty
Speaker 1: one other people each have one either, and you all
Speaker 1: pool your EITHER together, then you have enough to stake
Speaker 1: validate transactions and earned fees, and then you each can
Speaker 1: have a cut of the fees. The work of validating
Speaker 1: transactions can be completely separated from the actual staking of ether,
Speaker 1: and in fact, a lot of ethereum validation runs through
Speaker 1: crypto exchanges such as coin base, crack Can, and Finance,
Speaker 1: which offers staking as a product to their customers. The
Speaker 1: biggest is a thing called leedo Finance, which isn't an
Speaker 1: exchange but a sort of decentralized staking pool. The customers
Speaker 1: keep their ether with the exchange anyway, so they might
Speaker 1: as well let the exchange stake it for them and
Speaker 1: earn some interest. Yes interest. If you're putting crypto into
Speaker 1: a staking pool, what it looks like to you is
Speaker 1: simply earning interest on your crypto. You have one d
Speaker 1: tokens you lock them up for a bit, you get
Speaker 1: back a hundred and three tokens. The stuff about validating
Speaker 1: transactions occurs in the background, and you don't really have
Speaker 1: to worry about it. You just get a percentage return
Speaker 1: on your money around four percent now, but maybe less
Speaker 1: after fees from locking it up before. You compare that
Speaker 1: to the passive income you might earn on, say a bond.
Speaker 1: Remember this is paid in volatile ether. Crypto has found
Speaker 1: a novel way to create yield. We'll talk about others later.
Speaker 1: Crypto has a whole business of yield farming, but this
Speaker 1: is one. You can deposit your crypto into an account
Speaker 1: and it will pay you interest. It will pay you interest,
Speaker 1: not for the reason banks generally do, because they're lending
Speaker 1: your money to some other customer who will make use
Speaker 1: of it, but because you are, in your small way,
Speaker 1: helping to maintain the security of the transaction Ledger three gas.
Speaker 1: Another difference between ethereum and bitcoin is that transaction fees
Speaker 1: are much more important in ethereum. The basic reason is
Speaker 1: that every transaction in bitcoin is more or less the
Speaker 1: same X sends why bitcoin to Z in ethereum, Though
Speaker 1: there are transactions like run this complicated computer program with
Speaker 1: ten thousand steps that takes longer. Thousands of nodes on
Speaker 1: the Ethereum network have to run and validate each computational
Speaker 1: step of each contract. If a contract requires a lot
Speaker 1: of steps, then it will use a lot more of
Speaker 1: validator's time and computer resources. If it requires infinite steps,
Speaker 1: it would crash the whole thing. To address this issue,
Speaker 1: Ethereum has gas, which is a fee that people and
Speaker 1: smart contracts pay for computation. Each transaction specifies one a
Speaker 1: maximum gas limit basically a number of computational steps, and
Speaker 1: to a price per unit of gas. If the transaction
Speaker 1: uses up all its gas, if it takes more steps
Speaker 1: to execute than the gas limit, it fails and still
Speaker 1: pays the gas fee. This deters people from sending super
Speaker 1: long transactions that clogged the network, and it absolutely prevents
Speaker 1: them from clogging the network forever. In early Ethereum, the
Speaker 1: gas fees, as well as built in mining rewards, were
Speaker 1: paid to the miner who mined a block. Since the
Speaker 1: move to POS, the built in rewards are lower because
Speaker 1: it's much less expensive to be a validator than a minor,
Speaker 1: so you don't need to get paid as much and
Speaker 1: now some of the gas fees are burned, the ether
Speaker 1: just vanishes instead of being paid to validators. The basic
Speaker 1: result is that Ether as a whole is paying less
Speaker 1: for security under pos than it used to. There are
Speaker 1: still gas fees, though, and some of them still go
Speaker 1: to validators. And generally speaking, the more you offer to
Speaker 1: pay for gas, the faster your transaction will be executed.
Speaker 1: If Ethereum is busy, paying more for your gas gets
Speaker 1: you priority for executing your transactions. It is a shared
Speaker 1: computer where you can pay more to go first. Four
Speaker 1: tokens one e r C twenty One. Thing a smart
Speaker 1: contract can do in Ethereum is create new cryptocurrencies. These
Speaker 1: cryptocurrencies are generally called tokens. Why would you want to
Speaker 1: do this? One reason we already talked about. One, you
Speaker 1: can make up an arbitrary token that trades electronically. Two
Speaker 1: If you do that, people might pay a non zero
Speaker 1: amount of money for it. Three worth a shot. No,
Speaker 1: this is extremely easy to do in Ethereum. The Ethereum
Speaker 1: white paper includes a four line code snippet for implementing
Speaker 1: a token system on Ethereum. And so there's the Shiba token,
Speaker 1: a decentralized meme token that evolved into a vibrant ecosystem.
Speaker 1: It's doage coin but on ethereum easy it has a
Speaker 1: wolf paper. But there are lots of other reasons to
Speaker 1: create cryptocurrencies. If you set up some sort of app
Speaker 1: that does a thing on the Ethereum system, and you
Speaker 1: want to charge people money for doing that thing, what
Speaker 1: sort of money should you charge them? Or if you
Speaker 1: set up a two sided marketplace that connects people who
Speaker 1: do a thing with people who want the thing done,
Speaker 1: what sort of money should the people who want the
Speaker 1: thing use to pay the people who do the thing.
Speaker 1: Dollars are a possible answer, though an oddly hard one.
Speaker 1: U s dollars don't live on the blockchain, but in
Speaker 1: bank accounts. Ether is the most obvious answer. You've set
Speaker 1: up an app and ethereum, so you should take payment
Speaker 1: in the currency of ethereum. But a persistently popular answer
Speaker 1: is you should take payment in your own currency. People
Speaker 1: who add value to your serve should be paid in
Speaker 1: your own special token. People who make use of the
Speaker 1: service should pay for it in that token, and then
Speaker 1: if the service takes off, the token might become more valuable.
Speaker 1: We'll discuss this idea in more detail later. For now,
Speaker 1: I'll just say that Ethereum has a standard for how
Speaker 1: these sorts of token should be implemented, and it's called
Speaker 1: e r C twenty. And when there are decentralized apps
Speaker 1: on the Ethereum blockchain, there's a good chance that they'll
Speaker 1: say they have an e r C twenty token. One
Speaker 1: essential property of an e r C twenty token is
Speaker 1: that it's fungible, like dollars or bitcoin or ether. If
Speaker 1: I create an e r C twenty token called matt
Speaker 1: coin and meant a billion matt coins, each of those
Speaker 1: billion tokens works exactly the same and is exactly interchangeable.
Speaker 1: They all trade at the same price, and nobody wants
Speaker 1: or gets any particular identified matt coin two e r
Speaker 1: C seven one. There's another way to do a token, though.
Speaker 1: You could have a series of tokens, each with a number.
Speaker 1: Token number one in this series is different from token
Speaker 1: number ninety nine in the sense that token number one
Speaker 1: has the number one and token number ninety has the
Speaker 1: number ninety nine. This is generally referred to as a
Speaker 1: non fungible token or n f T. The most popular
Speaker 1: Ethereum standard for n f T s is called e
Speaker 1: r C seven one, and you'll see that name sometimes.
Speaker 1: Let me quote a bit of the e r C standard.
Speaker 1: The e r C seven twenty one introduces a standard
Speaker 1: for n f T. In other words, this type of
Speaker 1: token is unique and can have different value than another
Speaker 1: token from the same smart contract. May be due to
Speaker 1: its age, rarity, or even something else like it's visual.
Speaker 1: Wait visual. Yes, All n f T s have a
Speaker 1: numerical variable called token i D. So for any e
Speaker 1: r C SE contract, the pair contract address numerical token
Speaker 1: i D must be globally unique. That said adapt can
Speaker 1: have a converter that uses the token i D as
Speaker 1: input and outputs an image of something cool like zombies, weapons, skills,
Speaker 1: or amazing kitties. Look how minimal this standard is despite
Speaker 1: the zombies and kitties. An n f T consists of
Speaker 1: a series of numbered tokens, and the thing that makes
Speaker 1: it an n f T is that it has a
Speaker 1: different number in its token i D field from the
Speaker 1: other tokens in its series. If you'd like to imagine
Speaker 1: that this different number makes it something cool like a
Speaker 1: zombie or a kittie, you can go right ahead. Or
Speaker 1: if there's a computer program or an ethereum DAP that
Speaker 1: looks at your number and says, right, this number corresponds
Speaker 1: to a zombie with green hair and a fetching scar
Speaker 1: on his right cheek. Then the computer program is free
Speaker 1: to say that and even serve you up a picture
Speaker 1: of that zombie, and you are free to believe it.
Speaker 1: We'll come back to this, it gets weird. Thank you
Speaker 1: Matt Levine, and thank you Mark Ledoff. As a reminder,
Speaker 1: if you're looking for these episodes in the Crypto Feed,
Speaker 1: will be publishing them every Sunday through December. If you'd
Speaker 1: like to read this issue in print form, you can
Speaker 1: head on over to Bloomberg dot com slash the Crypto story.
Speaker 1: This is Bloomberg Crypto, a daily podcast from Bloomberg and
Speaker 1: I Heart Radio. For more shows from I Heart Radio,
Speaker 1: visit the i Heart Radio app, Apple Podcasts, or wherever
Speaker 1: you get your podcast. Send us your comments, questions, or
Speaker 1: suggestions for the show to Crypto at Bloomberg dot net
Speaker 1: or find us on Twitter. We're at Crypto. The supervising
Speaker 1: producer of Bloomberg Crypto is Vicky Vergelina. Our senior producer
Speaker 1: is Janet babin Our producers are Mohammed Farup and Sharon Barriro.
Speaker 1: Our associate producers are Ty Butler and Moses on Them.
Speaker 1: Desta wonder At is our engineer. Original music by Leo Sidran.
Speaker 1: I'm Stacy Marie Shmall. We'll be back tomorrow. M