Bitcoin and other crypto assets: what are they really?

In our fifth article serialising ANDREW CRAIG’s book How to Own the World: A Plain English Guide to Thinking Globally and Investing Wisely, Andrew demystifies bitcoin, crypto assets, and blockchain.

Andrew has worked in the City of London for over 20 years. In 2011, he founded plainenglishfinance.co.uk, a personal finance website that aims to help people to improve their finances.

Perhaps the best “plain English” description of what bitcoin, crypto assets and blockchain actually are that I have seen is that they are a technology that enables triple-entry bookkeeping (or accounting). To explain: for most of human history, humans were hunter-gatherers and any trade that did occur took place under a barter system. As a result, trade was pretty limited, and humans didn’t really make any forward progress in terms of becoming wealthier or more technologically sophisticated for tens, arguably even hundreds, of thousands of years.

Then, a few thousand years ago, some smart folk in what is modern-day Iraq (the Sumerians, as it happens) invented a transformational technology: something called single-entry bookkeeping (or single-entry accounting – the terms are basically interchangeable). This simply meant that they figured out how to write down that person X owned something and/or that person X owed person Y something.

Archaeologists have found clay tablets dating back to several thousand years BCE which recorded the fact that a certain individual owned a certain quantity of an agricultural crop. Although this may not seem like much of a breakthrough, it was actually completely transformational for humanity and for our ability to grow economically and technologically.

As the website Hacker Noon has put it:

“Once you can keep track of who owns what, trading starts to happen at a much larger scale. That’s why the kings and queens of ancient times could build castles and establish professional armies and create great wonders of the world …”

The problem with single-entry bookkeeping was that you had to trust the person who was keeping score. Any unscrupulous scribe in a position of power could very easily alter the record to enrich his friends or family at the expense of the rightful owner of any given property. If the lesson of history is to be believed, this is very often precisely what happened – leading to a great deal of strife and bloodshed.

Fast-forward a few centuries and we find that various human cultures had upgraded this single-entry accounting system to a version 2.0: logically enough, we call this double-entry bookkeeping. Double-entry bookkeeping is the foundation of modern accounting and, without exaggeration, modern civilisation. There would be no nation states, no large buildings, bridges, roads, cars, planes, boats, drugs or supermarkets had humans not invented the fundamental technology of double-entry accounting. (Think about this next time you describe accountants or accounting as ‘boring’. Actually, none of the most important or fun things in life would exist without them or it – truly.)

The way double accounting works is pretty obvious to us twenty-first-century geniuses, not least because we have the benefit of hindsight. In essence, rather than some arbitrary class of aristocratic scribe or record keeper being in charge of keeping a record of everyone’s wealth, there were now two records kept – credit and debit or asset and liability. Crucially, these records were also now invariably kept by an independent third party who could mediate between creditor and debtor and ensure that both sides fulfilled their obligations. The independent third party has been through various guises since the system was invented (think of the moneylender Shylock in Shakespeare’s Merchant of Venice as one example), but the two main institutions that underpin any double-entry system are governments/nation states (and, by extension, their militaries – a point we will come back to) and banks.

Enter triple-entry bookkeeping

The double-entry system has underpinned virtually all human development since roughly the Middle Ages. With the arrival of bitcoin in 2009 we may have moved into an era of triple-entry bookkeeping – the point being that the technology behind bitcoin embeds the ‘trusted third party’/intermediary element of the double-entry system (the bank or government) within the technology itself. It does this by encoding the necessary information in a distributed ledger called the “blockchain”.

The “ledger” incorporates a record of every transaction that has taken place, and the fact that it is “distributed” (i.e. doesn’t sit in one place but is essentially in little pieces of code in thousands of places all over the world) theoretically make the system robust. The security and trust elements to do all of this are enabled by advanced cryptography (writing and solving complex codes) – which is why bitcoin is described as a “cryptocurrency”.

As you might imagine, the ability to remove banks and governments from financial (and other) transactions is potentially highly transformational, arguably even revolutionary in scope. Given this fact and given the vested interests involved, the arrival of cryptocurrency and blockchain has been met with a very wide range of reactions depending on the audience in question. Unsurprisingly, futurologists and techno-anarchists are delighted and see the emerging technology as a catalyst for a bright future where the power of nation states is severely limited and handed back to “the people”. Governments, central banks and the banking establishment are less sure, not least given how useful such technologies are to criminals and “rogue states” – another key consideration in the debate.

The primary question to answer in this section of the book, as far as I’m concerned, is whether or not I include bitcoin and/or crypto assets more generally as one of those major asset classes alongside shares, bonds, cash, commodities and property as part of an “own the world” approach to investment. The simple answer, as far as I’m concerned, is yes – but with meaningful reservations.

My belief is that any money you allocate to it should be thought of just as you might think about investing in one single risky share or similarly speculative investment and not as a core pillar of owning the world. In practice, this means that you might consider investing 1, 3 or – at the maximum – 5 per cent of your wealth into the space.

Bitcoin or bitcon?

My reason for this stance is quite simple: while it is certainly a fascinating and explosive emerging market and technology, the whole area reminds me of the dot-com boom of the late 1990s when I saw at first hand precisely the same thing that I have seen in the last year or so with crypto assets – huge press exposure, a massive frenzy of interest, and a whole slew of people who have never invested before in financial products of any kind being sucked into the space in the hope of getting rich quickly.

When the same thing happened in the dot-com boom of the late 1990s, the vast majority of people lost a great deal of money and it was a tragic thing to watch. Without wanting to be excessively gloomy, I think it is worth explicitly acknowledging that when people lose their entire life savings or are declared bankrupt, it can and does have exceptionally serious and unpleasant ramifications for them and for their families. This is serious stuff. For every resilient individual who is able to shrug their shoulders, dust themselves down and look to rebuild their now decimated finances from scratch again, there are people whose lives are destroyed and, in some cases, even lost (there were several thousand additional suicides on both sides of the Atlantic following the dot-com crash of 1999/2000 and the financial crisis of 2008/9 – this should not be forgotten).

The trouble with the current maelstrom of interest in crypto for me is that it is just like the dot-com boom of nearly 20 years ago but almost certainly considerably worse.