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The Only Crypto Story You Need, by Matt Levine

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CRYPTO CAN BE

PROFESSIONAL

Grayscale's crypto funds are supported

by best-in-class service providers.

Experience crypto differently with Grayscale

Businessweek Oct 25, 2022, 05:00 AM

The

Crypto

Story

Where it came from, what it all means, and why it still matters. By Matt Levine

⟳ Replay

Bloomberg

US Edition

Live Now Markets Economics Industries Technology Politics Wealth Pursuits Opinion Businessweek Equality Green CityLab Crypto More

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Part I

Ledgers, Bitcoin, Blockchains A. Life in Databases B. What If You Don’t Like It? C. Digital Cash

Part II

What Does It Mean? A. A Store of Value B. A Distributed Computer C. A Slow Database D. Web E. Uncensorable Ledgers F. Digital Scarcity

Part III

The Crypto Financial System A. Your Keys, Your Coins, Your Hard Drive in a Garbage Dump B. CeFi C. Stablecoins D. DeFi E. Reinventing 2008

Part IV

Trust, Money, Community A. Trust B. Money C. Community D. Finance

There was a moment not so long ago when I thought, “What if I’ve had this crypto thing all wrong?” I’m a doubting normie who, if I’m being honest, hasn’t always understood this alternate universe that’s been percolating and expanding for more than a decade now. If you’re a disciple, this new dimension is the future. If you’re a skeptic, this upside-down world is just a modern Ponzi scheme that’s going to end badly—and the recent “crypto winter” is evidence of its long-overdue ending. But crypto has dug itself into finance, into technology, and into our heads. And if crypto isn’t going away, we’d better attempt to understand it. Which is why we asked the finest finance writer around, Matt Levine of Bloomberg Opinion, to write a cover-to-cover issue of Bloomberg Businessweek, something a single author has done only one other time in the magazine’s 93-year history (“What Is Code?,” by Paul Ford). What follows is his brilliant explanation of what this maddening, often absurd, and always fascinating technology means, and where it might go. —Joel Weber, Editor, Bloomberg Businessweek

If you have money, what you have is an entry in your bank’s database saying how much money you have. If you have a share of stock, what you have is generally an entry on a list—kept by the company or, more likely, some central intermediary —of who owns stock.

1 These intermediaries include the Depository Trust & Clearing Corp., which owns most of the shares of most US companies on behalf of everyone else. If you own stock, what you have is an entry on DTCC’s list entitling you to some of the shares DTCC holds, and it has an entry on a company’s list of how many shares it owns.

If you own a house, things are slightly different. There’s a house involved. But your ownership of that house is probably written down in some database; in the US this often means there’s a record of you buying the house—your title—in a filing cabinet in the basement of some county clerk’s office. (It’s not a very good database.) In many ways the important thing here is the house: You have a key to the front door; your stuff is there; your neighbors will be unsurprised to see you leaving the house in the morning and would be surprised to see someone else coming back in. But in many other ways the important thing is the entry in the database. A bank will want to make sure you have the title before giving you a mortgage; a buyer will want to do the proper procedures to that record before paying you for the house. The key will not suffice.

Lots of other stuff. Much of modern life occurs online. It’s not quite true that your social life and your career and your reputation consist of entries in the databases of Meta Platforms and Google and Microsoft, but it’s not quite false, either.

Some of this stuff has to do with computers. It’s far more convenient for the money to be computer entries than sacks of gold or even paper bills.

MODERN LIFE CONSISTS IN LARGE PART OF ENTRIES INMODERN LIFE CONSISTS IN LARGE PART OF ENTRIES IN

DATABASES.

Some of it is deeper than that, though. What could it mean to own a house? One possibility is the state of nature: Owning a house means 1) you’re in the house, and 2) if someone else tries to move in, you’re bigger than them, so you can kick them out. But if they’re bigger than you, now they own the house.

Another possibility is what you might think of as a village. Owning a house means you live there and your neighbors all know you live there, and if someone else tries to move in, then you and your neighbors combined are bigger than them. Homeownership is mediated socially by a high-trust network of peers.

A third possibility is what you might think of as a government. Owning a house means the government thinks you own the house, and if someone else tries to move in, then the government will kick them out. Homeownership is mediated socially by a government. The database is a way for the government to keep track. You don’t have to trust any particular person; you have to trust the rule of law.

2 You don’t need to live there, because the government’s knowledge is sufficient. You can rent out the house: Someone else can move in with your permission. If you revoke the permission, you can go to the government, and it will—subject to landlord-tenant law, etc.—kick the person out.

Money is a bit like that, too. Sacks of gold are a fairly straightforward form of it, but they’re heavy. A system in which your trusted banker holds on to your sacks for you and writes you letters of credit, and you can draw on those letters at branches of the bank run by your banker’s cousin—that’s pretty good, though it relies on trust between you and the banker, as well as the banker and the banker’s cousin. A system of impersonal banking in which the tellers are strangers and you probably use an ATM anyway requires trust in the system, trust that the banks are constrained by government regulation or reputation or market forces and so will behave properly.

CRYPTO CAN BE

REGULATED.

PROFESSIONAL.

####### Experience crypto differently with Grayscale

Neighborhoods, where everybody knows your name.

But we don’t always trust them, and they’re not always trustworthy.

Sometimes they just aren’t. There are banks you can’t trust to hold your money for you and places where you can’t trust the rule of law to regulate them. There are governments you can’t trust not to seize your money from the banks, or falsify election results, or change the property registry and take your house. There are social media companies you can’t trust not to freeze your account arbitrarily. Most people in the US, most days, live in a high-trust world, where it’s easy and reasonable to trust that the intermediaries who run the databases that shape our lives will behave properly. But not everyone everywhere lives like that.

Even in the US, trust can be fragile. The 2008 financial crisis caused huge and lasting damage to a lot of people’s trust in the banking system. People trusted banks to do nice, safe, socially productive things, and it turned out they were doing wild, risky things that caused an economic crisis. After that it became harder for many people to trust banks to hold their savings.

Also, though, you might have a philosophical objection to trust. Even if your bank has an absolutely unblemished record of keeping track of your money, that might not be good enough for you. Your bank is, to you, a black box. “How do I know you’ll give me my money back?” you could ask the bank. And the bank will say things like “Here are our audited financial statements” and “We are regulated by the Federal Reserve and insured by the Federal Deposit Insurance Corp.” and “We have never not given back anyone’s money.” And you’ll say, “Yes, yes, that’s all fine, but how do I know?” You don’t. Trust is built into the system, a prerequisite. You might want proof.

3 This is probably a modern desire, or at least a desire that’s more intense and easier to satisfy in modern times. In a world without the internet, without Wikipedia, without links, without open-source software, etc., you had to take a million facts on faith every day; what were you going to do, look them all up?

CRYPTO CAN BE

PROFESSIONAL

Grayscale's crypto funds are supported

by best-in-class service providers.

Experience crypto differently with Grayscale

Can you name this bank? Doesn’t matter, it’s still a black box!

####### ii. Composability

Even if you’re generally cool with trusting the keepers of modern databases, you might have a more technical objection. These databases aren’t always very good. Lots of the banking system is written in a very old computer language called Cobol; in the US people still frequently make payments—electronic transfers between electronic databases of money—by writing paper checks and putting them in the mail. US stock trades take two business days to settle: If I buy stock from you on a Monday, you deliver the stock (and I pay you) on Wednesday. This isn’t because your broker has to put stock certificates in a sack and bring them over to my broker’s office, while my broker puts dollar bills in a sack and brings them over to your broker’s office, but because the actual process is a descendant of that. It’s slow and manual and sometimes gets messed up; lots of stock trades “fail.”

Subscribe and listen to “The Crypto Story” in parts, delivered every Sunday.

Don’t even get me started on the property registry. If you buy a house, you have to go to a ceremony—a “closing”—where a bunch of people with jobs like “title company lawyer” mutter incantations that let you own the house. It can take hours.

If your model of how a database should work comes from modern computers, the hours of incantations seem insane. “There should be an API,” you might think: There should be an application programming interface allowing each of these databases to interact with the others. If your bank is thinking about giving you a mortgage, it should be able to query the property database automatically and find out that you own your house, rather than send a lawyer to the county clerk’s office. And it shouldRegister to read more. Get Started

C. Digital Cash

In 2008, Satoshi Nakamoto published a method for everyone to run a database, thus inventing “crypto.”

Well, I’m not sure that’s what Satoshi thought he was doing. Most immediately he was inventing Bitcoin: A Peer-to-Peer Electronic Cash System, which is the title of his famous white paper.

What if there was one database, and everyone ran it?

Satoshi’s white paper.

What Satoshi said he’d invented was a sort of cash for internet transactions, “an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.” If I want to buy something from you for digital cash—Bitcoin—I just send you the Bitcoin and you send me the thing; no “trusted third party” such as a bank is involved.

When I put it like that, it sounds as if Satoshi invented a system in which I can send you Bitcoin and nobody else is involved. What he actually invented was a system in which lots of other people are involved.

Often it found worse ways, heading down dead ends that traditional finance tried decades ago, with hilarious results.

Often it hit on more or less the same solutions that traditional finance figured out, but with new names and new explanations. You can look at some crypto thing and figure out which traditional finance thing it replicates. If you do that, you can learn something about the crypto financial system—you can, for instance, make an informed guess about how the crypto thing might go wrong—but you can also learn something about the traditional financial system: The crypto replication gives you a new insight into the financial original.

Also, I have to say, as someone who writes about finance, I have a soft spot for stories of fraud and market manipulation and smart people putting one over on slightly less smart people. Often those stories are interesting and illuminating and, especially, funny. Crypto has a very high density of stories like that.

And so, now, I write a lot about crypto. Including quite a lot right here.

I need to give you some warnings. First, I don’t write about crypto as a deeply embedded crypto expert. I’m not a true believer. I didn’t own any crypto until I started working on this article; now I own roughly $ worth. I write about crypto as a person who enjoys human ingenuity and human folly and who finds a lot of both in crypto.

Conversely, I didn’t sit down and write 40,000 words to tell you that crypto is dumb and worthless and will now vanish without a trace. That would be an odd use of time. My goal here is not to convince you that crypto is building the future and that if you don’t get on board you’ll stay poor. My goal is to convince you that crypto is interesting, that it has foundRegister to read more. Get Started

some new things to say about some old problems, and that even when those things are wrong, they’re wrong in illuminating ways.

Also, I’m a finance person. It seems to me that, 14 years on, crypto has a pretty well-developed financial system, and I’m going to talk about it a fair bit, because it’s pretty well-developed and because I like finance.

Riveted: A crowd at a Bitcoin conference in Miami, April 2022.

A financial system is, well, a series of databases. It’s a way to shuffle around claims on tangible stuff; it’s an adjunct to the real world. A financial system is good if it makes it easier for farmers to grow food and families to own houses and businesses to make awesome computer games, if it helps to create and distribute abundance in real life. A financial system is bad if it trades abstract claims in ways that enrich the people doing the trading but don’t help anyone else.

I ... ehhh ... uh. A salient question in crypto, for the past 14 years, has been: What is it good for? If you ask for an example of a business that actually uses crypto, the answers you’ll get are mostly financial businesses: “Well, we built a really great exchange for trading crypto.” Cool, OK. Sometimes these answers are plausibly about creating or distributing abundance: “Crypto lets emigrants send remittances cheaply and quickly.” That’s good. Often they’re about efficient gambling. Gambling is fun, nothing against it. But a financial system that was purely about gambling would be kind of limited.

Meanwhile, crypto’s most ardent boosters say crypto is about building real, useful things. Crypto will redefine social relationships, and gaming, and computers. It will build the metaverse. Crypto is the vital component of the next leap in the internet; crypto will build “web3” to replace our current “web2.” Maybe? If you ask for an example of a business that actually uses crypto, you’ll get a ton of real, lucrative financial businesses, then some vague theoretical musings like “Well, maybe we could build a social media network on web3?”

It’s still early. Maybe someone will build a really good social media network on web3. Maybe in 10 years, crypto and blockchains and tokens will be central to everything that’s done on the internet, and the internet will be (even more than it is now) central to everything that’s done in human life, and the crypto early adopters will all be right and rich while the rest of us will have fun staying poor, and schoolchildren will say, “I can’t believe anyone ever doubted the importance of Dogecoin.”

I don’t want to discount that possibility, and I do want to speculate about it a little bit, maybe sketch a picture of what that might mean. I’m not going

BUT NO ONE SHOULD CAREBUT NO ONE SHOULD CARE THATTHAT MUCH ABOUT AMUCH ABOUT A

FINANCIAL SYSTEM SYSTEM.

A related point. Other than (maybe?) Satoshi, basically everyone involved in cryptocurrency is a hilariously outsize personality. It’s a good bet that if you read an article about crypto, it will feature wild characters. (One story in Bloomberg Businessweek last year mentioned “sending billions of perfectly good US dollars to the Inspector Gadget co-creator’s Bahamian bank in exchange for digital tokens conjured by the Mighty Ducks guy and run by executives who are targets of a US criminal investigation.”) Except this one! There won’t be a single exciting person in this whole story. My goal here is to explain crypto, so that when you read about a duck guy doing crypto you can understand what it is that he’s doing.

####### iii. Digression: The “crypto” in crypto

Cryptography is the study of secret messages, of coding and decoding. Most of what I talk about in this article won’t be about cryptography; it will be about, you know, Ponzis. But the base layer of crypto really is about cryptography, so it will be helpful to know a bit about it.

The basic thing that happens in cryptography is that you have an input (a number, a word, a string of text), and you run some function on it, and it produces a different number or word or whatever as an output. The function might be the Caesar cipher (shift each letter of a word by one or more spots in the alphabet, so “Caesar” becomes “Dbftbs”), or pig Latin (shift the first consonants of the word to the end and add “-ay,” so “Caesar” becomes “Aesar-say”), or something more complicated.

“Anyone Seen Tether’s Billions?” by Zeke Faux.

A useful property in a cryptographic function is that it be “one-way.” This means it’s easy to turn the input string into the output string, but hard to do it in reverse; it’s easy to compute the function in one direction but impossible in the other. (The classic example is that multiplying two large prime numbers is quite straightforward; factoring an enormous number into two large primes is hard.) The Caesar cipher is easy to apply and easy to reverse, but some forms of encoding are easy to apply and much more difficult to reverse. That makes them better for secret codes.

4 This has a more technical meaning than what I’m using here. What I call a one- way function in the text is, more strictly, a function that we hope is one-way, based on current understanding of computer technology and math and cryptography.

One example of this is a “hashing” function, which takes some input text and turns it into a long number of a fixed size. So I could run a hashing function on this article—a popular one is called SHA256, which was invented by the National Security Agency —and generate a long, incomprehensible number from it. (To make it more incomprehensible, it’s customary to write this number in hexadecimal, so that it will have the digits zero through 9 but also “a” through “f.”) I could send you the number and say, “I wrote an article and ran it through a SHA256 hashing algorithm, and this number was the result.” You’d have the number, but you wouldn’t be able to make heads or tails of it. In particular, you couldn’t plop it into a computer program and decode it, turning the hash back into this article.

5 If you want to try it for yourself, there are various SHA-256 calculators online; one is at Xorbin. Or if you want to program it yourself, or do some hashing with pencil and paper, there is a US government publication (FIPS PUB 180-4) that spells out the algorithm. (Or it’s on Wikipedia.)

The hashing function is one-way; the hash tells you nothing about the article, even if you know the hashing function. The hashing function basically shuffles the data in the article: It takes each letter of the article, represented as a binary number (a series of bits, 0s and 1s), and then shuffles around the 0s and 1s lots of times, mashing them together until they are all jumbled up and unrecognizable. The hashing function gives clear step-by-step instructions for how to shuffle the bits together, but they don’t work in reverse. It’s like stirring cream into coffee: easy to do, hard to undo.

6 A simple example: One way to mash data together is called an XOR function, for “exclusive or.” If you apply XOR to two bits (1 or 0), it returns 1 if one of those bits is a 1, and 0 if both or neither of them are. Say you ran XOR on the numbers 1100 and 0101, applying it first to the digits in the first position of each number (1 and 0), then to the digits in second position (1 and 1), and so on. It would return 1001. Knowing the inputs, it is easy to compute the output. But if you know the output is 1001, you don’t know the inputs: They could be 1100 and 0101, or 0011 and 1010, or 1001 and 0000, or 1111 and 0110, etc. If you take half of this article and

and I store that on my list. When you try to log in, you type your password, and I hash it again, and if it matches the hash on my list, I let you in. If someone steals the list, they can’t decode your password from the hash, so they can’t log in to the system.

9 It’s beyond the scope here, but there’s a lot more cryptographic fun—“rainbow tables,” “salt,” etc.—involved in defeating or strengthening this sort of security.

There are other, more crypto-nerdy uses for hashing. One is a sort of time stamping. Let’s say you predict some future event, and you want to get credit when it does happen. But you don’t want to just go on Twitter now and say, “I predict that the Jets will win the Super Bowl in 2024,” to avoid being embarrassed or influencing the outcome or whatever. One thing you could do is write “the Jets will win the Super Bowl in 2024” on a piece of paper, put it in an envelope, seal the envelope, and ask me to keep it until the 2024 Super Bowl, after which you’ll tell me either to open the envelope or burn it. But this requires you and everyone else to trust me.

Another, trustless thing you could do is type “the Jets will win the Super Bowl in 2024” into a cryptographic hash generator, and it will spit out:

64b70b0494580b278d7f1f551d482a3fb952a4b018b43090ffeb87b662d

and then you can tweet,

Not a real tweet! But you can follow me on Twitter at @matt_levine. Everyone will say, “Well, aren’t you annoying,” but they won’t be able to decode your prediction. And then in a while, when the Jets win the Super Bowl, you can say, “See, I called it!” You retweet the hashed tweet and the plain text of your prediction. If anyone is so inclined, they can go to a hash calculator and check that the hash really matches your prediction. Then all the glory will accrue to you.

Aside from hashing, another important one-way function is public-key encryption. I have two numbers, called a “public key” and a “private key.” These numbers are long and random-looking, but they’re related to each other: Using a publicly available algorithm, one number can be used to lock a message, and the other can unlock it. The two-key system solves a classic problem with codes: If the key I use to encrypt a message is the same one you’ll need to decode it, at some point I’ll have to have sent you that key. Anyone who steals the key in transit can read our messages.

With public-key encryption, no one needs to share the secret key. The public key is public: I can send it to everyone, post it on my Twitter feed, whatever. The private key is private, and I don’t give it to anyone. You want to send me a secret message. You write the message and run it through the encryption algorithm, which uses 1) the message and 2) my public key (which you have) to generate an encrypted message that you send to me. Then I run the message through a decryption program that uses 1) the encrypted message and 2) my private key (which only I have) to generate the original message, which I can read. You can encrypt the message using my public key, but nobody can decrypt it using the public key. Only I can decrypt it using my private key. (The function is one-way as far as you’re concerned, but I can reverse it with my private key.)

A related idea is a “digital signature.” Again, I have a public key and a private key. My public key is posted in my Twitter bio. I want to send you a message, and I want you to know that I wrote it. I run the message through an encryption program that uses 1) the message and 2) my private key. Then I send you 1) the original message and 2) the encrypted message.

You use a decryption program that uses 1) the encrypted message and 2) my public key to decrypt the message. The decrypted message matches the original message. This proves to you that I encrypted the message. So you know that I wrote it. I could’ve just sent you a Twitter DM instead, but this is more cryptographic.

Imagine a simple banking system in which bank accounts are public: There’s a public list of accounts, and each one has a (public) balance and public key. I say to you: “I control account No. 00123456789, which has $250 in it, and I’m going to send you $50.” I send you a digitally signed message saying “here’s $50,” and you decode that message using the public key for the account, and then you know that I do in fact control that account and everything checks out. That’s the basic idea at the heart of Bitcoin, though there are also more complicated ideas.

CRYPTO CAN BE

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