So many of you replied to my last email asking for an explanation of Bitcoin, cryptocurrency, and non-fungible tokens (NFT) that I thought I would send my explanation to everyone. There is no politics here, just an explanation of how a certain technology (blockchain) works. More politics to come on Sunday.
Shortly after I sent Sunday’s email mentioning NFTs and decentralized finance, Jack Dorsey (founder of Twitter) announced that he is selling his very first tweet ever as an NFT. The current high bid is $2.5 million. All of which begs the question: what is an NFT? What does it have to do with Bitcoin? What the hell is going on?
The essential problem is that everything “digital” — everything on our screens, on our phones, on all our devices — get reduced down to just electricity or no electricity. That’s the only thing machines understand: is there power, or not? My emails, text messages, Zooms, Facetimes, Youtubes, Netflix… all of it gets broken down into tiny pulses of electricity. So to make a copy of something, all you have to do is have the exact same series of pulses of electricity.
This creates a challenge. If I have a twenty-dollar bill, no one else can have that twenty-dollar bill. You could photocopy it with a color copier, but the Treasury goes through great lengths to make that not work. The money doesn’t physically feel the same. So my $20 is my $20. This becomes a real issue when we translate that money into pulses of electricity. It gets hard to figure out who owns it and how to keep it from being copied. We’ve grafted our giant financial institutions designed to keep gold and paper safe onto the digital world, and there are a whole bunch of reasons that’s a bad idea and not working well. (Foremost among them: it will eventually be too expensive from a security standpoint.)
This is true of art as well. I take a photo and post it on Instagram. I also sell a limited edition physical print for $1,000. But you can just go to Instagram, download the photo and get a gorgeous print of it at Kinkos for $20, and skip paying me $1,000.
Blockchain is a technology designed to solve the problem of how easy it is to duplicate digital things, and therefore it creates scarcity. Bitcoin is a kind of blockchain that is money. Other kinds of blockchain are used for signing contracts or creating NFTs for art (explained below). You can trade dollars for Bitcoin, just like you can trade dollars for euros or yen. There are market exchanges for Bitcoin and other cryptocurrencies (the most reputable is Coinbase) where you can use your US dollars to buy all manner of strange digital currency.
First, a caveat: a purist might dispute some of my characterizations. But it pretty much works like this:
Over the weekend, I was trying to teach my daughter JJ some math. She has exhibited a phobia of numbers, but she is also a chocoholic. I made it a game: every time you solve the math equation, you get a piece of chocolate. We started with 1+1=2.
But every time she correctly solved the equation, I changed it and made it a little harder by adding the previous sum to the front of the new equation: 2+1+1=4.
Soon my son Tom wanted to join in. (The chocolate attracts them like bears to honey, and apt metaphor has given them ferocity.) But now, every time my daughter solved an equation, she had to break off a little piece of her chocolate and give it to her brother Tom for safe-keeping. And every time he correctly solved an equation, he had to give her a little piece of his chocolate for safekeeping. This was an explicit exercise in building sibling trust (something we’re working on in this household).
I kept track of all the pieces of chocolate on a piece of paper: how many pieces Tom had, how many JJ had, how many pieces of JJ’s chocolate Tom was keeping safe, how many pieces of JJ’s chocolate Tom was keeping safe. All the while, the equation got progressively harder, with Tom and JJ taking turns solving it.
My oldest son Asa saw what we were doing and wanted in. (Did I mention the chocolate?) Every time he solved an equation and got a piece of chocolate, he had to break off two little pieces and give them to his two siblings for safekeeping. I added a column to my paper to track who has what chocolate. My paper is the chocolate “ledger.”
When we’re done with math-chocolate time for the day, there is a major sibling dispute. JJ is convinced that Asa will sneak into my office and change the ledger to make it look like he owns more chocolate than her, a situation not without precedent. As a solution, I tear up the ledger into several pieces and share different pieces of it with each kid. If they want to recover their “safekeeping” chocolate from their siblings, they have to come together, re-assemble the pieces of the ledger, and then they can collect the chocolate their siblings are keeping safe for them. They can also trade chocolate with each other for chores or what have you. But if they changed the ledger, they would have to tear it up again and distribute it for safekeeping.
This is exactly how blockchain works. There is an equation. It is a vastly more complicated equation than 1+1=2. Every time the equation gets solved, it gets a little harder to solve. The equations are so hard to solve that only computers can solve them; humans can’t. Every time a computer solves an equation, it gets a “little piece of chocolate” — what we nerds call a “hash.” A hash looks something like this: “ZjQpmGgdq2w!q*3pa3RwDzd@”
As more computers start solving the equation, they have to start giving parts of the hash to each other for safekeeping (even if they don’t want to). If you own a single Bitcoin (or even a tiny portion of a Bitcoin), you get the “owner” hash, but thousands (sometimes millions) of computers keep part of the “safekeeping” hash. And your computer reciprocates, storing tiny bits of other people’s “safekeeping” hash for their Bitcoin.
The interesting piece is the ledger. The ledger is packaged up as part of the hash and is distributed across millions of computers. This is called the “distributed ledger,” and it is the heart of blockchain’s innovation. With the ledger distributed across millions of computers, no single person or entity can control it. And it is virtually impossible to hack — you’d need millions of computers to hack it. Anyone can see the ledger at any time, although the human identities of who owns the pieces of hash are unknowable.
Years ago, I set up my laptop to solve the Bitcoin equation, so I could have a Bitcoin or two. To do this, I downloaded an app that was designed to solve the equation and produce a Bitcoin hash. Today, the equation is so hard to solve that you need a huge computer — or really multiple computers connected to each other — to solve the equation; consumer laptops don’t have the processing power to do the math that complicated. But eight years ago, the equation was still simple enough that I could run the Bitcoin mining app on my computer while I answered email. I remember it took three days to solve the equation the first time; five days the second time, and within a couple of weeks, it would slow everything down on my computer to solve it. I thought about buying a separate computer to just “mine” Bitcoin (mining is what we call solving the equation), but that seemed pretty expensive, and Bitcoin wasn’t worth much. I tried to imagine explaining to my wife why I wanted to spend a couple of thousand dollars on a computer to “mine” virtual currency worth $10… not going to fly.
Instead, I went online and bought some Bitcoin in a public market. Now, I had a bunch of “chocolate” — hashes. I kept them in a bulleted list in a Microsoft Word document, my dozen or so “bitcoins.” It looked like this:
Coin 1: 9Q39nWijbgg_mqrG8M.zAtnv
Coin 2: oAX8_hkBU7TaG.XDJh3Q!84-
Coin 3: 4kCXjUmpsVmY-t8*c_GKy8Xo
and so on.
For a random project, I hired a computer programmer in Finland to do some coding work. He charged me $10,000 but wanted a deposit to start work right away. It was going to take a couple of days to wire the money, and the bank was going to have fees, and there was the exchange rate… he asked if I used Bitcoin. I said yes. I emailed him some of my “bitcoins” — just an email with a hash in it: sFUDmpU@KmN9XA9r*yfJ9zoX — and boom, he was paid his deposit like that.
How come I can’t keep the hash and re-use it, duplicating the money? Well, the answer is a bit complicated, but basically, you can’t — the hash unlocks all the ‘safekeeping’ bits stored in other computers all over the world and generates a new hash. As soon as someone sends me a hash, I use it to generate a new hash, and the old hash doesn’t work. [Sort of this is where an expert would want to really get into the weeds, but my explanation is close enough.]
When discussing blockchain as currency, economists get hung up on value. The Federal Reserve guarantees the integrity of the dollar, what guarantees the integrity of Bitcoin? Well, the math does. As the equation gets harder to solve, the supply of Bitcoin slows down. Curiously, as the value of Bitcoin goes up, you can buy tiny fractions of Bitcoin. Right now, you can buy just 0.0000000000001 of a Bitcoin… or even less if you want to.
The nature of the distributed public ledger brings integrity to digital transactions. This is why I think some version of blockchain will replace signing contracts digitally. (Forget DocuSign.)
Now let’s return to Jack Dorsey selling his first tweet for $2.5 million as an NFT (non-fungible token). NFTs are a form of blockchain, a “coin” that only you can own. This coin or token is just a hash that proves the image or video, or digital asset belongs to you and no one else.
Nifty Gateway is the Sotheby of digital art. Let’s say you see this video — currently for sale for $2,690 — and decide you want to own it. You buy the video, and you get the hash that proves you own it. Other people can copy the video — anyone can just download it from the website and play it on their television. But you’re the only one who owns the art. You’ve got the hash, the token, the coin. A hundred thousand people could make the video their screensaver, but only you have the hash — the NFT — that proves you “own” it. If ten years from now the artist is incredibly sought after, you could sell your token at a digital art auction for a lot more than $2,690. There’s no accounting for taste.
Special thanks to loyal readers Karim Sahyoun and Eric Anderson for their feedback on this piece.
Talk to you Sunday — nicco