This week, Tesla announced it purchased $1.5 billion of the cryptocurrency Bitcoin. The company even hinted that customers might soon have the option to pay for their cars with Bitcoin. Welcome to 2021, where nothing makes sense anymore.
Tesla's desire to legitimize both cryptocurrency and blockchain with its Bitcoin investment has brought these technologies into the forefront of the news and has sparked a mainstream interest. However, cryptocurrency and blockchain are often confused, and they can also be challenging concepts to understand.
is the foundational technology used by various cryptocurrencies such as Bitcoin and Dogecoin.
In its simplest form, Blockchain is a database. With a traditional database, information is stored in fields, organized into rows and columns, and indexed for fast retrieval. Those fields can be things like name, address, phone number, and also pointers to "blob" data like multimedia files -- videos, images, waveform audio, that sort of stuff. We call these collections of rows and columns "tables." The structure of these tables and the relationships between them are referred to as a database schema.
Fields can be updated in traditional databases as they are changed. For example, when you use Facebook or Instagram and add new tags, mark the location, or reply to someone's comment, you're interacting with a traditional database.
With blockchain, data is organized in a completely different way. Information is collected in groups or blocks, and any data that follows the first block is compiled into a newly formed block added to that chain. So the information is sequential and continues to build on each other.
It's important to note that this blockchain structure creates an irreversible data timeline when it is decentralized. Every block of data is fingerprinted with this timeline and cannot be changed; it has an exact timestamp when added to the timeline.
Most blockchain systems are decentralized -- that is, the computers that process the transactions are distributed worldwide. A transaction is entered somewhere on a client computer connected to the blockchain. This transaction is then transmitted to the network of connected peer-to-peer systems -- aka nodes -- that collectively solve a series of equations to validate the transaction. That's where the "crypto" aspect comes into play.
A blockchain can have as few as a dozen nodes on a network to as many as 10,000 nodes (as Bitcoin has) or, potentially, even more. Once that transaction is confirmed to be legitimate, they are then clustered into blocks. Once the blocks are created, they are chained together with the history of all the other transactions on the blockchain, and the transaction is complete.
So what is Blockchain good for besides cryptocurrency?
In summary, a blockchain-based system's objective is to allow digital information to be recorded and distributed but not edited. This has applications in many industries. Companies are already using this technology to perform supply chain tracing of stuff like seafood.
For example, when a scallop fisher catches their haul on a fishing trawler off of Cape Cod, that catch's location is recorded in the initial blockchain transaction. The fisher uses a grading process to record the type of scallop, takes a photograph and video, and puts the catch in cold storage. The seafood is brought to a port, processed and packaged, then shipped out to a distributor's refrigerated warehouse. From there, boxes of scallops are loaded onto trucks and sent to your local supermarket chain's distribution center. Next, the seafood is trucked to your local supermarket -- where the fishmonger takes the scallops out of the crate and puts them up for sale in the refrigerator or freezer case.
If anything goes wrong with the scallops, or if you, the consumer, want to know where those scallops came from, that scallop package has a serial number and can be traced back to the moment it came out of the water in Cape Cod. IBM built a system for precisely this purpose. And companies like Walmart are using it for produce tracking, such as for leafy greens like lettuces and spinach. Consider how important this is: We've seen those kinds of vegetables become contaminated with E.coli and other pathogens. The blockchain system enables anyone in the chain to track down which field in which farm in California a particular bag of green stuff comes from.
Whenever you need a timestamped transaction record that cannot be altered, and for supply chain traceability, this technology will be essential. There's already talk about using this technology for COVID-19 vaccine passports.
As with scallops, so with vaccines.
When a vaccine is manufactured at a pharmaceutical plant, the specific manufacturing run is recorded as a batch. The batch is dispensed into vials (each vial has a serial number), which goes into a box (each box has a lot number). That box is then loaded onto trucks, which may go to a pharmaceutical distributor and then is shipped to a hospital network, which opens those boxes, opens a vial, and finally distributes doses to patients.
Each timestamped dose can then be recorded in the patient's record: Which vaccine they received and when and where they received it. And that record cannot be altered because of the encrypted transactional nature of how blockchain works.
Blockchain technologies can be applied to insurance, mortgages, and even voting systems -- anywhere you need that end-to-end record of something and multiple parties are involved.
When blockchains are used in this trust establishment way -- where more than one party may have to authenticate the blocks before something else can happen -- these are referred to as Smart Ledgers or Distributed Ledgers. And several highly regulated industries are already looking into blockchain for this sort of application.
What is cryptocurrency anyway?
Ok, but first, what the heck is money? Money has been an abstract construct throughout human history; it was created to exchange goods and services. Typically, money has value because it is exchanged for something of value, and the value of that item depends on the overall demand for that item.
At a basic level, the monetary value of, say, what someone does for a living is valued against what someone else does for a living based on demand and scarcity. It is commonly accepted that a ditch digger gets paid less than a doctor because of the value of the education the doctor achieved and invested in. Similarly, a one-kilogram lobster costs more than a kilogram of rice because of the effort and resources that it took to produce and harvest those things on a relative basis.
In previous decades, a nation's money or currency was backed by precious metals -- such as gold, but that's no longer common practice. A country's output in goods and services is traded with other countries' goods and services, and their currencies are valued on the open market using currency exchanges. The value of a nation's currency is determined by fiat, which is derived from the relationship between supply and demand and the government's stability that issues it.
That all sounds hugely existential, and it becomes an intense conversation when you start to explore monetary systems and capitalist theory and things like that.
But cryptocurrency, as it exists today, does not have a value based on fiat -- it is based on the computational power of the network that produces it, so it is independent of nation-states. Cryptocurrency systems use blockchain to establish the indelible record that each fractional unit of currency exists, that they are unique, and cannot be altered after they are created.
The dark side of cryptocurrency
This process of creating something out of effectively nothing -- other than a large group of computers churning processor cycles -- is called mining. Mining is achieved by running a special program on a client computer. It runs through a series of complex equations until the result yields a block recorded as a fractional unit of that cryptocurrency.
Typically, a single mining node dedicated to cryptocurrency production is a modest x86 PC CPU with one or more high-end GPUs for accelerating the compute processes. Entities that are highly-invested in this endeavor have set up "mining farms" where dozens or even hundreds of computers dedicate their processing cycles to produce cryptocurrency like Bitcoin.
Naturally, it takes a lot of power and cooling to generate cryptocurrency, and the energy required to do this requires fuel. The world is still primarily reliant on fossil fuel power generation. So it's not a particularly green way of creating things of value.
Although considered a very environmentally wasteful act of using computational resources, using and mining cryptocurrency is completely legal in most countries -- Algeria, Egypt, Morocco, Bolivia, Ecuador, Nepal, and Pakistan have outlawed it because it potentially threatens their fiat currency.
However, while completely legal in the majority of nations, it's no coincidence that cryptocurrency mining farms have proliferated in parts of the world where a large number of cybercrime's bad actors reside, such as in China, North Korea, Russia, the Middle East, and Eastern Europe. We have seen miner programs being used by actors from these countries as secondary malware payloads, so your computer could end up running one in the background as a virus, and you might not even know it.
Your mom's $300 PC she bought at Costco may not be a $3000 crypto box with multiple GPUs that can chew out Bitcoins or Ethereum at a significant pace. Still, a bad actor who infects 10,000 of those mom PCs can generate many crypto coins.
Additionally, entities with significant computational resources -- be it a nation-state or a bad actor -- can potentially mine an awful lot of cryptocurrency. And they can become disproportionally large players on a cryptocurrency network and potentially control that network for short periods by preventing new transactions from getting confirmations and, in turn, halting payments between some or all users. They might also be able to reverse transactions completed while they control these networks, meaning they could double-spend the coins.
Fortunately, controls are built into these networks that prevent these so-called 51 percent attacks, where malicious actors with large amounts of computational power can temporarily control a cryptocurrency network.
Why does Elon Musk care so much about cryptocurrency?
As a company, Tesla is only profitable because a significant portion of its income comes from selling Renewable Energy Credits (RECs). If its income were solely based on automobiles and solar panels' production, the company would be posting hundreds of millions of dollars in losses per quarter.
Tesla can sell these credits because, in 13 states, any auto manufacturer that wants to sell their cars in that state must also sell a certain amount of electric or zero-emission vehicles (ZEVs). If you sell enough electric cars, you get a credit with that state. If an automaker doesn't sell ZEVs or doesn't sell enough of them, it has to buy them from someone with that credit to make up the carbon deficit and sell cars in that state.
Since Tesla sells a lot of electric cars, or rather, only electric vehicles, it has no reason to keep those credits; it can sell them to other automakers. These credits also expire, so it's in Tesla's best interest to unload them. With the sale of their surplus carbon credits, Tesla made about $428M in the second quarter of 2020 alone, beating their first-quarter sales of credits of $354M.
Eventually, automakers like GM, Volkswagen, and Nissan will all be producing lots of electric cars and meeting their carbon credit quotas, which means that Tesla will need to find other ways of making money. It will need to sell more cars and more solar panels (which they could also use, presumably, to mine cryptocurrency in large farms).
Other than using their vehicles and technology to directly generate income -- such as by creating an autonomous rideshare service, selling more of their batteries to third parties, or massively scaling out their solar roof production and becoming the market leader in that space -- Tesla will need other sources of revenue when the carbon credit game evaporates.
Expanding the way people can pay for cars (and presumably, their panels and their batteries) is critical for Tesla to stay afloat financially. And people want to have avenues to spend that Bitcoin or Dogecoin or Ethereum or whatever. Today, cryptocurrency is not unlike Amex points or airline travel credits -- it exists and circulates within its own limited ecosystems; moving it out of those ecosystems to convert it into cash or use it as a direct method of payment is difficult.
So being the car or tech manufacturer for cryptocurrency millionaires today gives them an edge, potentially a lifeline to staying profitable in the longer-term, when everyone with some crypto cash can use this new form of money as a down payment on a car or a solar array.
Does cryptocurrency have value, and can it be legitimized?
Tesla's challenge is this: A currency only has value if it can be spent. Large investment banks like UBS are saying that Bitcoin and other cryptocurrencies don't have intrinsic value. It isn't legal tender like fiat currency issued by a nation-state. These banks characterize it as an underworld, sketchy thing with which they don't want to be associated. Analysts at UBS also believe that the nature of cryptocurrency always having a fixed supply -- meaning that currency supply cannot be restricted as a nation-state would do if the demand for a currency goes down, as with real money --- is a severe economic flaw and could eventually cause the entire system to collapse.
Fiat currencies have value because nation-states say they have value and agree to exchange their value with other nation-states. Likewise, there are cryptocurrency exchanges that allow for converting one's holdings into cash, such as Coinbase and Kraken. For many, cryptocurrency investment is a long game, a gamble on the belief that they will eventually be intense competition for fiat currency or commodities like precious metals.
There is also the issue of the currency's seedy reputation, which has arisen from the type of black market goods -- drugs, guns, and even financing North Korean nuclear weapons programs, for example -- for which it's become convenient tender because it's an anonymous and utterly untraceable way of exchanging something that has intrinsic value. And with any emerging technology, some aggressive players want to get in early and control it with offensive use of patents in the blockchain and cryptocurrency space.
There's some hope on the horizon, though. Square, one of the leaders in merchant services aggregation and mobile payments, has founded COPA, a cryptocurrency patent alliance, to ensure that the ecosystem remains vibrant and open for developers and companies investing in the industry. Square has also invested $50M in Bitcoin because it believes it is an economic empowerment instrument and allows individuals and small businesses to participate in a global monetary system. Square is led by Twitter CEO Jack Dorsey, a huge fan of cryptocurrency and Bitcoin who recently set up his own Bitcoin node. And while it has not done so yet, Twitter's own CFO has suggested that the company may soon add Bitcoin to its balance sheet, as well.
Despite large investment banks like UBS stating that cryptocurrencies aren't good portfolio investment strategies for their clients, some large institutions are starting to get in on the cryptocurrency act. On February 10, Mastercard Inc., one of the largest financial services players, and Bank of New York Mellon Corp, one of the largest banks, announced they would make it easier for their customers to use cryptocurrencies. Mastercard will focus its support on the so-called "stable coins" tied to the value of other assets, such as the US dollar. In contrast, the Bank of New York said that it would transfer and issue Bitcoin and other cryptocurrencies for institutional customers.
As of this writing, few businesses accept cryptocurrency as a direct form of payment. For now, companies like Tesla are on the fringe, and unless we see lots of companies accept Bitcoin and other cryptos as a payment method, the company is essentially on its own here. But with Elon Musk's stake in the ground, we may see other companies -- particularly makers of luxury goods that are in lesser demand during this pandemic-hampered global economy -- begin to accept crypto as payment and help to legitimize it as actual money.