S3E4: Cryptocurrency 101: Entering the Crypto World

S3E4: Cryptocurrency 101: Entering the Crypto World

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Professor David Yermack of NYU Stern School of Business brings us into the world of crypto and covers a 101 mini class on the world of cryptocurrency, the history, the background, the idea of blockchain, and so much more. Dr. Yermack helps make the sometimes intimidating, occasionally scary, and regularly confusing world of crypto easier to grasp and more accessible, whether you're coming into this as a complete beginner, or as somebody who may have some background on the topic. Dr. Yermack's 101 mini class with YWYM will get you ready for your next investment, or your next "light" dinner conversation.

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ABOUT THE SPEAKER

DAVID YERMACK is the Albert Fingerhut Professor of Finance and Business Transformation and Chairman of the Finance Department at New York University’s Stern School of Business, where he has been a member of the faculty since 1994.

 

In 2014 Prof. Yermack began teaching a full semester course at NYU on Digital Currency and Blockchains with his Law School colleague Prof. Geoffrey Miller.  The course was the first in the world on this topic taught at a major university, and it now draws more than 300 students annually.

 

Professor Yermack was awarded AB (1995), MBA (1991), JD (1991), AM (1993) and PhD (1994) degrees, all from Harvard University.  In addition to his research on blockchains and digital currencies, Professor Yermack has published some of the most cited papers in the fields of executive compensation and corporate governance.  He has also written papers on such diverse topics as options in baseball player contracts, incentive compensation for clergymen, tobacco litigation, fraudulent charitable contributions, CEOs’ mansions, and the fashion industry.  He is a frequent speaker on digital currency and blockchains to academic, industry, and government audiences.

Download the episode's key takeaways here.

This episode was produced by Global Thinking Foundation USA and Hangar Studios.

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Read more about Professor Yermack and his works here

View Transcript

[00:00:00] Nolan: Welcome back to the podcast. This is your host, Nolan. I'm really glad you could join us today. As we launch into a brand-new series, exploring the topic of cryptocurrencies. To me, the world of crypto has always been a little confusing. I've heard a lot over the years about what a game-changing technology this may be, driven by innovations like decentralized blockchain tech and, well, other jargon like that. It's always been a bit of a mystery to me, how to understand the increasingly astronomical price of Bitcoin and put it into the proper context of exactly what this technology is, who is using it, and how this all plays out.

 

[00:00:37] Nolan: So, whether you're coming into this as a complete beginner into the world of cryptocurrency, or as somebody who may have some background on the topic, I think this conversation offers a lot to everyone. I'm going to be talking to Professor David Yermack of the NYU Stern School of Business, and there's literally no one I'd be more excited about to introduce this topic for us.

 

[00:00:57] Nolan: Professor Yermack has been writing about cryptocurrencies since the Dawn of Bitcoin and teaches a fabulous course on the topic at Stern. He brings a wealth of knowledge on economics and finance that helpfully contextualize everything that's happening in the world of crypto, from the development and politics of the technology. And well, even the theory of money itself. I hope you enjoy the conversation and learn as much as I did.

 

[00:01:23] Mary, Nolan, Laquita Ann: Hi, I'm Mary. I'm Nolan. I'm Laquita Ann. We are your hosts, and this is 'Your world, Your Money.' We will be talking real money, with real people, in a real way. Because everyone deserves the opportunity and tools for freedom, financial or otherwise. 'Your World, Your Money' is brought to you by Hangar Studios, a New York city based recording studio, and Global Thinking Foundation, a global nonprofit working toward financial freedom and equality.

 

[00:02:09] Nolan: All right, welcome Professor David Yermack. Thank you so much for joining the podcast today. I'm so excited to be able to chat with you.

 

[00:02:16] David: Well, thank you for inviting me on.

 

[00:02:19] Nolan: So, let's get into it. When you introduce the idea of blockchain and cryptocurrencies, to folks who might not be familiar with it, how do you do it? How do you explain this?

 

[00:02:31] David: I think the very concise way to explain it is that cryptocurrency is money that's issued by a computer network. Most people think of money being issued by a government, by a central bank. And if you go back in history, there were commodities, especially gold, that were created by nature and used as money because of their scarcity.

 

[00:02:54] David: Computer issued money is very new. And you're really relying on the computer program itself to control the supply of money and also to protect the scarcity so that people can't replicate it and copy it and inflate the money supply and so forth. And arguably computers could do a better job of this than people, which is really where the novelty comes from.

 

[00:03:18] David: And most of our banking... We ultimately have to trust commercial banks and the federal reserve and all of the bank examiners and political oversight. But I think many people are probably more prepared to trust cryptography and mathematics than to trust the political process to oversee the money supply, which is really, you know, how this idea took hold of cryptocurrency when it was first introduced in 2009.

 

[00:03:45] Nolan: Interesting. And so, the blockchain within that I think is important and this is just more or less the way to keep track of everything, right? The transactions, the store value, and it cannot - and I think this is the important part. It cannot be changed or hacked or, or cheated in some ways. Is that correct?

 

[00:04:03] David: The blockchain is a new type of ledger for keeping track of financial things, or really anything that you want to keep track of. Most people are pretty bored by the details of accounting and the history of how we keep track of things. But the big innovation 700 years ago was double entry bookkeeping that many people would either work with in their jobs, or maybe studied in school. And the blockchain is really a successor technology to double entry bookkeeping.

 

[00:04:33] David: It's a big step forward in accounting. And what it does is connect every transaction to the subsequent transaction, which is why it's called a chain. So that if anyone goes back and changes something in the ledger, it spills over and then changes the subsequent transaction and every transaction forward from that point.

 

[00:04:54] David: So, this structure provides a huge amount of security because if anyone goes back and tampers with the ledger, which is typically how fraud or theft would occur, you can see that it's happened and you can see exactly where it makes the audit of the ledger, almost a trivial exercise. And this provides just much more security than double entry bookkeeping ever has.

 

[00:05:16] David: So, I think if cryptocurrency were simply issued on a classical accounting problem, there would be all kinds of things to worry about. But because when it was rolled out, it was paired up with this new accounting technology, it really impressed people who looked at it and understood how different it was from some of the innovations that had come before in electronic record keeping.

 

[00:05:39] Nolan: So, without going into too much of the weeds here, I'd like to talk a little bit about the history of cryptocurrency. From your view, what's, what's the short version of the history here and what problems were cryptocurrencies trying to solve?

 

[00:05:54] David: The history really goes back about 40 years. There were people who began meeting in the early 1980s in Silicon Valley. They call themselves the cipher punks. And they were very concerned with computers being used by the government to monitor people, engage in surveillance and take away all of our privacy. But they also observed that the tables could be turned on the government. That you could use the encryption from computers to keep things secret from the government.

 

[00:06:25] David: And very quickly, they came to the conclusion that your patterns of spending and saving - your economic footprint, if you will - is really an important part of your personality and that people wish to have financial data private in the same way that they wish to have demographic and vital statistics and their friendships private.

 

[00:06:44] David: So, a project really began to try to create a type of cryptographic money that was secure in the sense that it couldn't be monitored by outsiders. And there were many attempts that occurred, each of which sort of advanced the project further along. But it took 27 years between the first serious effort, which was something called Digi cash in 1982 - it was a doctoral student at University of California, Berkeley who proposed this.

 

[00:07:14] David: And then finally Bitcoin in 2009. And there were many innovations in between that people build upon and so forth. But this was really a project and there was a whole community of people who were interested in it. And some of the important problems that had to be solved, probably the most straightforward, is what we call the double spending problem. That anything in computer memory can be copied. And so, if you have computer money, you don't want someone to just copy your money or you don't want people to spend the same coin twice, if you will. So having a security system that would prevent that was very important. And if you were going to have a network with thousands of people and ultimately millions of people attached to it, you have to worry about conflicting signals. About two people claiming to have received the same coin. And you need a way to sort out the truth from the misrepresentations on the network. And Bitcoin did this in a particularly clever way, using competition that we've come to call mining. And so, every 10 minutes, there's an update of a new block on the Bitcoin blockchain, where people have very strong incentives to report, truthfully, what has happened on the network in the last 10 minutes. And this is really the breakthrough that, um, Satoshi Nakamoto had with Bitcoin - was solving not only the double spending problem, but this other problem has come to be known as the Byzantine general’s problem, which takes its name from an ancient battlefield, where you've got armies in the field and headquarters.

 

[00:08:47] David: Can't really see what's going on. And all of the generals in the field are asking for more resources and more than they really need. And headquarters has to sort out who's telling the truth and who's not. It's an old computer networking problem in a decentralized network. And Bitcoin uses game theory from economics to solve this in a particularly clever way.

 

[00:09:10] David: So, it turns out that it's not just for finance. In fact, the original blockchain was developed by a group of entrepreneurs who are working at Bell Labs in New Jersey, and they were interested in intellectual property. They began with the observation that in the modern world, more and more valuable assets are virtual in nature.

 

[00:09:30] David: And you know, things like a track of recorded music are really just bits and bytes. And a lot of documents are stored electronically instead of in paper form. And they were looking for a way to record the true authorship and ownership of these things without these problems of double counting. You know, other people replicating them and claiming to be the true owners and so forth.

 

[00:09:52] David: So, the first serious blockchain was really targeted more at the arts and the humanities. And I've gotten to know these guys who were among the developers who indirectly contributed to Bitcoin ultimately, but they didn't care at all about finance. It never occurred to them that you'd want to keep track of people’s bank balances or bills that they paid. They were more interested in the arts and creative property and so forth. It's a nice story that the blockchain developed in the creative world and then was kind of migrated into finance. You might've thought it would have been the other way around, but the finance part came later.

 

[00:10:30] Nolan: Yeah. It's interesting that it's almost come full circle now to NFTs and maybe we'll get into that in a bit. Um, but I, I actually did not realize it had that start in the humanities and the arts.

 

[00:10:41] David: Yeah.

 

[00:10:42] Nolan: And another one of the mysteries, there's many things that are just fascinating to me about the development history of crypto here. But it's still striking me that Satoshi Nakamoto is still anonymous, right? We still don't know this person's true identity. Is that correct?

 

[00:10:58] David: There's a lot of suspects. But Nakamoto vanished about nine years ago and left an enigmatic email that said, 'I've gone on to other things.' And there is now a trial in federal court in Florida with a defendant who says that he is Satoshi. This is an Australian gentleman named Craig Wright, who may have been part of a three-person group. I think it's quite possible (that) Nakamoto is more than one person and, you know, a group of people. And, um, whomever Nakamoto was mined about 1.1 million Bitcoins to get the project off the ground. And that today, as we sit here, is worth about $70 billion. So, whomever Satoshi is they have a big capital gain, and the tax authority would want to track them down, but there are a number of other suspects.

 

[00:11:51] David: The one that seems most likely to me is a fellow named Nick Zabo, who is the father of the so-called smart contract, which is an important blockchain application that is widely used on Ethereum. And Zabo was among this community of people going back into the 1980s, who helped to develop increasingly robust versions of digital currency.

 

[00:12:15] David: He's denied strongly that he's Satoshi and there are many other suspects. But one, one of the hypotheses is that Satoshi may have actually died and there was this three-person group of whom Craig Wright, the Australian, was one of the three - but there was a fellow from Florida named David Kleiman who did die of the Mercer virus.

 

[00:12:36] David: And it may be that Satoshi is no longer among us. And you know, that may be the reason that Satoshi vanished because he realized that he was mortally ill. We may know this with more certainty at some point in the future. But it certainly adds a lot of intrigue and mystique to the story of Bitcoin. You know that nobody knows who Nakamoto is. And I think if Nakamoto is alive and well, there are clear financial and security reasons that they would want to protect their privacy.

 

[00:13:05] Nolan: Right. From a lay person's perspective, it sounds like Bitcoin came around, was the first to solve a lot of these problems in an efficient, effective way. But in the past number of years, there's been a whole slew of cryptocurrencies that have come into place and, you know, Ethereum and Ether is commonly mentioned. Sometimes the, as a more or less a joke, I think DogeCoin is frequently mentioned, but really there are just thousands and thousands of these. So again, from a layperson's perspective, how do you sort through how to think about just how many cryptocurrencies there are, what's the metric by which you measure what's relevant to keep track of versus not?

 

[00:13:46] David: Now most of these, nobody is ever going to hear of you can think of these as entrepreneurial startup ventures that probably never are going to gain traction. But if you go back to 2009, when Bitcoin is launched, it really had technology that looks primitive by the standards of 13 years later. So, what you see is a lot of improvements and innovation. Bitcoin's actually a very slow network with bottlenecks and some of the more recent projects are meant to address... I wouldn't call them flaws, but simply the limitations. Bitcoin was an enormous accomplishment, but it is 2009 technology and, in an industry, where progress occurs very, very quickly. So, you see a lot of attempts essentially to build systems that are stronger, hold more transactions, process them faster. And I think, you know, this is very worthy work that you see in any industry where people try to improve the product or the service.

 

[00:14:43] David: Many of the coins that you see circulating today also have very narrow purposes. So, Bitcoin is meant to be a general-purpose currency that you could go shopping with and spend anywhere. But some of these are really for use just to activate one product or service. One of the ones I talk about in class is called file coin, which allows you to be a customer on a cloud storage system on a particularly interesting type of blockchain that is distributed all around the world.

 

[00:15:14] David: There's another one called the basic attention token, which allows you to use something called the brave browser. Where you can use this coin to suppress advertising or to reward people who create ads that are particularly effective. You have a browser with its own little economy that is mediated by a coin. That's good only for use in the browser. So, a lot of these are really designed for single use cases, which is an interesting reconsideration of the role of money. You think of the us dollar as a universal currency that you could in principle spend anywhere. But many of these other things are more like a subway token.

 

[00:15:53] David: You know, it used to be the, to ride the subway in New York, you needed a special token that was really good only for one thing, which was for riding the subway and the bus in New York. And a lot of the digital coins you see today are sort of created, you know, with that kind of logic behind them, and then still others are unique. These would be the non-fungible tokens, meaning that you can't really duplicate them. And they represent ownership rights in a unique asset, but they can also represent things like your passport or your birth certificate, um, that can be used to authenticate things. There can only be one person in the world with my identity and if I have the token to prove that nobody else can have it. You know, these kinds of systems have a lot of potential in supply chain and medicine. Um, there's just a whole bunch of innovation going on and it's all building off of the technology that Bitcoin first rolled out but has been vastly improved over the course of 13 years and continues to change very rapidly.

 

[00:16:57] Nolan: So, let's talk about crypto and perhaps Bitcoin in particular. But crypto in general, as a means of currency exchange. In 2014, you wrote an influential paper arguing that cryptocurrencies in some very fundamental ways are not an optimal technology to enable currency exchange for value exchanging. I think cryptocurrencies for goods and services. Can you tell me a little bit more about that? And I'm particularly curious if your thoughts have evolved in any way since then?

 

[00:17:33] David: If you think about the definition of money, if you'd ever took an economics course, you learned that money has three characteristics. It's typically a unit of account. So, in the case of the U.S. We keep track of things in dollars. It is a medium of exchange. So that rather than bartering, we all agree to use the dollar is a common point of reference. And finally, it's a store of value, meaning that if you kind of put it in your wallet and then put the wallet on your bed stand and get up the next morning, the dollar is pretty much the same value as when you went to bed, you know. You can count on it to hold its value, at least over a reasonable period of time. So, if you look at Bitcoin - and I wrote that paper when Bitcoin had been circulating about four, four and a half years, it really didn't meet any of those criteria particularly well.

 

[00:18:24] David: And at that point, there weren't too many other coins that you might even have tried to analyze. You know, it was just Bitcoin and light coin and a couple others. But nobody quotes prices in Bitcoin. You know, to the extent that people do take Bitcoin, and you now have an entire country, El Salvador, where it's legal tender, they still don't quote the retail price in Bitcoin.

 

[00:18:46] David: They use, in fact, the U.S. Dollars as the unit of account in El Salvador. So typically, when people do accept Bitcoin, the unit of account is still the local money, whatever it might be. But they'll take the equivalent in Bitcoin. But that changes really minute by minute, based on the trading value of Bitcoin. So, it's not really used anywhere as a unit of account.

 

[00:19:07] David: It's not a good medium of exchange either because there are real bottlenecks that it turns out only four people per second worldwide can use the Bitcoin network. And if you think about how many people are actually spending money around the world, Per second, it's vastly more. The visa credit card network by comparison can do 48,000 credit card swipes per second.

 

[00:19:31] David: So that's 12,000 times faster than Bitcoin. So as a medium of exchange, there's just way better technology. And as a store of value, cryptocurrency has been extremely volatile. It goes up and down in price, like a technology stock, but even more extreme. And it's just so different from dollars and Euro and yen and Swiss Francs, which, you know, typically they have a modest amount of volatility. But, but not very much, you know, they hold their value like safe assets and crypto has never been a safe asset.

 

[00:20:06] David: So, I think that to consider Bitcoin or Doge Coin or Light Coin or any of these as suitable substitutes for a government issue money is a long way off. The technology could improve and so forth, but it's, it's nowhere near that point yet. But and this is really important, I think crypto has made people reconsider the nature of money itself, and here's where it starts to get very interesting, because I just told you money typically has three properties.

 

[00:20:34] David: What you've seen is the unbundling of those three. So that some coins just do one of the three. So, a great example is Tether, which is essentially a synthetic version of the U.S. Dollar. So, no one keeps track of prices in tethers. They'd simply quote in dollars, but tether is a very widely used medium of exchange that it is really designed to be easy to transact on blockchains.

 

[00:21:00] David: And it's grown to be - I think I looked at the number of Tether earlier today, and it was 69 billion of them are circulating and the velocity with which they turn over is immensely quick. So, tether is actually done very well as a medium of exchange, and it's not a bad store of value. Surprisingly so. Tether's have been pretty stable at a dollar to a tether.

 

[00:21:24] David: And so, tether gives you sorta two out of three, and people are perfectly willing to let the U.S. Dollar continue to play the role of the numer rare. And to narrow the solution to just those two is, you know, maybe more achievable. I think though, in the long run, what's going to happen and it's already underway in China, is two things. That the government will look at the technology behind crypto and re-introduce the currency that we all grew up with on that platform. In other words, you're going to have a crypto Euro. China is already ruling it, rolling out a crypto version of the Rnb. And a digital dollar and so forth. These are already under development because of the better security and so forth that you get from the blockchain.

 

[00:22:10] David: But the really interesting threat I think is from the social media companies. You've got a group of companies that have billions of very loyal customers. Global in nature, they have way better IT than the government has. So, I think in the future, you're going to see crypto issued by the Googles and Amazons, as it pretty much has been already in China, by Alibaba and WeChat.

 

[00:22:35] David: And you're going to have a very interesting competition between the big media companies and the central banks to see who are the best creators of money. And I think Amazon would probably be well-served not to create a new unit of money called the Bezos or the Amazon. They'll just create an Amazon dollar and offer people 0.5% discount if you shop on Amazon with their currency. And since most of us buy most of our things on Amazon already, the adoption will be very, very quick. Facebook had this Libra project a couple of years ago, which scared the daylights out of Congress because it looked like a very credible threat. And I think the miscalculation they made was trying to introduce the Libra as a unit of money.

 

[00:23:18] David: If they had simply had a Libra dollar and a Libra Euro, it would have been much easier to, I think, get consumers interested in this. And they're now relaunching this with a new name. It's now called DM. And there's going to be in fact, a DM dollar, a DM Swiss Franc, and so forth. But I think the governments of the world need to be deeply concerned about these social media companies who I think have a big comparative advantage in creating money. And I don't see how they'll stay out of that business forever.

 

[00:23:50] Nolan: This might be an interesting time to bring up the debate, as I see it in the world of crypto and blockchain, on centralization versus decentralization. Can you tell me a little bit about what that means in the context of the industry of this tech and how that debate is playing out right now?

 

[00:24:08] David: So, you have this ledger, which is the blockchain, and all the transactions are linked together. But the key question is who gets to write the blocks into the blockchain. And classically, when we have an accounting ledger, there is some trusted third party, a bank, a clearing house, someone who plays the role of the record keeper. And that third party has a lot of authority to resolve disputes, to charge transaction fees and so forth. The record of these trusted third parties is not particularly good. You know, all of our banks collapsed in 2009. There's a lot of mistrust in some countries, bribery and political connections between the banking system and autocratic governments.

 

[00:24:52] David: So, the approach taken by Bitcoin was not to appoint anybody to be in charge. But to have a different person write each block every 10 minutes and they would have to compete for that right in a competition that anybody in the world could enter. So, a decentralized network is a network with no leadership, where there's code that mediates the competition between people, but all of us have the right to be auditors of everybody else.

 

[00:25:20] David: And all of us have the opportunity to compete, to win the next block. And so, the incredible achievement of Bitcoin was to create a decentralized network with no leadership, no people are in charge of it. But nevertheless, to get people to do the work and update the ledger and keep very accurate books, which has now been going on for well over 12 years.

 

[00:25:40] David: But the key to decentralization is that nobody's in charge. This is true of a lot of the cryptocurrencies that are circulating. At the other extreme, there are blockchains that are used often in private industry, and they keep very accurate records of things. So, a great example is the food trust safety system that Walmart has, they track produce from farm to table.

 

[00:26:03] David: And you can see the whole history of a bunch of bananas or a pound of beef from where it was farmed and where it was shipped and where it was warehoused and so forth. But there is a sponsor, in fact, it's IBM who is hired to be the trusted third party. And ultimately if you trust the data on the food trust, it means that you're also trusting IBM not to take bribes or monkey with the records and so forth.

 

[00:26:30] David: It's much more efficient to have central control, because it costs almost nothing for them to update the blockchain. But you lose the benefits of decentralization, which provides immense security, because nobody's really in a position to influence the network when it's decentralized. And I think that it's not either or, there's probably good applications of both. And there's often a middle ground where you have some decentralization to try to keep people a little more honest, but not such complete decentralization as Bitcoin, which can be very unwieldy and very costly. And it's a young industry. But I think when again, you look at the 12,000 coins that are out there, many of them are engaging in interesting trade-offs, innovations that address this issue of how much decentralization do you really want?

 

[00:27:21] Nolan: Am I right in assessing that in, in the world of crypto, there's maybe some number of evangelists who are really committed to this idea of decentralized finance and decentralized currencies? And I'm somewhat sympathetic that the technology can enable that to flourish and new innovations to come about from that. But at the end of the day, I think the market forces at play, like you said, the social media giants and other central heist companies have an incentive sometimes to control the evolution of these things. Without being able to be sure which of those forces are going to win out.

 

[00:28:00] Nolan: How do you see that? Is that the tech that's going to enable more decentralization or market forces that are going to encourage continued centralization of control of these things?

 

[00:28:10] David: I do think there's room for both. And we sort of overlooked a very important dimension to this. When something is very decentralized, it's almost impossible to regulate because there's nobody you can hold accountable. We have a lot of financial regulation for taxes and money laundering and all kinds of other things. But typically, we rely on the payments process or the bank or the credit card company to vacuum up data from all their customers and report to the government to withhold payroll taxes, all these kinds of things.

 

[00:28:42] David: When it's decentralized and people don't do those things, there's nowhere to go to freeze their account. Or to force people to comply with the law. In fact, this became obvious in the early days of Bitcoin, there was a marketplace called the Silk Road that dealt in drugs on the internet. They took only Bitcoin for payment, and it took them a couple of years, but they found the person who was controlling it. And he had a lot of Bitcoin in his wallet. And the government declared that those Bitcoin were now forfeit, you know, under our drug laws, you forfeit the proceeds of, of your crimes. The young man, his name was Ross Ulbricht said, well, I don't really feel like giving them to you today. And if he had an account at JP Morgan, you would go to JP Morgan and say, freeze his account.

 

[00:29:30] David: And you could ultimately arrest the leadership at JP Morgan if they didn't cooperate. But when it's on Bitcoin, there's no Bitcoin sheriff or headquarters there. There's absolutely nowhere to go to enforce the law. So, we have had this explosion in the last 12 months or so of this new thing called decentralized finance, where people are engaging in pretty routine borrowing and lending and swapping of assets on these decentralized platforms in the cloud.

 

[00:29:58] David: And frankly, a lot of them are simply out there to avoid reporting obligations for taxes and so forth. They are attracted to it, both because it can be a tool of getting out from under government regulation. But some of them it's, you know, almost ideological that there's a big libertarian streak in a lot of this. And these are people that think that the government shouldn't be collecting taxes and plays way too big, a role in our lives and so forth. And so, it's not so much about saving money in taxes, as it is to simply frustrate the administration of ordinary government. And these decentralized networks are a huge challenge to the agencies and parliaments of the world.

 

[00:30:41] David: You've got people in Washington at the securities and exchange commission and the FDIC and the CFTC, all of whom think that they have laws in place to deal with this. But those laws are extraordinarily difficult to enforce against a decentralized network with no leadership. So, a lot of people have been very amused to see the government chasing its own tail, if you will. You know, to, to make all these declaratory statements about how we have laws against this, and we're not going to tolerate this. But when push comes to shove, enforcement is incredibly difficult and the government's going to have to reimagine an awful lot of financial regulation. So, you know, the question you asked is will things end up being centralized or decentralized?

 

[00:31:23] David: I think there is room for both, but a lot of the impetus to decentralization has a root, fundamentally, in any ology that is anti-government. And the irony of this is that most libertarians are from the extreme right. But a lot of the adopters of crypto are from the extreme left. And I don't think either side is fully aware that this is the way it's worked out.

 

[00:31:48] David: And other people think that if you go far enough out to the political extremes, you meet on the other end. And I have an uncle with a lot of libertarian tendencies. He worked in the Reagan administration and then he wouldn't work for the Bush's because they weren't conservative enough. But he's a big crypto enthusiast and I'm very far to the left and we've had a lot of conversations.

 

[00:32:10] David: We clearly have a lot of shared beliefs about the importance and the value of this technology. But we couldn't be more different politically. But nevertheless, because we both are fairly extreme in our views relative to those of the rest of our tribes, we've we found a surprising amount of common ground here.

 

[00:32:27] David: So, you know, there's a lot of amusement and a lot of the important figures who were involved in the development of this were really motivated more by politics. Or in some cases, the arts, it's really not about the money for many of these people. And that's kind of what makes it fun to teach and bring some of these people in from time to time as guest speakers as well.

 

[00:32:47] Nolan: So, if you'll indulge me here, I'd love for us to maybe start at the end and work a little backwards. I'd love to hear your vision for what crypto and blockchain might unlock in terms of innovation and new technology, new ways of thinking through the economy. What do you think the world will look like if the technology reaches its promise, what kinds of innovation and disruption might come about with a long-term view of all this?

 

[00:33:18] David: I think you shouldn't be focusing on finance as the frontier of this, that really in any industry where data is important, you can have much more security and trust in the data if it's kept on a blockchain. Rather than if it's kept on the kind of ledgers and databases that we have now. So, the industry that uses the most data is actually healthcare and there are many mistakes made. There are many prescriptions that are forged for opioids. There is a lot of data about the records of physicians and the records of patients that is very hard to access. Trust to be complete and truthful. So, I think, you know, just to pick one industry, you're going to have much more precise and accurate delivery of healthcare in the future, once people migrate medical records to blockchains - and that's well underway.

 

[00:34:10] David: I think another huge opportunity is in shipping and logistics. So, we now have two global networks that track containerized freight, as it moves from port to ship to rail car and so forth. And it's about much more than just locating the goods in transit. It's about knowing when something has crossed a border and there's a customs duty to be collected and knowing the temperature of that container to make sure that the food has not spilled and so forth. If you can do that, not only accurately, but record it in a way that people believe the data is true, there are immense improvements that can be made in the productivity of shipping and logistics.

 

[00:34:51] David: So, some of the early trials suggest that you could cut the time at sea for ships by 50%. Which is really something that we would all benefit from. Not only would we get goods much faster and cheaper, but there would be less pollution from ships, belching smoke in the Harbor, waiting in the queue at Long Beach and so forth.

 

[00:35:11] David: So, there's really the opportunity for first order productivity improvements in any industry where data is important. And I think these days. that's pretty much all of them. Data has become central to almost any industry that you can think of even agriculture, but people typically don't trust data because they know that people have incentives to exaggerate, to backdate, to edit after the fact and so forth.

 

[00:35:36] David: But the blockchain is. It was called by the economist magazine, a trust machine. It's a new type of ledger that creates trust simply by the way, the data is organized. And if we all believe that the information, we were looking at was actually true with a high degree of certainty. We wouldn't need nearly as many safeguards and audits and layers of redundancy.

 

[00:35:57] David: A simple example from finance is that to settle a trade on the New York stock exchange currently takes two days. And that's a big improvement over the three days that it took until just a couple of years ago. And the reason it takes so long is that there's like seven layers of error checking and offsets and people who check on the checkers.

 

[00:36:19] David: And, you know, there's just all kinds of safeguards built in because there are so many incentives to lie and misrepresent the history of a financial transaction. But if we could do this on a blockchain, in a fraction of a second and eliminate the two-day settlement and all of the capital that's tied up in the tens of thousands of people we have to pay to make sure people are telling the truth.

 

[00:36:40] David: It's immense productivity savings that could occur. Probably government is the biggest potential. Most of government is involved simply in keeping track of things. And things like the registry of real estate deeds, the registry of motor vehicles, vital statistics, border security. You may remember when they were handing out the stimulus checks about a year and a half ago.

 

[00:37:03] David: They couldn't figure out how to find people who deserve them. And they ended up sending them to dead people and people living abroad and divorced people. You know that the government's records are so bad. That anything that could come in and improve them and create trust in government databases could be immensely important.

 

[00:37:22] David: So, you know, it's a really exciting time. And the reason there's 12,000 coins is because there are so many exciting startups that are very often addressing very small problems that have big price tags for their solution that often are pocketed just within one industry. So, I think you're seeing the biggest change in accounting in 700 years.

 

[00:37:44] David: And most of us don't like to really think about that, but if you take a step back and consider the enormity of this and, you know, maybe what was the world like before and after double entry bookkeeping, which was the Renaissance happened after that was, you know, and we had the first ocean going ships that would explore, you know, it, it really did change the world when double entry bookkeeping came in.

 

[00:38:06] David: And I believe you're looking at something of equal significance that you know, is going to, um, far into the future have, have a profound impact on people's lives.

 

[00:38:17] Nolan: So, do you think these use cases are compelling enough that we shouldn't be as concerned that cryptocurrency could be in a bubble currently, or do you think that's fundamentally irrelevant to assess whether particular coins at this moment may be in a bubble regardless of what the future implication of blockchain technology could be?

 

[00:38:38] David: You're asking now a completely different question, which is what are these coins worth? And can you begin to explain why a Bitcoin today is trading for $63,000? And I have to say that when we teach this in the university, we try very hard to avoid these questions because nobody knows even what's the value of a share of stock or a bond, you know, very classical financial asset.

 

[00:39:03] David: But crypto, all I can tell you is it's set by supply and demand. And that historically it's been very risky. So, I get asked all the time, how many Bitcoin, how much crypto do you own? And I've always given the same answer, which is none. Are you crazy? You know that stuff is way too risky to justify for any rational investor. But a lot of people like the casino aspect of crypto, the volatility resembles gambling, the people who trade crypto skew very much younger, male high-income people.

 

[00:39:40] David: And. Yeah, I think during the pandemic in particular, when sports were all kind of canceled for public health reasons, people turned not only to crypto, but to some of these meme stocks for a substitute, you know. A different type of entertainment. But it's very hard to either justify or undercut the value of Bitcoin or Ether or any of the others.

 

[00:40:03] David: It's, you know, it's now, well, north of two and a half trillion. So, if I'm an investor, just trying to diversify, it's become big enough that I should probably own a little bit of it. But it's not something that I recommend in particular that people invest in. And it's not something where there's a clear framework to value it, you know, with a stock, we can talk about the present value of dividends.

 

[00:40:27] David: You know that there are ways that professors have been teaching for decades that have some logical sense. But crypto for the most part is a speculative asset. And that sense it resembles gold. Nobody has ever been able to explain the value of gold either. And so, you know, this is not unique to crypto right. On the whole, I'd like to steer conversations away from this topic and avoid giving people investment advice, but it is breathtaking to see the values, you know, if you had told me - we started our course seven years ago. If you'd told me Bitcoin would be $60,000 by 2021, I just never would have believed it. But here we are. And there are people who think it's going to go much higher. Nobody knows.

 

[00:41:13] Nolan: Right. I want to make time for a question before we wrap up here. And that is around a common criticism of Bitcoin. Cryptocurrencies... the environmental impact of the energy use involved in computing, mining, processing, these transactions. How do you think through this? And do you think this is a legitimate enough concern that it might have implications for the viability of the industry?

 

[00:41:38] David: I read about a week ago that the amount of energy used in gold mining last year was pretty much at parity with the amount used in Bitcoin mining and people are up in arms about how can you spend all this energy and money in Bitcoin? But no one says a word about gold and there, there are many other social activities like using hairdryers or air travel for vacation where you can, you know, perhaps be outraged in principle about the energy consumption. To me. I don't think we should differentiate as a society between good and bad uses for electricity.

 

[00:42:13] David: We typically sell electricity at a price in a market. And if we think people are using too much of it, we can tax it. You know, there are very well understood methods to reduce energy consumption. I don't think that they should single out Bitcoin though, as opposed to any other use of energy. So, this is of course a long running debate about whether we should have a carbon tax or different other emissions quotas.

 

[00:42:37] David: And I think we probably should, in fact, but I don't think that crypto should be treated any differently than other uses of energy. It's also important to point out that if you are mining Bitcoin and many people are around the world, there are very clear incentives to use renewable energy because it has zero marginal cost that, you know, the main input to Bitcoin mining is energy. And to the extent that you're using fossil fuels, you're probably overpaying relative to your competition who are using wind power and hydro power. The best place for a Bitcoin mine is in the far north, like Northern Norway, Sweden, Canada, Iceland. More than half of the energy on the Bitcoin grid these days is renewable energy. And I think in the long run, almost all of it is likely to be because the economics pretty ruthlessly drive you in that direction. So, I tend to think that the critique is pretty misinformed and a little bit overblown that if you really want to focus on people who are using too much energy for stupid things, Bitcoin would be far down the list of things that you might criticize.

 

[00:43:44] David: Yeah, it was a good story in the paper today about the Russian methane flares that are releasing ungodly amounts of deadly gas is much worse than Bitcoin. And all of the people harping about Bitcoin really should be looking in other directions if they want to identify the, the real hazards to the environment.

 

[00:44:04] David: But in the end you can tax this and regulate energy consumption. And there are countries and municipalities who have done that. And I would just think that you should treat all consumers of energy, even handedly. You know, Bitcoin mining is not any better or worse than people playing video games or drying the dishes or, you know, any other use of, of energy that's out there.

 

[00:44:26] Nolan: So, I want to wrap up here and, to set up the conversation for what our next episode is going to be, we're going to take a deep dive into a look at who's investing in cryptocurrencies and what's driving that. What opportunities there are not necessarily from a speculative investment perspective, but you know, to unlock new forms of economic participation that might previously have not been available to folks. So, I was going to ask, um, what your advice to people may be that want to get involved? They're genuinely interested in the tech and the potential, but don't know how to maybe avoid the smoke and mirrors of their investment perspective of things?

 

[00:45:09] Nolan: Do you have advice for people in terms of just how to follow the world of crypto, such that they can appreciate the ways in which this might genuinely improve the world, disrupt the economy in innovative ways, but without getting too caught up in the smoke and mirrors of what particular coin to invest in and what the predicted value of that be?

 

[00:45:36] David: I'll take the second question first. And I'll just say, take my course at NYU, but there are many, many university courses and websites and tutorials. I helped edit a children's book on Bitcoin over the summer that is marketed, I think, to the eight- to 10-year-old range. And so. Those interested should find ways to become educated in this.

 

[00:46:01] David: And it's becoming easier and easier. And I think frankly, it will be unavoidable that everyone will need to understand this in the very near future, but the sooner you do the more you'll be able to make sense of the world around you. And if you're thinking of investing in any one coin, I would really take the time to understand what the business case is. You know, what problem is solved by this coin? That isn't already solved by something in the more traditional realms of finance. And to be sure many of these are quite innovative projects that provide security or new services that didn't exist before. And a lot of the ones that have done very well, there is a business case that probably made a lot of sense at every step of the way that there was risk, but people who took the time to understood it, understood they were investing in the potential of a business that the token was somehow connected to. But to address your first question about, you know, the general advice, this question is not a new question. You can ask exactly the same question about these 6,000 stocks on the Wall Street, on the NASDAQ and the NYOC.

 

[00:47:07] David: And the timeless lesson in finance is that people should diversify. Rather than picking two or three coins, spread your money around. There are now crypto index funds. And interestingly, there's a lot of classical stocks that are now heavily participating in the crypto industry. So, I mentioned IBM and JP Morgan. Another one would be Nvidia, which makes graphics cards, which are used in mining of crypto. Bank of America, just today, put out a list of 43 companies that are publicly traded and are closely connected to the crypto industry. It's only a matter of time before there'll be crypto mutual funds that you'll be able to buy on Wall Street.

 

[00:47:50] David: There, there are many ways to invest. But diversification is almost always good advice. Don't put all your eggs in one basket, unless you really know something about the company and so forth. But I've, I've avoided doing that myself. We own only index funds in my household because every finance professor will tell you to just spread your money as wide as possible.

 

[00:48:12] David: But I recognize that in the S and P 500, you now have 30 or 40 companies that are fairly connected to the crypto industry. It's now, you know, two and a half trillion-dollar industry. So, there will be people writing the software, building the machines and adopting the databases and so forth so that you indirectly are probably already invested in this industry, whether you wish to be or not.

 

[00:48:34] David: It's, it's grown so big that it's unavoidable.

 

[00:48:38] Nolan: Diversify the risk. I think that's sound advice and probably a sound place for us to bring the podcast to a close. So, um -

 

[00:48:45] David: Don't put all your eggs in one basket. They've they've given the Nobel prize for these two or three times already.

 

[00:48:52] Nolan: Exactly. Well, David Yermack. Thank you so much for coming on and sharing all of that insight. I can't tell you how much we appreciate it.

 

[00:49:00] Nolan: All right.

 

[00:49:00] David: It's been my pleasure. Thank you.

 

[00:49:02] Nolan: So, listeners, thanks so much for joining us today. I hope the conversation was as illuminating for you as it was for me. And join us next week, as we continue to explore this world of cryptocurrencies. We'll be taking a look at who makes up this new crop of investors powering the crypto trend and what their motivations and values are.

 

[00:49:21] Nolan: And like I said, in the intro, whether you're brand new to the topic or a seasoned crypto veteran, I think you'll get quite a lot out of the conversation. We can't wait to see you then. As always, check out our website for updates and past episode archives at ywympodcast.com. Again, that's ywympodcast.com.

 

[00:49:40] Nolan: We'll see you next week.

 

[00:49:44] Mary, Nolan, Laquita Ann: You've been listening in with 'Your world, Your Money.' You can find us at ywympodcast.com and stay updated on Instagram at Global Thinking Foundation USA. Be sure to rate and review us and you can reach us with questions or thoughts at hi@ywympodcast.com. Our thanks again to Hangar Studios and Global Thinking Foundation. Thanks friends. Happy moneymaking. We'll see you next time.