The Rule Breakers Guide to Cryptocurrencies: Why Bitcoin and Blockchain Are Transformative

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On this week's Rule Breakers podcast, Motley Fool co-founder David Gardner takes on a topic that he's never hit before, but that plenty of his listeners want to hear about from him: cryptocurrencies. To answer their questions about bitcoin, Ethereum, blockchain technology, and more, he's enlisted the help of Fool analyst Aaron Bush.

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In this segment, they discuss the three biggest reasons that blockchain changes everything: its power to create vast decentralized networks of people, its ability to transform information into value, and the way it makes open protocols work so much better. There's a lot to unpack there -- along with a sidetrack into what exactly a cryptocurrency miner is -- so let's get to it.

A full transcript follows the video.

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This video was recorded on Oct. 18, 2017.

David Gardner: What is this technology enabling? I think a lot of us think of bitcoin, first and foremost, and I think a lot of the reason that people think about that is because the value of bitcoin over the last couple of years has skyrocketed. There are a finite number of bitcoin, right?

It is a new asset class, but like real estate, there's only so much Earth. So it's defined, and therefore this moving price of the commodity is just how much, within this finite class of a commodity, this new asset class, how much people value it or want it. And roughly, I think, these days, I think it's around $6,000 or something like that, for a bitcoin.

Aaron Bush: I think it's about fifty-five...

Gardner: Fifty-five. It's changed $500 since I last looked ...

Bush: ... but still a $93 billion market cap, which is phenomenal.

Gardner: A $93 billion market cap. That's a number I didn't know. Now I'm going to say two years ago, and I'm not looking at a chart right now, Aaron, but bitcoin was maybe worth about one-tenth? I mean, we're talking about a 10-bagger in the last couple of years.

Bush: It might not be quite a 10-bagger, but it's still pretty phenomenal.

Gardner: So a $93 billion value to this asset class. That implies to me, Aaron, that there's some real value here. And even if bitcoin is zooming up and down on a daily basis and is somewhat speculative, there's real value being created out there. In what is that value centered? Why do we care so much? What's happening out there?

Bush: I think this entire movement is really groundbreaking for three or so reasons. The first one, and one significant reason why humans have stood out as a species, is simply because we can organize behavior at a larger and larger scale. In some ways that is the story of our history, our evolution from small tribes to superpowers. And the result of that is more centralization, because as we create more value as a species, we also have to build structures into existence, like governments and multinational corporations, to protect it.

What blockchains and cryptocurrencies bring us are a new way to organize networks of humans in a bigger and sometimes more efficient way, but it completely reverses that trend of centralization for maybe the first time in thousands of years. And I think we're only starting to scratch the surface of what that really means.

Gardner: So that's No. 1.

Bush: That's No. 1.

Gardner: A new way to organize human productivity.

Bush: Absolutely.

Gardner: You and me.

Bush: Second, this movement is transforming the internet of information into an internet of value. This new money, through tokens and coins, literally lives on the internet and, importantly, these currencies hold real utility. They provide access to networks that do real things, and as you mentioned, it's really the supply versus demand of that that gives these currencies, these tokens, value.

And what's a breakthrough about this is that the incentives are actually built into the network. For example, with bitcoin it's the miners who uphold the network that verify the transactions. That create the new coins. Produce the supply. They get paid in bitcoins to make it possible.

When the incentive structures are built into the code, not only does it allow it to be a stand-alone type of service, but it also encourages people to jump on early, and the early users are the people who sometimes are rewarded the most, unlike other internet applications. Maybe I was an early Facebook user, but I didn't gain any monetary incentive from that. So this is a new way to incentivize networks to grow rapidly.

Gardner: We're going to get to No. 3 in a sec, but I want to zoom up high level and then come back to where we are. We started by saying that blockchain is the big technology. That's the life changer. That's what started with bitcoin in 2008 -- the first blockchain.

Within blockchain, one subset is cryptocurrencies ...

Bush: Yes.

Gardner: ... and within that subset are bitcoin. So we can see the big picture. I want to drill down because you just used two terms in that last explanation that I think deserves a little bit more understanding. I've got questions about them. The two terms I'm thinking of are tokens and miners. Now, you referred to both, and you broke down miners a little bit, but can you give us the dictionary definition or the Fool's guide to understanding what a token is and again, what exactly is a miner?

Bush: I'll start with miner, because I think that might be a little bit easier. The miners are simply the people who have installed the software, whether it's bitcoin or Ethereum or another cryptocurrency, and they're the ones who are verifying the transactions. They're the ones who are competing to bring a new block of bitcoin, or whatever the currency is, into existence or whatever the specific currency dictates. So they're the ones that are really making the network work.

Gardner: Aaron, are you a miner?

Bush: I am not a miner, actually.

Gardner: But you or I could become a miner. Inspired by this podcast, we could download the software and we could start helping. Mining and hoping to get value for our mining.

Bush: I think you could. I would say with bitcoin, specifically, it has become increasingly competitive as the number, or as the supply, of bitcoins has grown. The mathematical difficulty in which the computers running the bitcoin software have to calculate, that difficulty has significantly increased. So right now what we're seeing, the people who are competing ...

Gardner: Highly sophisticated.

Bush: Yeah, they're highly sophisticated. They're running a warehouse of supercomputers to compete, to win the next block of bitcoin.

Gardner: So if you and I are going to mine, that's probably not the place to go. It's at the outset of a new idea. A new form of blockchain. A new cryptocurrency where it might be more doable or interesting to actually mine.

Bush: Yeah. And I think what's becoming increasingly interesting is that becoming a user is actually a way to get these tokens, and by joining the network, becoming a user, you have just as much of an opportunity to reap the rewards and the gains of whatever the underlying currency is just by using it, because at the end of the day, these systems are worthless if there aren't people using them. So the early adopters, in this case, are incentivized to help spur that value creation.

Gardner: And now tokens.

Bush: What's important about tokens inside this blockchain revolution is that scarcity is a key determinant in making this work. In a lot of open protocols that exist out there, that's not really a factor, so there isn't a way to retain value without scarcity. Tokens introduce the idea of scarcity. It's sort of baked into the definition.

If you have a service that's worth a certain amount of money, the tokens are what divide the value. So if I were to create, let's just say ...

Gardner: Aaron Bush currency.

Bush: Absolutely. And I wanted to build an Uber competitor that's decentralized. I don't know why I would do that, but just say I was.

Gardner: Right. There's Lyft, there's Uber, and then there's Aaron Bush Taxi ...

Bush: Right.

Gardner: ...with Aaron Bush currency.

Bush: So I would have Aaron tokens, let's say. And what you would do is buy Aaron tokens and then spend them to use in the network. To pay for a ride, essentially.

Gardner: Understood.

Bush: And as the value of the service increases -- and as more people realize, "Oh, if I can join this network and get paid in Aaron tokens, that sounds great, so I'll join" -- then all of a sudden you'll see that these tokens are now worth this amount versus what they were before.

Gardner: Because more people are using them. They're getting away from Uber these days. Getting away from Lyft. And Aaron Bush Taxi, solely driven by one guy, is somehow managing to compete, thanks in part to your own unique tokens that as more people use your business, whatever your business is, they become more real, and scarce, and valuable.

Bush: Absolutely. So there's always going to be a limited supply, or generally there will be a limited supply of these tokens, and as the value of the service increases, more people pour on to the network. The early adopters who have those tokens -- just say you're paying $10 in tokens, so one token was worth $10 to pay for a ride. Maybe that's now worth $100. Now you can pay for 10 rides.

That's sort of what we're seeing. Tokens are really just the vehicle that measures the scarcity that changes over time as the value of the entire system changes.

Gardner: Nice job, Aaron. I realize these are complex topics. It can go really deep and shoot off in different directions, so it's hard to nail it all down. Really, the technology is evolving and changing as we speak, and new things are popping up, so thank you. You did a good job breaking those down.

You were talking about why this is such a big deal. You were giving three reasons. Just to summarize, No. 1 is a new way to organize humanity. Human productivity. Ourselves. And second, you said we're transforming information into value, and we talked some about mining and tokens. What is a third big deal to what's happening with blockchain?

Bush: I would say that this is game changing for open-source projects. Venture capitalist Chris Dixon put this very well. He said that this breakthrough combines the societal benefits of open protocols with the financial and architectural benefits of proprietary networks.

If we think about it, open protocols built the internet. This is things like HTTP and HTTPS. That provides tremendous value for everyone who uses the internet, but it doesn't actually capture any value itself. Instead we see companies like Facebook, Google, and Amazon build on top of that protocol layer of the internet, and they are the ones who capture all the value.

What is changing here is that, through allowing value to live on the internet and to create monetary scarcity for some underlying utility, we're now seeing these protocols, now being called fat protocols, be able to capture value themselves. They are the ones that are creating this tremendous value as people start using them more and more, and not necessarily, although sometimes, what is built on top of it.

Bitcoin is a protocol, for example. Ethereum is another protocol. Those are the two big ...

Gardner: Those are the best-known cryptocurrencies.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Aaron Bush owns shares of Amazon and Facebook. David Gardner owns shares of Amazon and Facebook. The Motley Fool owns shares of and recommends Amazon and Facebook. The Motley Fool has a disclosure policy.