How do you best explain cryptocurrency to an 8 year old

I think the best way to explain it would be step by step, building from concepts that can be explained in more practical terms that she might understand. You may feel the below is overly harsh, but at bear minimum, think of it like this: If you can't articulate why I am wrong about the below [and while the below is quite opinionated, these are indeed opinions that I hold], you may not be ready to explain it to a child, and further to the point, you may be in over your head yourself.

1. I would start by explaining the Dutch tulip crash of 1637 - nice introduction to the idea of how something can seem like it makes immediate practicable sense, but that market frenzy can turn something possibly profitable into something that no longer bears relation to the underlying asset.

2. Then I would go into the South Sea Bubble of 1720 [nice little segue here into how even a genius like Sir Isaac Newton can make emotional decisions without understanding the underlying financial reality]. This is all just setting the stage for the idea that a market can remain irrational longer than you can remain solvent, meaning that prices often do get detached from the underlying reality of value, and that she shouldn't worry, prices do normalize eventually.

3. You could discuss how a barter economy led to minted coins, which then became the backing for national currencies, and then how, quite naturally, the gold standard became irrelevant to the underlying economy, allowing countries to print money by fiat, still holding value on the basis of that government's own projected stability and ability to collect taxes, thus leaving no need for non-governmental, non-asset backed currencies like Bitcoin.

4. You should then discuss trivial cryptography concepts, and show how hashing with private and public keys can prove identity, which through a simplistic blockchain explanation can be used to assign a chain of ownership to specifically minted 'coins'. You could sideline here to discuss how the Markov chain allows for some really remarkable concepts with proven value, primarily using Github as an example of the proof of authorship and unchanged-ness of published code.

5. You would then need to dive into how turning a Markov chain into a public blockchain requires currency to motivate miners to waste power cycles [and by extension, waste precious natural resources to do this] to keep the blockchain from being overrun with a 50%+ attack that would threaten the very foundation of Bitcoin if mining conglomerates ever merged at greater numbers than they already have.

6. You could discuss the risk of irreversible transactions. You may feel that trustless = good, but you might want to discuss that with her parents first, something like "hey, I'd like to teach your daughter that no institution can be trusted, that all power is a lie, and that in reality if she has a problem there is always a risk that no one will help her, not her bank, her government, or anyone with power, and that the only good force in the world we can believe in is the Good of Greed that will ensure miners always act in their own self interest." They may not feel this to be an appropriate lesson for a 9 year old, of course.

7. You could tell her that Visa processes about 7,000 transactions / second globally, but the blockchain can only handle something like 7 transactions / second at theoretical peak capacity [my numbers may be off, but not by an order of magnitude in either direction], meaning it will never truly be a global currency.

8. You could discuss how the majority of bitcoin has never been moved since its initial mining date, meaning it is entirely unclear what the true usable supply actually is [because many wallets are surely lost forever on old hard drives etc.]

9. You could explain how there are thousands of cryptocurrencies, with more being published all the time, some with identical or near-identical rules and codebases, leaving 'value' as being largely driven by social inertia and 'branding', with the ultimate risk that any leading darling gets washed away in the future, so Bitcoin is only questionably a 'store of value'.

10. You could discuss how moderated inflation is preferable to massive peaks and valleys of inflation vs deflation every week month and year.

11. You could discuss how the ease of purchasing bitcoin without understanding the blockchain is leading new investors to ignore the lessons of MtGox - "not your wallet, not your coins". As an accountant, I am personally curious how one could ever 'secure' coins in a way that would prevent anyone with the ability to transact on behalf of their company, from simply transferring to their wallet after already leaving the country for a beach somewhere.

And at the end of all that, I would explain to her "don't ever invest your money in something where you don't understand the value proposition in a way that you could explain it to another 9 year-old".

imagine if keeping your car idling 24/7 produced solved Sudokus you could trade for heroin
Theophite on Twitter

It's funny, but it also explains one of the most crucial parts of any popular cryptocurrency: It takes vast amounts of energy to keep the thing running, and this is by design. Any distributed cryptocurrency has to be expensive to run in order to ensure the integrity of the blockchain. Many 8 year olds are conscious of the debates over energy and climate change and this could be a very interesting topic to discuss.

It also gets at the other truth of cryptocurrencies: what they produce is very disconnected from things that an 8 year old would value. To an extent this is true of all currencies, but you're not asking how to explain money. Just like we like gold because it's shiny, there are some people who like the mathematical beauty of the blockchain and all those 'Sudokus' it has solved. But there's no defined value to those Sudokus - there's a maximum value (based on the cost of electricity and computers), but there's no lower value. Unlike other stocks, it doesn't represent things people like to buy: land, products, companies, the hours of labour workers put in. For these reasons it's very different from investing in general stocks like Apple. You're not buying a slice of a company's assets and revenue, you're buying a Sudoku with the hope someone else will want to buy it off you for more later on. Like those who 'invested' in Beanie Babies in the past, you should explain to your 8 year old that you should only buy cryptocurrencies if you really like the technology and will be content if you can never sell them back even for what you bought them originally. You could explain that some cryptocurrencies have features like smart contracts, or the ability to run programs; those things have arguably more inherent value than cold metal, but the current cost of those cryptocurrencies is still mostly driven by speculation, not the value of those services.

(BTW, if you like cryptoart and NFTs, you can buy that tweet! But don't. Because you'd just be contributing to the problem.)

It becomes easy to understand by asking:

What problem(s) does cryptocurrency solve?

Or even more deeply:

What do people currently use to solve their problems, and how does cryptocurrency compare to those solutions?

Cheap, near-instant transfer of money around the world

Consider a quad-bike company based in Melbourne, Australia who needs to buy 50,000 AUD worth of parts from Japan. This would cost them $3000-$6500 just in fees to banks

"The biggest problem with electronic payment systems is fees – they can add as much as 6 to 11 per cent to a transaction, Brim says. Bitcoin charges just 1 per cent."

Whereas bitcoin could do it for 1% ($500) - so if a financial service provider could undercut its nearest competitors by 83-91%, surely that's a pretty serious advantage, right?

Kids language:

Banks take less of your money in fees

Store of value

Something we may take for granted (until a financial crisis) is the ability to store wealth and know that it will be there (possibly some years/decades) later when it's required.

During the financial crisis of 2008, many realised their 'safe' cash and property investments were written down to a small fraction of their initial worth. This was partly because of "a breakdown in responsibilities"¹, and partly because of inflation caused by quantitative easing, which involved the purchasing of $40 billion of long term securities every month in the US alone.

In any case, 'low risk' investments like bonds, and even treasury notes were shown to be not as low risk as they appeared. Investors could look into other investments, like precious metals, and even asteroid fragments. But each investment has its pros and cons, for example, holding gold comes with risk of theft or a cost of you storing it at your local bank/mint. So cryptocurrencies offer another option for storing wealth. Is it a 'better' option? Not necessarily, but it's a matter for individuals to decide

Kids language:

Your savings are safer from some risks

More power to online sellers

This doesn't necessarily make cryptocurrency better, but it simply makes it different, which will appeal to some, but not everyone:

When buying online via a service like paypal, the seller probably won't see that money for 90 days, and they have a risk that you could call your credit card company after 89 days and say you never received the goods. This is a big problem for online sellers. But not with cryptocurrency. So this is useful if the seller doesn't want that risk.

Kids language:

Reduced risk of fraud for online sellers

Micropayments

Prior to around 2015, major online payment providers (e.g. PayPal) were not amiable towards payments under $5. So online sellers of small, cheap, and easily delivered products (e.g. stickers, stamps) had much smaller profit margins due to extremely high fees relative to more expensive products. This meant that many online retailers and paid applications simply didn't exist, since it would not be profitable due to payment fees exceeding their revenue.

Kids language:

Tiny payments can be feasible (for things like stickers!)

Reference

¹ The Great Crash of 2008, Ross Garnaut, pp 137

This example might be good for a 10 year old.

There are 10 people in the household and they want to exchange money owed to each other for paying for external services and goods such as food/petrol/water/taxes etc. For that they devise their own IOU based currency with one IOU equal to one unit of local currency.

Centralised/bank based payment model

Two people Peter and Paul are payment processor and are entrusted to carry out transactions between different parties, each of them is responsible for four other inhabitants and themselves.

So if Alice wants to pay Bob and they are both serviced by the same payment processor Paul, any IOU will have to pass through Paul.

Alice > Paul > Bob

Paul stores all the transactions for people he manages and every so often he exchanges them with the other payment processor, Peter. So if Alice wants to pay Bart who is not serviced by Paul, she needs to rely on Paul to relay that information to Peter.

Alice > Paul > Peter > Bart

Problem with that approach is that Paul or Peter could manipulate intentionally or unintentionally transactions passing through them.

Distributed/blockchain based payment model

All the parties in the household meet together and witness IOUs being exchanged out in the open.

IOU transfer by Alice to Bob is direct.

Alice > Bob

IOU transfer by Alice to Bart is direct.

Alice > Bart

Advantage of the second approach is that you do not need to trust any party to do their job properly as all transactions are in the open. No one can claim that some of their IOU have been manipulated as all transactions have been witnessed by everyone present.

With distributed backend this trust can expand to many other areas, making blockchain services more transparent and in some case more democratised.

Other example

You could talk about a much older instance of a public ledger, rai stones which might be a slightly more intuitive and certainly less technical.

Problems

Potential problems brought up by Grade 'Eh' Bacon are absolutely valid and are being fixed out bit by bit. I'll address few here breiefly.

1. Proof-of-stake or proof-of-kernel-work solutions will allow for transactions and smart contracts to submitted with far less energy being wasted on mathematical puzzle.

2. Over excitement about internet companies many which provided payment services led to the dot-com bubble, sure many failed but also many titans emerged and along with a host of new services.

3. Traditional financial service providers also had to learn from their mistakes in order not to be robbed or defrauded and still aren't very forthcoming about letting public know about a breach.

4. Layer 2 solutions and new blockchains such as Polkadot/Algorand/Cosmos are working on increasing the total speed and throughput of the transactions.

I think most importantly Bitcoins is really a proof of concept rather than a full fledged blockchain solution.