Bitcoin: 10000 feet Overview

Money, or ‘fiat’ money, started in China¹ during the Song dynasty and, ever since, people have been trying to get ‘money’ right. Traditionally, this ‘paper’ money has been susceptible to manipulation, overproduction, and tight regulation by governments and used as leverage by financial institutions. Additionally, transaction fees and exchange rates exist primarily because different nations have different forms of fiat. For the sake of argument, let's call these ‘faults’ of ‘paper’ money. In 2009², Satoshi Nakamoto introduced the bitcoin, a fiat currency that is designed from the ground up to be free of the ‘faults’ but still satisfies the three primary functions of any fiat currency: (1) a medium of exchange, (2) a unit of measure & (3) a store of value.

Bitcoin is a digital fiat currency that circulates in a globally distributed computer network called the blockchain. (Please refer to appendix 1 for our detailed analysis where we present a summary of advantages and disadvantages when used as a payment platform). The advantage of Bitcoin is that it is global and immune to factors like counterfeiting, institutional manipulation, and leverage by those with power or criminal intent. Additionally, bitcoins can be bought, sold, and used without the aid of financial institutions or other forms of intermediaries, and they have fee structures that are significantly lower. Transactions can be carried out pseudonymously; however, transparency is key in making bitcoin work. Some disadvantages of Bitcoin is that it is relatively arcane and as yet not fully understood or trusted by either the general public or large financial institutions. Unlike other forms of currency that have either a gold backing or federal backing, Bitcoin has little to none and there is no intrinsic value either. Like myspace™, icq™, or altavista™, this technology has the same exposure to risk from a superior form of cryptocurrency at any time. Fee structures, though currently low, may rise over time as incentives for mining bitcoins will reduce as fewer and fewer bitcoins are left to be discovered. The main disadvantage of bitcoins as a purchasing medium is that very few places accept them at the present time.

Centered around this technology, several startup business models are possible, and the first of these is the one-sided merchant service. The prominent player in this space is BitPay, which is currently the largest payment processor specializing in allowing merchants to accept bitcoins for their products and services. One advantage of this service is that it allows one to participate without knowing very much about how the technology works. If I’m a retail store using BitPay, then I can start accepting bitcoin, expect financial statements to integrate into my current accounting systems, and also use the bitcoins collected to either purchase inventory I need from say amazon.com at a discount⁴ or simply hold on to the crypto as an investment. Additionally, BitPay offers (1) flat-rate pricing, (2) guaranteed exchange rates, (3) daily bank settlements, and (4) integration into QuickBooks™ or other accounting packages. The main disadvantage here is the volatility. If used simply as a medium of exchange then there are fewer issues, but if used as a store of value (e.g.- BitPay combined with a digital wallet service) now you have exposure to risk from the inherent volatility. Additionally, the fee structure can and has changed over time, and consumer protections for cryptocurrencies at present are weak to non-existent.

The next type of business model is a one-sided digital wallet⁶ service. They are peer-to-peer payment technology companies that allow users to hold, send, and receive both traditional fiat as well as cryptocurrencies. Payments move similar to email with the primary mode of exchange being HASH-based. A payment is converted into HASH data and sent via blockchain at very low fees. Exposure to bitcoin volatility is very low as the transaction times are short. The main advantage is instantaneous transfers at low prices via the removal of intermediaries thus deriving competitive advantage over traditional services. The integrated solution is both modern and convenient. There are, however, some disadvantages to consider. For example, software written and maintained for a business to implement a digital wallet service requires a high initial investment. Also, dependence on support technologies such as near-field communication introduces additional vulnerability from theft. Meanwhile, system outages are a possibility of networks and may not be under direct control. Finally, security is a concern as the biggest vulnerability, since the responsibility is shared between the service and the user.

The third type of business to consider is two-sided providers of both merchant services and digital wallets (e.g. Coinbase). Businesses in this category provide the ability both to hold various types of cryptocurrency as well as to convert them into conventional currencies, such as USD. Advantages include the ability to buy, sell, and invest in various forms of cryptocurrency with no minimum investment required. The app incorporates multiple ways to pay for bitcoin, such as credit cards or bank transfers. Other advantages include alerts, 2-factor authentication, and BTC vaulting, whereas disadvantages include system latency and frequent crashes due to high volumes. There are multiple layers of fees for different types of transactions. For example, bank transfers take days with a 1.5% fee while CC/Debit payments are instantaneous at 4%. Fees apply both at the time of buying and selling. Additionally, the SIP insurance only covers USD, which means that users tempted to keep their money in crypto have exposure to volatility.

Charles Allen, CEO of The Bitcoin Shop called Bitcoin (blockchain) “the most disruptive technology in the last 500 years”. We remain critical of this statement; however, we did hear his statements along with a talk given by Charles Hoskinson⁸ and the disruptive components of this technology are compelling. The blockchain and any information stored in it is (1) there forever, (2) impossible to tamper or censor, (3) public and verifiable, (4) immune from external leverage, (5) global, and (6) requires minimal interface hardware: just a smartphone with an internet connection. The applications go beyond currency and extend into practices such as contracts, credit analysis & other microfinance applications. Essentially any centralized service can be re-imagined as a decentralized service and the blockchain provides infrastructure to implement this at scale⁹.

One such service that can be re-imagined is that which is provided by the global remittance industry, commonly known as one of the most oppressive and exploitative markets. 192 million people who live away from their home countries send money home; that total money is about 400 billion USD⁸ with an industry market value of 540 billion USD⁸. The cost of moving this money sits between 8.6% to 12% average according to a World Bank estimate, but it can be much higher depending upon where you live. Furthermore, the economies of many nations depend on remittance. For example, 26% of Liberia’s GDP is remittance-dependent, and that figure is almost 17% for El Salvador¹⁰. With Bitcoin, we have the opportunity of rebooting those flows of money and allowing immigrants a way to send money home instantly without paying fees. Bitcoin is global; it’s the first transnational currency. Sitting here, I can pull out my smartphone and pay my subcontractor in Bangalore, India, and they will receive that payment in a few seconds. I’ll pay 40¢ to send it and they will pay nothing to accept it. It will be in their smartphone bitcoin account instantly. That kind of power can revolutionize global trade and can revolutionize services like the remittances market, where every year companies like Western Union extract 74 billion dollars from some of the poorest people in the world¹¹.

Decentralized systems allow one to operate at large-scale and achieve consensus. Operationally, the minimum viable product could be an extension of a two-sided provider with interconvertibility between both crypto and traditional currencies. This completely insulates both the sender and receiver from the arcane aspects of the technologies involved and allows them to have simple and effective tools that are very secure. Additional benefits for people in the third world, where there is no formal credit history, are that the spending history in the blockchain can be mined and that attributes like ‘reputation’, ‘credit-worthiness’, or ‘cash flows’ can be established without the need for institutions like credit unions, banks, or governments. Imagine the remittance industry transforming into a microfinance industry where, say I have $500.00 burning a hole in my pocket: I lend to individuals over the blockchain and get a return at my specified terms without involving banks. We end with reminding our reader that the problems of scale that centralized systems solve no longer exist in the world of ubiquitous communication. What decentralization ultimately disintermediates are not necessarily exploitative businesses but rather corruption, exploitation, and greed at large.