27 November 2014

Jeanne Capachin

Jeanne Capachin - Capachin Research

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Bitcoin, Currency, and the Elements of Trust

25 February 2014  |  1109 views  |  0

Bitcoin in particular, and crypto-currency, in general are coming under scrutiny by regulators in the US, Israel, and other jurisdictions in 2014. To provide some context, I thought I’d share some of my musings on currency, trust, and Bitcoin. 

The way I see it, there are six elements that contribute to a sense of trust for any form of currency.

  1. A secure system of issuance and exchange – For most currencies, this is a national government and central bank, but private parties such as Western Union and Visa also provide networks to transact with payment instruments that are pegged to or backed by national currencies.
  2. Stable value – Predictable valuation can be a problem for all but the largest countries, but it is critical to promoting acceptance. To solve for fluctuation, island nations will often peg their currency to the dollar or the euro.
  3. Secure warehousing/safekeeping – The banking industry developed in part to safeguard deposits, and deposit insurance provides added protection.
  4. Broad merchant acceptance – New payment types introduce added costs for merchants.
  5. Universal consumer access – Consumer adoption will provide incentive for merchants to accept new payment types, so it needs to be cheap and easy for consumers.
  6. Strong legal framework – Laws, regulations, and operating rules govern existing payment networks. New legal precedents and regulatory action will define how crypto-currencies will fit into the existing framework.

These elements just described are inherent to the successful payment systems and currencies we use today. Under this umbrella I include national currencies, card transactions, money orders, and other electronic payment networks such as Paypal or the ACH. For Bitcoin to succeed as currency, it must meet these high standards of trust, but so far, almost all of these elements are under question. What is bolstering Bitcoin up now are some other characteristics – which are mostly transient. These elements are as follows.

  1. The nerd cool factor – You want to use it, even if just to give kudos to such an elegant solution.
  2. What’s called anonymity, but is really, lack of regulatory oversight – Silk Road and other black markets have been greased with crypto-currency, but as they grow, legal authorities crack down and put them out of business.
  3. Investors and speculators – It’s been a wild ride, and hugely profitable for those who got in early and held on.
  4. Distrust of government and banks – I’m sure it’s no coincidence that Bitcoin was first announced in 2008. Anti-establishment retirees invested in gold, and anti-establishment nerds invested in Bitcoin. As trust returns, will this natural audience fade away?
  5. Miners – The guys who invest in computer equipment and power to extend the blockchain are using private resources to earn bitcoins, and in some cases earn processing fees. This group, including some consortia, is heavily invested in continuing growth of the currency.

Bitcoin is now coming under more scrutiny – both by regulators and those seeking to exploit it for personal gain. The Bitcoin community acts quickly to repair deficiencies and self-police, but the genesis of Bitcoin only dates back to 2008, and it really hit the mainstream in 2013. Launching a new global currency, based on cryptography and consensus, is a huge goal. The cryptography and the framework is a marvel. Whoever Satoshi is, he had a deep understanding of payment systems and built an open ledger system that may outlast the currency.

Bitcoin as a framework for open-source, modern ledger accounting is the genius idea, but with some potentially tragic flaws. For example, it’s not real-time, and forks in block chains and fraudulent transaction postings have already occurred because of this gap. Another issue is the slowly expiring incentive to contribute computing power. Already miners must invest in fit-for-purpose equipment and high energy bills to have a chance at earning bitcoins, and transaction processing fees have been introduced to cover some of this expense. Lastly, regulators are taking action – requiring money transmitter licenses and reporting, with potentially more regulation to follow.

I’m still excited about Bitcoin the idea, and have my Bitcoin wallet, but I’m skeptical about it’s future as a currency. I’d love to know who Satoshi really is, and see what other ideas he’s dreaming up. No matter what happens to Bitcoin, it’s a brilliant idea that came at a time when people were willing to take a chance on currency that was free of governments and banks.

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Jeanne Capachin

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Principal

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Capachin Research

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2014

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Norfolk MA

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Jeanne is the founder and principal of Capachin Research (www.capachin.com).

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