Making Sense of Bitcoin - Part 2

When Tim Berners Lee invented the World Wide Web,  I doubt he could have envisaged the multitude of uses for the HTTP protocol and the business transformation it would cause.  The disruption to existing business, entirely new business and new modes of human communication that would arise could not have been easily foreseen.

In the similar way,  a case is to be made that bitcoin protocol has a similar capacity to transform payments.  Internet commerce has suffered from the difficulties of fitting existing payment technology which were designed long before internet existed. Existing card payment solutions are not intrinsically suited to insecure networks and where identity is required and difficult establish.  An adaptive strategy has worked to a point, and companies like Paypal have arisen to on top of the existing payment infrastructure to provide greater usability, security and consumer protection to end users.  

Bitcoin has a number advantages over existing payment infrastructure.  It was built and conceived in the internet age, and uses the native features of distributed peer to peer processing.   It shares many of the internet’s intrinsic features including high resilience and scalability.  Being distributed it has no central control and therefore can not suffer from an outage in the way that a centralised payment system is vulnerable to single point of failure.

One of the main advantages of bitcoin is the comparatively low fee structures compared to existing payment networks.  This is because the overhead of running a distributed open source P2P network are much lower than running centralised payments hubs with proprietary scheme interfaces which are difficult and costly to administer and maintain.  A bitcoin payment itself can be made with very minimal fees (typically 0.0001 BTC or 0.5 pence at today’s prices).  The economics of low charges means bitcoin may penetrate markets which are highly sensitive to charges, such as low value micropayments, or to enable acceptance in underdeveloped nations where the populous do not have access to mainstream banking facilities.  The addition of bitcoin to the M-Pesa network is an example of possible bitcoin adoption.

The bitcoin protocol also offers other potential applications such as coloured bitcoins which reutilises the existing bitcoin block chain for distributed asset management, such as this example from BitcoinX.   The bitcoin protocol may find extended use within social payment network ripple, by circumventing some of the problems associated with centralised exchanges for bitcoin.

Bitcoin transactions are non reversible, and merchants can not be directly subjected to chargeback.  Mainstream retail commerce adoption of bitcoin will require new mechanism for consumer protection and the creation of PayPal-like services that provide chargebacks or fraud case management.  In the same way that Paypal has enabled convenience, so hosted bitcoin wallet providers and other solutions will make it easier for users to use bitcoins without having to worry about the underlying complexity of handling bitcoins.  This will be necessary before mainstream adoption of bitcoin becomes common place. 

A vibrant eco system already exists around bitcoin,  venture capital money is pouring, bitcoin company acquisitions are starting to occur, and bitcoin investment vehicles are emerging.  Bitcoin has its own stock exchanges for example Mpex and markets also exist in bitcoin derivatives trading.

Several variants of bitcoin crypto currency exit, such as litecoin, fricoin and namecoin each addressing different perceived weakness of bitcoin, but none of these yet exist on the scale of bitcoin.   Since its genesis in 2009, bitcoin as a currency has gained a significant market capitalisation (US$ 1 billion as of July 2013).  It also taps into a growing sentiment that the banking and payments industry in general is ripe for disruption.  However, this fact tends to ignore the extreme inertia for change within the financial sector.  Whether bitcoin is the catalyst and correct technology for this change remains difficult to predict.

So does this mean traditional payment companies have anything to worry about?   Personally, I think it is unlikely that bitcoin takes over any time soon as the world’s reserve currency or that normal people will be ordering caffe latte or using them en masse at merchant Point of Sale.  However, as the bitcoin infrastructure evolves and matures, more and more uses will be found which do add value and reduce payment fiction, and these will indeed start encroaching on the established payment players.  It is therefore likely that crypto currencies in one shape or form will be a permanent feature of the future payment landscape.