Thoughts on Bitcoin

This is going to be somewhat of a departure from your regularly scheduled programming here. I had some extra time over the past week or so and I decided to learn what I could about Bitcoin. This rant is going to contain some poor semblance of economic theory and really I should just stick to tech but I couldn’t resist.

Skip this if you already understand Bitcoin

Bitcoin is a peer-to-peer currency that has gotten some press lately. If I have a Bitcoin wallet (and I do), you can easily send me some “money”. I didn’t read through the code, but my understanding is that this is handled by adding my Bitcoin address to the digital data, signing it with your private key and then broadcasting it to the world. In that way, Bitcoin participants have the entire history of every transaction and only one person possesses any given Bitcoin at any given time. As you might guess, if everybody started using Bitcoin tomorrow, scalability might be a problem. However, it works for now.

What rocks about Bitcoin

A lot of different companies are trying to “solve” payments — be they mobile, physical, digital or anything else. One reason why folks think our current (credit card based) system needs solving is that it is pricey for merchants. The generally expected fees are somewhere just shy of 3% and can also include a fixed transaction fee as well. Fixed fees mean that credit card transactions don’t scale down very well when you are buying something cheap. Ever seen a sign saying $10 minimum for credit cards? That’s why. Bitcoin payments are virtually free which sounds awesome from a merchant’s perspective. They are not generally reversible unless the receiver chooses to reverse it and there’s no central authority to decide who is allowed to pay whom and for what. This is particularly useful if you’re Wikileaks and you’ve been cut off from payment processors or you operate a gambling website and you’re having problems with US banks stopping or reversing your transactions.

For regular users, Bitcoin comes with some advantages such as some level of privacy. No more embarrassing credit card statements. Jokes aside, anonymity of payment has quite a few legitimate purposes and is obviously useful for illegitimate purposes. In addition, Bitcoin requires very little upfront cost. There’s no need to setup a bank account or have a credit limit. It functions like cash but over the internet. You get yourself some Bitcoins and buy whatever you want with them. This has great potential where credit cards have limited penetration but you still want to have transactions over the internet. It’s also quite useful as a “universal” currency because you can avoid currency exchange fees when dealing internationally.

What sucks about Bitcoin

While there are few monetary barriers for a merchant to accept Bitcoin, it requires a lot of planning and constant vigilance. In the last year, Bitcoins have gone for as little as $0.20 and as much as $20. This causes havoc for a merchant who needs to buy things from his suppliers in dollars (or Euros, Yen, etc.) but gets paid in Bitcoin. The merchant needs to constantly be exchanging the Bitcoins he receives for his local currency or absorb some level of currency risk — and Bitcoin is a fairly volatile currency. Suddenly, a merchant needs to have a feel for the Bitcoin economy on top of understanding their business. In addition, exchanging Bitcoins for local currency involves fees (~0.5% usually) and a lack of fees was one of the main reasons a merchant would want to accept Bitcoin anyway. These problems can be mitigated somewhat by a merchant whose supply chain accepts Bitcoin.

For users, Bitcoin seems like a total pain. If I want to pay for something in Bitcoins, first I need to go to one of the exchanges and get myself some Bitcoins. This involves fees! People are not used to paying fees for buying things. In our credit card system, the merchant absorbs that fee and is often prohibited from passing that fee directly on to the consumer. The same problem of currency risk also arises. Holding Bitcoin in your wallet involves risk that the exchange rate could decline. Although the reverse is also true, rational people like to be compensated for taking risk. From a consumer’s perspective, Bitcoin is also not as safe as a credit card. If there is fraud on my credit card, I can reverse the charges. With Bitcoin, there’s no such luck. There’s no recourse short of a bad review for a merchant who sells you a defective product and won’t honor a return. This is the bad side of Bitcoin functioning like cash but on the internet.

The future of digital money?

For consumers, the proposition Bitcoin offers is generally awful. There’s no reason to pay with Bitcoin unless you are forced or incentivized to do so. For merchants, it makes considerably more sense but there are a few kinks to work out. I could see a future where merchants are provided with easy ways to manage or mitigate their currency risk and then they could offer incentives to customers who use Bitcoin because they can pass the fee savings from not using a credit card on to consumers. I could also see Bitcoin becoming/remaining fairly strong where anonymity or decentralization is very strongly desired or required (funding Wikileaks, gambling, illicit materials, private minded folks) or where banking infrastructure is not setup.

That said, I intend to procure and spend some Bitcoins but mostly for novelty reasons.