Why You Should Care About Bitcoin
Money is going digital and it is impacting the biggest growth industry of the past 75 years
Bitcoin has attracted a lot of news and high-profile investors in recent weeks, while the media still focuses on how early buyers have made money and how authorities are onto its role in online narcotic sales. Less attention has been paid, however, to the underlying long-term potential of Bitcoin as a catalyst for innovation in global financial services by decoupling transactions from the networks previously required to ensure their execution and enforcement.
To really understand the power of Bitcoin, you need to think about it as 3 things: (1) a protocol, (2) a commodity, and (3) an ecosystem.
Bitcoin as Protocol
Bitcoin is a network protocol designed to move and track the transfer of individual bitcoins from one party to another. The Bitcoin protocol leverages cryptography to ensure individual bitcoins, while divisible, cannot be copied and used twice simultaneously. Once validated, transactions cannot be refunded, rescinded or otherwise disputed. Simply put, bitcoins are a digital good that cannot be counterfeited and whose use cannot be reversed arbitrarily by the sender (or as with credit card chargebacks, an organization on behalf of the sender). Like accepting cash, once in your possession, bitcoins are yours until you decide otherwise. Ownership of bitcoins is maintained through the blockchain, a globally distributed public ledger that is open-source, decentralized, and secure. The trust normally provided for a fee by banks or payment processors online is now globally distributed and open to public viewing and analysis from anywhere on the planet with an internet connection.
Bitcoin has taken a very hard problem — how do you facilitate and record transactions online — and solved it for anyone to leverage for free. This capability may have profound implications that are not yet well-understood, such as redefining the source of future profits for financial services (hint: it’s no longer at the transaction layer).
Bitcoin as Commodity
Bitcoins themselves (as a finite resource) resemble precious metals and make an attractive investment as a store of value and currency, while the Bitcoin protocol is a near limitless source of verified transactions that can be incorporated into products and services with relatively minimal effort.
Much has been made of Bitcoin’s similarities to gold, and it has been touted as a hedge against sovereign risk in places like Cyprus and Argentina. Bitcoin, unlike banks, cannot be compelled by a failing government to turn over 15 cents of every bitcoin you have, or worse yet accidentally spend your bitcoins. Investor Chamath Palihapitiya calls Bitcoin “schmuck insurance”. Bitcoins will continue to have universal appeal as an easily obtainable and globally transferable commodity investment,especially in markets where depositor protections are easily ignored and inflation becomes an increasing reality.
Early investing in bitcoin has been defined by extreme volatility (the BTC>USD exchange rate over the past year has ranged from $13 to $260 and is now around $122), but it’s important to keep in mind that it takes time for the true market use case of a commodity to be developed. Standard Oil was founded in 1870, a full decade after the commercialization of oil extraction in Titusville, PA. At the time, kerosene was the valuable component of refined petroleum as the primary fuel for lanterns and heat. Gasoline was an unwanted byproduct and thought to have such little value it was simply dumped into rivers. The mass market for gasoline-powered cars didn’t really take off until the 1920s. A barrel of oil didn’t cross the $100 threshold until 2008.
Like oil, Bitcoin can be refined and put to use in novel and yet-to-be imagined ways. Bitcoin’s scripting language can be used to create transactions with multiple components (a standard bitcoin transfer needs just two things: (1) proof of bitcoin ownership by the sender and (2) the address of the recipient). Contracts can be designed and enforced that can require additional approvals, reference external facts, or even be timed to complete in the future. Because these conditions can be built directly into the Bitcoin protocol, this provides an interesting alternative to relying on (and paying!) banks, lawyers or other institutions regularly entrusted to help craft, facilitate and enforce transactions between private parties. Bitcoin can be used in marketplaces where others can’t or won’t usually go (especially for less than their market rate). Similarly, marketplaces with historically high transaction fees no longer require hourly or commission services to execute simple exchanges. Developers are only scratching the surface of what Bitcoin can do.
Bitcoin as Ecosystem
Entrepreneurs have a new opportunity to address the massively profitable finance market that in the US alone represents 7.5% of GDP and 20% of corporate income. With such a large market opportunity, investment in both time and capital for innovative new solutions is inevitable.
Early investment has focused on the mining of new bitcoins and venture capital has been flowing into exchanges like Coinbase and Buttercoin that help consumers easily acquire, store and exchange bitcoins for other hard currencies.Others are working hard to give ordinary investors exposure to Bitcoin as an asset class.
Bitcoin has massive implications for markets that the current financial services industry has ignored or struggled to penetrate. Online commerce all but requires preexisting access to a credit card or bank account, yet according to the GSMA 1.7 billion people have a mobile phone and no alternative to the cash economy. As digital cash, Bitcoin appeals directly to consumers as an accessible payment alternative without the risk and fees associated with existing credit and debit networks. Rapid growth of startup payment networks like M-PESA in Kenya (which was founded in 2007 and now is now processing 30%(!) of the country’s GDP) are a great early indicator for both market demand and adoption. Bitcoin will be a precursor to renewed innovation for financial services that have been long bundled or unavailable to various market segments.
Why Does It Matter
“Hackers are the animals that can detect a storm coming or an earthquake. They just know, even though they don’t know why, and there are two big things hackers are excited about now and can’t articulate why – Bitcoin and 3D printing”
- Paul Graham
Businesses built around supporting transactions are increasingly competing with protocols and algorithms that can do the job more quickly, securely, reliably and without requirement of profit. By commoditizing transactions, Bitcoin offers this previously ‘expensive’ service to entrepreneurs without the risk of building and maintaining this capability themselves. For the first time in Internet history, settling transactions between multiple parties can be dictated and applied directly through open-source software and not through (largely) for-profit 3rd party institutions.
When transactions become more binary and less dependent on interpretation, we will need to rethink the fundamental ways we use banks, lawyers, insurance, buy/lease property and transfer wealth. Like email with the postal service or VoIP with long-distance telephony, Bitcoin replaces today’s gatekeepers with a toll-free network capable of taking commerce anywhere to anyone.
Start paying attention, because this reality is too big to ignore and will be here sooner than you think.
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