Who are you? Why are you writing about Bitcoin?
Do you ever feel like there is that person who is un-naturally enthusiastic about a new currency even though they have no idea how/why it will be used?
That’s me! For years I have been into virtual/crypto/digital currencies of different kinds. Including, but not limited to: letting people transfer cellphone minutes peer-to-peer and use them as micro currency, PM-ing Facebook Credits and Facebook global payments, buying World of Warcraft Gold online, and of course Bitcoin. Additionally, I have lived much of my life overseas in China, India and the Philippines and have struggled to accept payments in those countries for my businesses, which fuels my enthusiasm.
With all the excitement around Bitcoin, I have had friends and acquaintances ask me questions on payments, stored value, etc. I’ll share my opinion here.
I own BTC, am a BTC supporter and enthusiast, and so am biased. Bitcoin has very real problems and risks, which I discuss below, and is highly speculative. In these FAQ, I refer to the currency itself as BTC and the protocol as Bitcoin. These are the most frequently asked questions I have received.
- What would it take for BTC to gain adoption?
- What’s your best Bitcoin startup idea?
- Why is regulatory buy-in so crucial to a payment system?
- What’s the difference between the different crypto currencies? Why does Dogecoin appear to be taking off?
- What would it really take for BTC to become a global remittance network, like good enough to replace Western Union?
What would it take for BTC to gain adoption?
There are many technology enthusiasts (myself included) really want Bitcoin to succeed and usher in a world of cheaper, frictionless, futuristic commerce.
One thing that is worth thinking about is the role of the underserved merchant in the adoption of a new payment system. Specifically, I mean merchants who today cannot easily collect payments from customers (i.e. it requires high up-front or ongoing cost), but with a new payment system they can collect easily and have enough margin to run a business.
Some examples of underserved merchants and their enablers are:
• eBay merchants enabled by PayPal
• Farmers’ Market merchants enabled by Square
• Developers who want to collect payments online enabled by Stripe
• Drug dealers enabled by Bitcoin
Underserved merchants have something people want, but customers can’t pay. The underserved audience is the engine that fuel the growth of new payment systems and helps the system move upmarket and be accepted by bigger, more established merchants.
With this lens, let’s think about a few specific examples where there are merchants who have something people want, but it is hard/expensive/capital-intensive/need-a-middle-man to accept payments today. I have chosen these examples specifically because each one illustrates tactical obstacles which will need to be conquered in order to bring the BTC ecosystem to life.
• Underserved Merchant: Sellers of apparel and professional services in Philippines, Bangladesh, Turkey, maybe Eastern Europe. Today, if you run call center from the Philippines or a garment factory in Bangladesh it is really hard to sell your products directly to a global market. Getting a merchant gateway to process credit cards as a (for example) a Filipino company is hard and requires up-front capital in the thousands of dollars and sometimes a trip to Hong Kong. PayPal kinda works, but they are pretty strict and they kick merchants off based on their policy (which has the perception of sometimes being arbitrary, especially for service businesses). Other payment mechanisms have restrictions on transaction size, and can hold your funds based on their policy. All of these factors don’t make it impossible to do the cross border business, but it certainly increases the barriers to entry. You need to raise a good amount of capital or have a multi-national partner (who will take a cut of the action) to use the current systems.
People overseas want apparel from Bangladesh and call center services from the Philippines, they get them today, but an alternative commerce system that didn’t require as much up front capital or connections would dramatically increase the number and variety of operators that could sell directly. They would also open up corridors which are really hard now, like Nigeria to Bangladesh, where both sides are underserved with regards to payment, but people still need and want apparel!
Why do I mention specifically Philippines, Bangladesh, Turkey (PBT) versus the more prominent China and India? The governments of PBT have not yet flexed their muscle with regard to restricting BTC transactions. If foreign exports were to pick up steam and benefit locals, PBT governments would be unlikely to do so. China has already started to regulate BTC, and the Central Bank of India has shown its willingness to crack down on cross-border transactions with its PayPal remittance restrictions a few years ago. If BTC were to catch on in India at the rate of millions, I suspect its use would quickly become restricted.
• Underserved merchant: US-based SaaS vendors. For US-based SaaS vendors accepting the long tail of global currencies is really hard and often not worth the investment for the incremental sales. Imagine you are a startup, e.g. Verbling, selling language tutorial lessons online and you want to sell lessons to people in Turkey. It’s easy for you to sign up for credit card payments and get a merchant account, but your payment gateway doesn’t support charges in Turkish Lira, so you need to charge the customer in USD. It’s hard enough to find one of a customer with a credit card, and when you do there is a very high decline rate for cross-currency transactions. Accepting a local payment method, like Mikro Odeme is expensive and time consuming to set up and may not be worth it. Even if the transaction goes through, there is a whole host of extremely irritating things for customers: they often have a Forex fee on their credit card, they don’t get a competitive Forex rate at time of transaction, and if you are doing recurring billing charges are different amount each cycle. Customers have to be pretty motivated to deal with these issues, and often merchants don’t have that luxury.
Assume for a second we were going to try and solve Verbling’s problem with BTC. Here is what would need to happen: Verbling (a US Company) would need to accept BTC on their website, easy, this can be done today. Second (and this is the harder part), there would need to be a way for local Turkish people to cash in through a local payment method to BTC. Payment methods are extremely local, and the ability to cash into BTC in the local market at competitive rates with high availability is crucial to being able to accept payments from there.
• Drug trafficking and BTC: this example is tongue in cheek, but it should be mentioned that illegal activity is also an example of the underserved merchant theory. Drug dealers can’t get credit card merchant accounts, and drug transactions through credit cards could be traced and the funds clawed back. An anonymous transaction system with no intermediary to claw back or freeze funds that Bitcoin provides served this purpose. I am concerned that people will latch onto the negative applications of this technology, and think that nefarious scenarios are all that it can enable. We need a legitimate scenario more enticing than drugs to bootstrap this ecosystem.
Growing by helping the underserved is not the only way to grow an alternative payment system. Payment systems and currencies can also grow, for example, by mandate, like QQ Coins or iTunes payments. Due to the decentralized nature of Bitcoin, I doubt this will be an option for BTC in the near future.
Another way to think about this issue is why did cool new payment methods like NFC or mobile cash like they have in Kenya (M-Pesa) struggle in the US? Because the merchants in those scenarios are not underserved. People rich enough to buy smartphones in the US almost certainly have credit cards and re-habituating them just won’t be easy. BTC scenarios that address merchants that are well served by credit cards or commercial banking won’t make a material difference in fostering adoption.
What’s your best Bitcoin Startup Idea?
I am often asked, what’s your best Bitcoin startup idea? A product person at heart I was briefly tempted by the flashy scenarios like one-click micropayment on mobile or BTC global credit card. While these are fun thoughts, and I hope they will be available one day, there is one fundamental building block that BTC needs right now: legitimacy.
The reality is that to the general public Bitcoin is a strange curiosity. If you are running a BTC based business, it is hard to get banking services and there are concerns regarding the requirements for money transmitter licenses in some jurisdictions. As a merchant, depending on your margins, you don’t want to take currency risk, so you cash out immediately so transactions aren’t upside-down (this is what Overstock.com does, for example). The perception of individual BTC holders is that they are speculators, or they use BTC it for applications like Reddit Gold, gambling or for illegal purposes. There is a perception of risk that the startup holding a BTC wallet, or the homegrown software users have on their computers are fallible and they will lose their money. All these things have a chilling effect on spending and transacting, and overall don’t help the ecosystem.
How can a startup help? My fictional startup is called BitLegit, Inc. and here is what it does:
A Know Your Customer (KYC) + Anti-Money Laundering (AML) + FDIC insurance equivalent for BTC would go a long way towards legitimizing the currency. Imagine if you were able to provide governments assurance that every BTC wallet that cashed out into USD had a thorough KYC procedure performed on the transaction. You know the identity, including SSN of the person who cashed out. They were fully OFAC checked and known to be a non-terrorist and non-money launderer. Basically, BitLegit would provide the same standard as existing businesses that transact in USD.
On the stored value side, you provide a guarantee. We guarantee if wallet service X, Y, or Z goes under that you will be insured up to 200 BTC. This is like what the FDIC does for consumer banks.
From a leadership perspective, I don’t think the rebellious hacker-founder is the right persona to start a company of this kind. We need legitimizers to make this happen. As long as I’m dreaming of a fantasy Bitcoin startup, I would make Meg Whitman the CEO, and Ben Bernanke Chairman. Or David Marcus as CEO and Larry Summers as Chairman. We need people with real gravitas on the executive and legal team with the credibility to put governments at ease. We also need these folks to start business before the governments of the US, Japan and Germany decide that they don’t want to take the risk on BTC. BitLegit would need to provide a “kit” to affiliates overseas on how to start a program to comply with your local government laws.
If fictional CEO Meg is doing her job, then she will have convinced the government that BTC related businesses don’t need a money transmitter licenses. She will have convinced regulators that the system can self-govern and they will still receive their tax revenue, catch criminals and do what they need to “piggy banking” on the existing financial system. The Bitcoin protocol is highly auditable, and can be made to be very transparent.
BitLegit’s business model? Transaction fees at the time of cash out BTC to USD or on verified transactions.
Why is regulatory buy-in so crucial to a payment system?
Control of payments methods and instruments are a law-enforcement mechanism for governments and ecosystems. Control and tracking of payments supports prevention of criminal activity and taxation. You see examples of this all over.
• Wikileaks says it is a victim of financial warfare
• Kasparov suggests freezing oligarch overseas funds as a method to prevent Russian aggression against Ukraine
• Apple app store requires all payments for digital goods in apps to be done through iTunes
• You must declare USD10K or more equivalent currency when you enter the US through customs
If regulatory bodies feel out of control of the situation they will crack down, and that would cause reduced confidence and slow adoption. Regulatory confidence is a foundational issue that we will need to be solved before we can get to the cheap, global, frictionless payments we all so desire.
News: The government has decided to tax BTC holdings like property, not currency, for federal tax purposes. This is actually good, legitimacy and less ambiguity increases confidence.
There are startups working on legitimizing Bitcoin, notably, Blockscore doing KYC and Inscrypto doing FDIC like insurance. I salute them, and think that they should merge, so that customers who do KYC get the benefit of FDIC insurance mirroring the existing banking system. They should also strongly consider bringing on Meg Whitman.
What’s the difference between the different crypto currencies? Why does Dogecoin appear to be taking off?
Each cryptocurrency has different properties, but the one that is relevant for this question is the rate of increase in money supply for Dogecoin vs the rate of increase in money supply for BTC.
The money supply for BTC increases slowly. This is discouraging transactions because (if you believe in the currency and its future) you should hoard your BTC. The amount of new BTC going into circulation is low, barring any disaster (e.g. Germany banning BTC, Kraken hacked), it just makes sense to hold because what you have today will be worth more tomorrow.
Because of the limits in the supply of money, today BTC is more of a stored value system (like gold), than a transactional currency (like USD).
Compare and contrast that to Dogecoin, the satirical currency whose mascot is a shiba inu that speaks like a caveman. New coins are issued frequently and at high volume and each coin has little value. It is used to give encouragement and kudos to others and you might as well give it away because there will always be more. People transact purely for fun!
Issuing currency through techniques like those employed by Dogecoin, are used in stored value systems to increase transactions and spur adoption. For example, Facebook issued Credits to users when the product first came out, WoW currency inflates so that every new level pack that comes out, the “rich” people from the past have their wealth obliterated. This has the effect of encouraging spending and discouraging saving.
I am truly torn about whether it is right to advocate for inflationary policy for BTC. Part of what draws me to BTC is that I believe that USD may experience periods of inflation over my lifetime, and I don’t want my savings to be obliterated by US debt and monetary policy, etc. I like that BTC has a known plan for issuing currency. It won’t have unpredictable inflation.
The low amount of new money in supply is an opposing force to encouraging transactions. People hoard, which is a big barrier to making BTC a transactional currency. This is a very hard problem, and I do not claim to have a meaningful solution.
So what can I recommend to enthusiasts who want to increase transactions in the global BTC ecosystem? I’m going to advocate taking an approach inspired by what Brazil did when they rebased their currency in the 90’s. The details of the Brazilian transition are long, but at a high level what they did was during a transition phase of moving their old currency, CR$, to the a new (then virtual) currency, URV, to display the price of goods and services in both currencies (Planet Money coverage). Once people became accustomed to and were able to make the mapping of the price of tomatoes to the new currency URV it helped the transition to transacting in the new currency.
How does it relate to encouraging transacting in BTC? Translating the Brazilian playbook into the current state of BTC requires the following:
- Price in BTC: meaning say that this laptop costs 1BTC, and the price never fluctuates even if the exchange rate BTC to USD changes
- Encourage merchants to show all prices in BTC in addition to USD or local currency
- Compensate merchants for Forex risk. For example, if the computer is 1BTC, but the USD price is $500 and the exchange rate is below $500, pay the merchant $500. Especially for e-commerce, margins are low and their suppliers don’t take BTC, nothing will alienate merchants more than making them take one on the chin.
- Offer “deals”, if people transact in the BTC, they get a discounted price in USD equivalent for their good or service. This is a method to encourage people not to hoard and recirculate the currency. You will need to compensate the merchants for the delta in price as well.
I know what you are thinking. This sounds incredibly expensive! Tell merchants to price in BTC and pay them the difference if needed? Yikes! This approach is not for the faint of heart, and probably cannot be bootstrapped. The way to think about this opportunity is that if BTC becomes a global currency, its value can be 10x what it is today ($8B market cap).
In my mind, apart from the regulatory issues, the money supply issue of BTC is the biggest challenge for adoption of the currency. It will take strong leadership and probably a fair amount of capital to bootstrap the system into being a transactional currency.
On March 15, 2014 the total market cap of BTC in circulation is ~$8B, with around 50% of total coins issued. If you believe that the ecosystem to eventually reach a market cap of, for example, $80B and you bought your BTC today, it just makes sense to hold.
What would it really take for BTC to become a global remittance network, like good enough to replace Western Union?
Futurists imagine a world where each person can transact with any other regardless of physical location, nationality, type of good being sold, whether you are strangers to each other or friends. These payments would also be safe, cheap, compliant and instant. It sounds wonderful.
When you compare it to, for example, remittance through Western Union, which is expensive and manual, it seems, at first glance, that Bitcoin based payments would be far superior. However, this argument discounts the value of the last mile services that organizations like Western Union and the like provide that make them of high value to those who use them.
Now that we have this fancy digital currency BTC we need to ask ourselves, what would it take to use BTC to make this global payment better than Western Union?
The first step involves understanding that payment methods today are very local. For example: while in the US we often use credit cards, in Germany they use Sofortüberweisung, and in Kenya they use M-Pesa. In the Philippines, a country where approximately 10% of GDP is remitted from overseas, many people do not have bank accounts and send/pick-up cash at kiosks (not kidding).
BTC transactions will need to support the reality of local payment methods to match and exceed the capabilities of existing remittance networks. Specifically:
1. Cash out: Each market needs a way to cash out BTC to local currency. Transaction fees are important here. 1% and under transaction fee is very competitive, a sub-5% transaction fee will probably serve some purposes, but a 15-30% transaction fee will likely be prohibitive for most products. It is also really important that this is cash out mechanism is widely supported. If a recipient needs to travel far to cash out her BTC, it is practically equivalent to a transaction fee for many.
2. Cash in: Each market needs a way to cash into from local currency to BTC that is convenient and has low transaction fees. In a local currency->BTC->local currency transaction you have transaction fees on both ends of a network, and this starts to add up quickly. It is often not the global banking system that causes the high cost of remittance, it is the cost of bringing the cash (and the security, etc. that needs to go with it) the last mile that really contributes to the apparent high costs of current remittance systems.
3. Speed: Cash in and cash out need to be fast (1-2 business days or less), if not instant. Holding money for an extended period of time limits the type of transactions that can be done, especially for those with low access to capital.
4. Regulatory: Local governments will need a way to monitor, tax and possibly freeze accounts, at the very least on the cash in/cash out BTC to local currency transactions.
5. Safety: If goods and services are being delivered for BTC, then some kind of recourse or arbitration process in case of non-receipt of goods needs to be in place, again to increase trust in the system as a whole. A clever application built on top of the Bitcoin protocol for this purpose could be of high value.
Overall, supporting legal cash in to BTC from local currencies and payment methods, without attracting the ire of governments and keeping transaction costs reasonable are the ingredients needed to make this global payment system of the future.
Having worked with many payment methods worldwide, this is a tall order. Some payment methods take 15-30% transaction fees, and others take 60 days to remit funds. Luckily, setting up local payment methods to BTC conversion is easy to “crowdsource.” With motivated entrepreneurs worldwide, and software tools to develop exchanges we just need the catalyst of a useful currency to put the whole train in motion.
The most important thing for a new payment system: there needs to be something for sale that people want to buy
This brings me to my final and most important point. The adoption of BTC for transacting and payment will be largely a function of what interesting things you can get or do with the currency. I can’t stress how key merchants (or peer to peer scenarios) are to driving adoption. Even if you have all the regulatory benefits, low fees, and instant payments, if you can’t use the currency to get useful things then the whole ecosystem won’t start.
Bending over backwards for merchants of all sizes, from small sole proprietors to multi-nationals, and opening up transactions for them that would be difficult otherwise will be critical.
Bitcoin has a very special property in that it has miners who are rewarded for verifying transactions. If the block rewards dry up, the security of the system will be compromised. Growth, in overall value, and transaction volume is key to balance and function of the system overall.
Transactions are growing, here is the growth in number of transactions over time.
Other applications of Bitcoin
I think that there are many opportunities for non-payment applications of Bitcoin and Bitcoin-like protocols. Some kind of programmable contracts that can be computationally enforced are likely to make more progress (in the short term) than the payments side due to the regulatory and money supply issues. I am smiling at the thought that in the future you might hire a programmer instead of a lawyer to write your contract. One day soon I’m going to try to write a simple contract using one of the protocols and I’ll report back.
Thank you to my friends Teck Chia, Cody Ebberson, Yariv Sadan and Yin Yin Wu for reading, critiquing and disagreeing with this post.