September 17, 2015    5 minute read

Bitcoin: The payment revolution

   September 17, 2015    5 minute read

Bitcoin: The payment revolution

Bitcoin is the first decentralised peer-to-peer payment network that is powered by its users and there are no central banks. It is the first implementation of the concept called “cryptocurrency”, i.e. a new form of money that uses cryptography, rather than a central bank, to control its transactions. The hacker Satoshi Nakamoto has created Bitcoin in 2008 by publishing the invention in a research paper called “Bitcoin: a peer-to-peer electronic cash payment”.

Since there are no central banks, new bitcoins are issued through a “Bitcoin mining” process: the miners use sophisticated software to solve math problems in the network and they receive, in exchange for their service, a certain number of bitcoins. Miners are people that decide to contribute to keep the Bitcoin network secure by approving transactions. Therefore, this mechanism of issuing new cryptocurrency incentivises new people to mine, thus leading to a more safe and stable network.

Bitcoin payments are easier to make than debit or credit card purchases. Payments are made through a wallet application, which is available on either computer or smartphone, simply by inserting the recipient address and amount. The essential breakthrough is that two users can now exchange money directly with each other, without the need of any intermediary. Before bitcoin, it was possible only using cash, and so in the physical world. This provides the advantage of payment freedom. Bitcoins can be sent anytime and anywhere in the world. No bank holidays or bureaucracy problems. They allow the owner to have full control of their money. Moreover, bitcoins have little fees that depend on the wallet application that the user has chosen. Although the number of merchants accepting bitcoins is increasing (e.g. Amazon, Target, CVS, Subway etc.), the major downside is that bitcoins could be used for payments of illicit goods.

The increasing number of users and the new possible transactions using bitcoins led to a bubble at the end of 2013. Because bitcoins is a relative small market compared to what it could be, it does not take a significant amount of money to move the market price up or down, thus the price of bitcoins is still very volatile. With respect to USD, the price of a Bitcoin soared over USD 1,100 at November 2013 then, following the bubble bursting, the price declined around a more stable USD 300. The price surge means that bitcoins can also be used as a speculative asset than a currency. A possible crash is another risk that bitcoin could face.

market-price

Concerns about limitations of bitcoins and the excitement about its innovation incite other people to develop new cryptocurrencies. For example, Litcoin and BitcoinXT. This resembles a similar story to what happened in the late 1990s with the file-sharing services. Napster was the pioneer of that kind of services and despite it was illegal, unlike Bitcoins, it demonstrated the incredible demand for that service, thus revolutionising the use of internet and inspiring other services like iTunes and Spotify. Similarly, bitcoins can trigger an increase in digital money innovations.

In Silicon Valley, there is great excitement about new “Bitcoin Wallet” start-ups. According to the Financial Times, a total of $317 million has been invested in bitcoin start-ups since 2012 and the flow of money is accelerating. Those young firms offer wallets to allow users to make payments and hold bitcoins. A currency protocol exists, but it is quite difficult to understand. Therefore, venture capitalists are investing into firms that make easier to use bitcoins. In September 2015, five bitcoins start-ups including Chronicled, Chain, Abra, Case and Coinalytics, have raised more than $45 million in funding from Wall Street investors, banks and venture capitalists.

In April 2015, Goldman Sachs Inc. made public its investment of $50 million in Circle, a start-up bitcoin wallet established by Jeremy Allaire. This new injection added up to a previous $26 million of financing funds for Circle and, according to the WSJ, the value of the firm is at around $200 million. Unlike other low-cost and fast digital money transfer platforms such as Pay Pal, which operate exclusively inside their own network, Circle allows users to send money outside the firm’s network. This is what the founder, Mr. Allaire, calls the goal of interoperability. Also another important bank, UBS, announced that it decided to explore the financial uses of the technology underlying bitcoins (the bitcoin blockchain). It seems that after the 2013 bubble, the investors are starting to look at digital money from a different perspective. The curiosity arises from the capabilities of the system to improve the payment mechanism worldwide, rather than the currency itself and its intrinsic value. Some start-ups are trying to introduce the low-fees Bitcoin also in Africa.

In the light of these considerations, it is not clear where the future of digital payment mechanisms is going. The excitement about Bitcoins can either rise or drop dramatically, as innovations will be introduced. Therefore, the rationale behind the choices of leading global investment banks, such as Goldman Sachs, could be for hedging purposes. In the scenario in which the bitcoins will become the most used payment method worldwide, then Goldman Sachs and the other investors will receive huge rewards.

To conclude, cryptocurrencies could still revolutionise banking. In few years, bitcoins passed from an obscure code to an international method of payment. After that the bubble had burst, the price of the Bitcoins has reversed towards the mean and the excitement has created a huge momentum around this new technology. New cryptocurrencies have been and will be created over time, and the technology improved. Moreover, bitcoins are more likely to have a wide use in the countries with especially weak currencies, posing new and challenging regulatory consequences to be explored for bitcoins.

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