Bitcoin – and its focused leveragors and imitators like Ripple – have gained a lot of press and traction. The question that I keep coming back to is, what are they good for? I do not mean this in a cynical sense, but in a literal, “what is the best use case” sense?
The answers I keep coming back to are two, and only two:
- Person to person payments
- International transfers
I am, for now, ignoring the “subversive” element of Bitcoin – a currency that is not controlled by any central bank, and thus not subject to inflation, deflation or other political motivations. After all, in most Western countries, despite the great skepticism about the motivations and competencies of central banks, few are ready to actually give them up.
New technologies and services are accepted into play only when the existing system is just too painful to work with. As anyone who has driven change in a company, a market or a family knows, a slight improvement is never good enough to get people to change their behaviours; the improvement has to be material.
In terms of financial transactions, for everyday usage, like getting paid by your company and paying bills by credit card, the existing system works just fine. Almost no one complains about getting (employees) or sending (employers) their paycheck via direct deposit, and very few consumers complain about paying online or in a store with a credit card.
Might that change if a severe enough breach at a large enough institution damages either the ledger-keepers (retail and commercial banks) or currency managers (central banks)? Definitely. Given that all of those are a real possibility, it is entirely possible that large numbers of people will want to move away from heretofore “trusted” centrally-controlled systems.
Nonetheless, assuming stability of the retail, commercial and central banks, there only are two areas where the current system is too painful, too expensive, or both:
- Person to person payments
- International transfers
Person to Person Payments
Whether it is the colleague at dinner with you, your sibling across the country, or your business partner on the other side of the planet, passing him or her funds is painful. You have to deal with 2 issues:
- Distance: Whether across the city or across the world, getting the funds to them is a pain.
- Precision: Even if you solve the distance problem by having them right in front of you, having enough cash and the exact right amount on hand at the moment they are there is a frustration.
Thus, the ability to send an exact amount of funds to anyone, wherever they are, with great ease, is of very high value.
Could existing banking systems solve this without Bitcoin? Most definitely. Many have tried, including PayPal and various retail banks’ person-to-person payments. But the existing banks simply are not set up to do this. Even intra-bank transfers – when the sender and receiver are in the same bank – have been slow and painful.
Interbank transfers are even harder, as they depend on the ACH system, which takes one to several days and layers of authorization.
Two or three or ten banks could get together and agree on an electronic system to transfer funds between them instantaneously. But if even one bank cannot get its act together for transfers between accounts, how can we expect multiple banks to cooperate well?
At heart, it is probably because the banks are too focused on making money on the float, rather than servicing the customer. If I send you money instantaneously, the bank uses the funds however it did before. On the other hand, if it takes 24 to 48 hours between the time I send it and you receive it, then the bank still has usage of the funds while neither of us does. Is this unsavoury? Sure. Doesn’t stop them from doing it.
Banks have become intensely profit-focused, rather than service-focused. When you focus on making the customer happy, profits tend to come along for the ride; when you focus on profits, you tend to have a short-term boost in profits followed by a long-term decline.
If transferring money between two accounts in one bank is hard, and between two two accounts in two banks is painful, transferring funds between two accounts located in two different banks in two different countries is impossibly slow and expensive.
The basics of wire transfers are:
- John “wires” Kate $100
- John’s US bank sends the wire authorization message to Kate’s UK bank
- John’s US bank takes $100 from John’s account and puts it in an account in their bank that is held by Kate’s UK bank, i.e. just an intra-bank transfer.
- Kate’s UK bank takes $100 from the account in their bank held by John’s US bank, and puts it in Kate’s account, i.e. just an intra-bank transfer.
In other words, you never wire funds; you just authorize the banks to move money around between accounts held on their own ledgers.
Given how simple that is – a wire transfer is just an electronic authorization plus two intra-bank transfers – one would expect it to be near instantaneous and almost free. Then again, given how difficult banks make it to transfer funds between two local accounts owned buy the same person, it should come as no surprise that this is that much more drawn-out and expensive.
What Banks Could Do
Banks could, very simply, make intra-bank, interbank and international interbank transfers instantaneous and cheap. If they did, they would take the wind out of much of Bitcoin’s usage, at least in developed economies. They can afford it; margins on these products probably are higher than roaming fees for mobile carriers.
Will they? Fat chance. It cuts to the heart of the business they believe they are in.
The real long-term risk to traditional banks is that their obtuseness in these 2 (and many other) areas can lead, and probably has already led, to growing demand for alternative payment mechanisms like Bitcoin and Ripple. These in turn may stabilize and mainstream sufficiently to solidify them not just as an alternative transfer mechanism, but as an alternative banking mechanism. Why keep your funds in banks which are breached, unreliable, and expensive, when you could just keep them in more reliable Bitcoin ledgers (i.e. the blockhain)?
Already Bitcoin-based payroll has emerged. It only exists if demand exists.
As long as banks were good enough, who would bother switching. But with a solid enough wedge via payments, the rest of the edifice looks a lot weaker.
Barriers to Entry
A key barrier to BTC adoption is the cost of getting traditional currencies in and out, usually 1%. If you are buying a $20 book from Amazon, why bother using Bitcoin which costs you $0.20 (1%) to get the funds from USD to BTC, when Amazon happily eats the 2-3% (at their volume, probably more like 1.5%) of the credit card cost. Sure, $0.20 doesn’t matter much, but if you are buying $1,000 worth of things from Amazon, that 1% in (and out) looks a whole lot more expensive.
It is hard to predict the net long-term effects. Could sufficient funds eventually end up in Bitcoin or alternate banking mechanisms to undermine the fractional reserve system and thus slowing the velocity of money? After all, if your funds are in Bitcoin and not Citibank or Barclays, who is lending them out, and what does that mean to credit availability? Conversely, could lending banks based on Bitcoin deposits arrive, thus creating a fractional reserve Bitcoin system that mirrors the fractional reserve Dollar, Pound or Euro system? And if so, would interest rates be set entirely based on risk, without any reference to central bank-set interest rates?
Would those rates be more competitive than those offered by banks, driving more transactions into Bitcoin? For example, if the premium for loans for a particular business is 3% over the Fed Funds Rate, and the FFR is 2%, then the borrower will pay 5% to Bank of America to borrow USD… but only 3% or close to it to borrow BTC. What happens to BofA’s ability to lend when that happens?
In the near-term, short catastrophic failure of ledgers at retail banks or currency management at central banks, Bitcoin will remain the purview of person-to-person and international transactions. But over time, those activities could constitute a wedge to drive further activity into Bitcoin.
Will it? Ask the banks and regulators.