Bitcoin – the world’s most well known crpyto-currency – is a game changer in the financial industry. There are vocal proponents from both sides of the debate on whether it’s here to stay and will revolutionize the way we use money, or whether it’s just a fad that will pass like most other trends on the internet.
The concept is actually fairly simple, however will all the talk of ‘mining’, ‘Blockchains’ and ‘cryptography’ they could fairly be described as exactly that – cryptic.
Essentially, the idea is to completely decentrallise the way we create, track and transfer money. Instead of a central bank printing money, Bitcoins are gradually generated in increasingly smaller amounts. Instead of the vast myriad of different banking and financial structures, there is one global ledger containing every transaction ever made. Transfers are made directly between individuals, and are relatively anonymous – one of the main initial uses of Bitcoin was on the Silk Road (a dark-web site used to purchase such undesirables as drugs, guns and even personal assassinations). You may wonder how such a system could exist without any kind of direct management?
‘Money supply’ in the system is itself the incentive to provide the computing power that enables the system to operate effectively.
The answer is ‘mining’ – the process by which people earn new Bitcoins. Every few minutes a group of computers will collect up some outstanding Bitcoin transfers and turn them into an increasingly complex mathematical puzzle. The first ‘miner’ (computer) which finds a solution will announce it to the others on the network to check – in doing so verifying if the transaction is actually valid (ie. the sender has Bitcoins to send). If enough computers agree, the transaction is added to the global ledger mentioned – hence the name Blockchain, as the transactions are continuously added in ‘blocks’ or groups of transactions. After another 99 blocks are added, the miner that first found our solution is rewarded with 25 Bitcoins (about $7,000) for his effort. Essentially, the ‘money supply’ in the system is itself the incentive to provide the computing power that enables the system to operate effectively.
This is all well and good, but aside from the rather unsavory uses we mentioned regarding illicit purchases (resulting from Bitcoin’s relative anonymity – users are only identified by a computer address for where their Bitcoins are digitally stored), why would anyone use a ‘currency’ without any kind of government backing or direction?
First, Bitcoin is completely nationless and provides a very obvious solution to the remittance fee problems experience by many developing nations. Second, mobile money transfer initiatives such as mPesa are taking off across the developing world are already based on tokens rather than direct money, and would actually appear to be better suited to a Bitcoin-esque solution given their other infrastructure and governmental issues. Finally Bitcoins are essentially just a line of code, and so could be integrated into our existing IT systems in a way that traditional currency simply can’t.
The World Bank estimates that remittances (sending money from one country to another) constitute more than a third of some countries GDP. These are often developing nations ($325 of the $440 billion transferred in 2010) where family members are sending money home, having moved abroad for work. These transfers are often vital for poorer rural relatives, older dependents or even children and younger siblings. However, up until recently there has been relatively few ways to securely transfer funds and the companies involved could charge fees proportional to their de facto monopolistic position.
Bitcoin introduces the possibility of creating a wholly decentralized system for transferring money
Recently however, the growth of mobile money services has put a dent in their profit margins. mPesa, originally from Kenya, allows people to transfer money via simple text messages. People were already transferring money using mobile phone credit, but the need to find someone to buy the airtime after the transfer made the system inefficient. mPesa simply replaces the mobile airtime with tokens that are directly backed by currency (either deposited at a cash terminal, office or purchased online). This allows simple and cheap money transfers, and after you’ve registered in one of the office branches you only need a mobile phone and signal. Over 70% of Kenya’s economy is now facilitated by mPesa, and the service has expanded worldwide into Afghanistan and South-East Asia.
SMS transfer like mPesa has already enabled significant savings for thousands of people across the developing world, however the system is still limited by the need for an appropriate account. Bitcoin introduces the possibility of creating a wholly decentralized system for transferring money simply using texts. In countries where corruption is rife, infrastructure non-existent and cash a target for exploitation, this has huge value potential.
This also introduces the final driver in Bitcoin adoption – digital. Specifically, Bitcoins are simply unique lines of computer coding – and thus are theoretically programmable. There is a possibility that we could start to see ‘smart money’ – that has other functions aside from simply storing value. We are already seeing a wide variety of people accepting Bitcoin as payment – from airlines to Tesla, but there’s a possibility for an entirely new branch of finance to appear. Bitcoin’s could actually be programmed to do specific functions on certain conditions – for example, instead of using expensive traditional escrow services the coins themselves could actually be programmed to only release form certain conditions.
We can clearly see that Bitcoin is a remarkable development in finance and business, and has the potential to create lasting humanitarian, economic and social change across the world. It is vital that we understand the Bitcoin phenomenon, and that institutions, from local governments to big-business, embrace the chance to take up their responsibilities.
There is a revolution taking place as monumental as the first time we traded sea shells in prehistoric times – but we will need to engage with it to ensure it delivers on this potential.