Bitcoin: The Esperanto of Money

Global communication has solved many problems and opened the door for new kinds of commerce. In many cases “big box stores” are increasingly obsolete. Electronic products have displaced physical ones where possible: ebooks are less expensive and are delivered faster than physical books, MP3’s (or their lossless cousins FLAC) have displaced CD sales. Streaming rivals (but has not eliminated) DVD and BRD sales. The list goes on.

For all the innovation the modern Internet has brought us, it has caused more than a few headaches. Nowhere is this more true than one critical area: point of sale.

A Brief History of Credit Cards

When credit cards were first created in the 1950’s the Internet did not exist and ARPANET (the Internet’s predecessor) was more than a decade away. At the time, it made sense to be able to magnetically swipe (or imprint with carbon paper) credit card numbers. Merchants only had to trust their employees and their bank. Fraud, when it happened, was rare and entirely small time. They were a big improvement over checks—which could be forged—and didn’t have the same drawbacks as cash—which could be stolen leaving the victim with no recourse. The only drawback for the merchant was the additional fee, but that could be mitigated by a slight change in pricing effectively passing the cost on to the customer.

As Internet based businesses began to crop up the problem of securing credit card information was instantly an issue. At first, this was solved by encrypting the credit card information in transit. This did not, however, solve everything. Early on merchants would store credit card information in databases that could be compromised. Though security did improve and small scale data breaches became less common. Data breaches, when they did happen, often were the result of customers with infected Windows based computers, not a breach of the vendor’s database.

As electronic commerce grew, so too did the size of databases with customer information. Which meant that when meaningful breaches actually occurred the results were often disastrous. Hundreds of thousands of customers could be impacted.

To help mitigate the risk intermediaries arose, such as PayPal, to reduce the amount of financial data various retailers needed to store for each customer. This did indeed help the problem, but with some additional drawbacks. Increased transaction fees, restrictions on trade in some parts of the world and a barrier of entry for merchants.

Bitcoin: A Whole New Ballgame

With the rise of bitcoin everything is different. There is no more need for a merchant to store financial data. Only the barest information is needed: a shipping address—and then only if the product is physical.

What is bitcoin?

It’s a new kind of currency called a cryptocurrency. That’s a $20 word that means it is based in the mathematics of cryptography. Instead of the customer sharing his credit card information, the merchant provides a payment address. Once the buyer has the payment address, he sends to funds from his computer or his smart-phone. The merchant gets the payment, and no private financial information is exposed.

The Perfect Really Is the Enemy of the Good

Bitcoin has many strengths:

  • Transactions are fast, nearly instantaneous at zero confirmations, 10 minutes or more for the first confirmation. By contrast, credit card transactions are in limbo for more than a month. Merchants are more keenly aware of this than consumers, but it’s important.
  • Transactions are global and cannot be interdicted. This means if you want to send money to a friend or relative in a country that makes this needlessly difficult (e.g., Argentina) you can do so… and nobody can stop you.
  • Because its digital and can be represented in many forms (including a memorizable pattern of information called a “brain wallet”) it’s much harder to take by theft or coercion.
    *Because it has a limited supply, bitcoin SHOULD become more valuable over time. But, who knows if that’s actually how it plays out.

Bitcoin has a few weaknesses:

  • It has a learning curve. Bitcoin addresses are long and unwieldy. I expect eventually most people will use aliases for their public keys. But, that is just a conjecture.
  • Bitcoin is digital. This means that if your computer gets compromised, you might lose your bitcoin. Certain technologies can mitigate this: not using inherently vulnerable devices (i.e., any computer running Windows), multi-signature addresses, paper backups, and encryption.
  • It’s not yet ubiquitous, but its rate of adoption is increasing. So, you can’t buy everything with bitcoin. But, in a lot of cases you can come close. For example, Gyft lets you buy a large number of gift cards using, among other payment methods, bitcoin.
  • The value of bitcoin fluctuates (sometimes wildly) against the US Dollar. This will always be the case, but I think the large swings will eventually go away. In any event, Bitcoin is designed to be deflationary, so it SHOULD get more valuable over time. This is more of a problem for westerners who are used to trading in only one currency: emerging markets don’t even think twice about this “problem.”