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CHAPTER VI - Platforms at the Edge of Disruption: Reinventing Money

Money, as everyone knows, makes the world go round. Or at least it has for the past several thousand years. (Gold and silver coins date back at least to the sixth century B.C. while paper money appeared in China in the seventh century AD). For all this time, money represented a promise of value that is backed by a bank and/or a sovereign government. The prospect of reinventing something as fundamental as money to the daily functioning of commerce and capitalism must rank very near the top of the list of potential disruptive forces. That is exactly what Bitcoin hopes to do.

According to Peter Vessenes, Founder and CEO of CoinLab and Chairman of the Bitcoin Foundation, Bitcoin’s fundamental innovation is that it makes it possible for anyone “to send money over data.” In fact, with Bitcoin, value is directly encoded in data. Until now, any transaction other than pure cash depended on intermediaries such as banks or credit card companies using currencies backed by national governments. But Bitcoin is completely peer-to-peer and enables these transfers to happen with no intermediary.

Bitcoin 101

Bitcoin—which is one instance of a larger category known as “crypto-currencies” and could also be described as “open source money”—has a short but eventful history. It traces its origins to 2008, when Satoshi Nakamoto (apparently a pseudonym for a person or perhaps a group of people) e-mailed a paper to a group of computer hackers and experts that proposed the creation of a new system for “electronic cash” that did not rely on third parties.i Nakamoto described a way of encoding value directly in software code that was open but highly secure. Ownership would be protected by use of public/private key encryption where the private key provided the owner with control while the public key enabled that ownership to be transferred openly and securely.

Nakamoto also proposed a process which came to be known as “mining” that would enable the creation of a controlled number of Bitcoins (since no bank would be involved in “issuing” the currency) through a competitive computer processing task that would also serve the purpose of maintaining a public ledger system known as the “block chain” that would keep track of who owns each Bitcoin and to whom it may be transferred. Whoever successfully completed this recurring task first would be rewarded (paid) with a specific number of Bitcoins. Nakamoto also proposed that there would be a fixed total number of 21 million Bitcoins that would be issued over time. To encourage early participation, the total number of Bitcoins created would decline by 50 percent every four years until the pre-determined total is reached.

Figure 7. How Bitcoin Works

Source: http://dupress.com/articles/bitcoin-fact-fiction-future/

The first Bitcoin transaction took place on January 12, 2009. The value of a Bitcoin has been highly volatile, with sharp rises and falls happening on a fairly regular basis. After reaching a high of about $1,100 in late 2013, the value of a Bitcoin has fallen, losing as much as 20 percent of its value in a few days due to speculation, some of it fueled by news about possible actions by governments to restrict or regulate the use of Bitcoins, or possibly by the steady increase in the supply of the currency.ii The currency has also experienced other growing pains. Perhaps the most spectacular event was the collapse of Mt. Gox, one of the first Bitcoin exchanges, in February 2014, after announcing that it has “lost” some 750,000 Bitcoins, which had a worth of approximately $350 million at the time.

Figure 8. Bitcoin Closing Price: October 2013-October 2014

Source: www.coindesk.com/price

Despite these ups and downs, the ecosystem of users and facilitators that supports the use of the currency has grown steadily. (Deloitte’s Carmen Medina characterized the collapse of Mt. Gox as “yet another stress test that Bitcoin has survived.”iii) The ecosystem includes providers of enabling software such as software “wallets” to hold Bitcoins; processors that enable merchants to accept Bitcoin payments for goods and services; exchanges that permit Bitcoins to be bought and sold for traditional currencies (which help to establish the value of a Bitcoin in these currencies); and service providers that offer such things as insurance for Bitcoin transactions. As of October 2014, there were approximately 13.35 million Bitcoins in circulation, or about half of the eventual total,iv while the number of daily transactions and the number of merchants willing to accept Bitcoins in payment has grown steadily.

What is the future of Bitcoin and other crypto-currencies as well as their underlying enabling technologies? They are still so new that it is hard to be sure how they will evolve. A recent report from Deloittev offered four dramatically different scenarios for how the future of Bitcoin may unfold ranging from remaining just an intriguing novelty to becoming the cornerstone of a new economy:

  1. Life on the Fringe: Bitcoin, the currency, never solves the trust and security problems, reinforcing price volatility and skepticism. As a result, companies in the Bitcoin ecosystem are unable to enter into mainstream commerce.
  2. Corporate Coin: Payment and technology companies incorporate the Bitcoin protocol into their payment systems, allowing payments to occur across the Bitcoin protocol without requiring consumers to hold Bitcoins.
  3. Satoshi for All: Bitcoin becomes the protocol for all transfers of value, creating new visibility into financial markets and transforming the services around these functions. The government creates the Block Chain Administration to oversee cryptographic exchanges and provide consumer protection.
  4. New Networks: Bitcoin’s utility in facilitating micropayments and its self-propelling decentralized, peer-to-peer network provide the infrastructure for new ways to work, enabling payment for the myriad activities individuals perform as part of a networked economy.

According to Vessenes, Bitcoin is both a technology and a new asset class. It has attracted a wide variety of supporters including investors, libertarians, retailers, Russians and anarchists who are attracted to the idea of owning something of value that does not depend on a financial institution or government. Part of the appeal of Bitcoin is that in demonstrating a way to have money without a central authority, it represents an ideology about the nature of money and government fiscal policy. (The appeal of crypto-currencies is somewhat akin to that of gold, but without being as cumbersome to own or transfer.)

Like a religion, Bitcoin has spread due to the enthusiasm of its most zealous and dedicated supporters who have served as evangelists for the currency. Bitcoin’s true believers are willing to do a lot to promote their cause. But Bitcoin remains a fringe phenomenon. Jackie Kosecoff pointed out that using Bitcoin is still a scary idea for many people who do not yet understand what it is. CEOs and Boards of Directors of publicly traded companies will remain wary of making significant investment in Bitcoin without more reassurance about its safety. In fact, the Bitcoin Foundation (headed by Peter Vessenes) is working on a “global campaign” to explain Bitcoin to the public.

What, exactly, might be disrupted by Bitcoin? First, it holds the promise of changing a lot of business processes. Conducting transactions using Bitcoin has the potential to be substantially less expensive than using a credit card. Companies that process international remittances charge as much as 15 percent. Using Bitcoin will make the cost of sending money from the U.S. to the Philippines or Africa much cheaper. In the long run, Robin Chase noted, the extent of the impact of the Bitcoin/cryptocurrency technology may depend on the development of mechanisms that take advantage of its potentially lower costs to enable small or even micropayments.

Some major financial institutions have, in fact, already begun to explore the implications of Bitcoin and the opportunities it may offer for new services. Harshul Sanghi, Managing Partner of American Express Ventures, expects that his company might embrace Bitcoin, and sees it as potentially important as the Internet. While he insists that “the current payments system is not broken” and that debit and credit cards work well for almost everyone, there are advantages to being an early mover. But adopting a radically new mechanism like Bitcoin is “non-trivial.” The questions he is asking now are: How should Amex respond to the opportunity? When should they move? When will consumers be ready to adopt Bitcoin?

Moving Beyond Money: The Block Chain. As innovative as the Bitcoin currency is, the underlying block chain ledger technology that provides transparency while preserving anonymity may have even greater transformative potential. For example, RAND’s Bob Brook suggests that a block chain could be used by the health care system to provide a secure universal ID for every patient. This could dramatically simplify the challenge of sharing information among disparate medical records.

Mumtaz Ahmed, Chief Strategy Officer for Deloitte LLP noted that the financial auditing process, which “has not changed at all since the beginning” and is still carried out manually, could be changed dramatically if financial transactions were conducted via digital currencies. Going digital could have a big impact on such things as the detection of fraud. And audits could evolve from a periodic activity to a continuous process taking place in close to real time. Peter Vessenes commented that “the best audit in the world” could be easily performed if an entity were willing to publish the “addresses” of all assets it owns and let an auditor check every transaction.

A block chain-based system could also be used to document ownership of tangible property (ranging from appliances and cars to real estate) and simplify its sale. Another possible use is for “smart contracts” once described as “the killer app of the crypto-currency world.” Today, John Seely Brown notes, we live in a world in which “contracts don’t compute.” A smart contract is essentially a computer program linked to a virtual currency that can automatically trigger a contractual provision when a certain condition is met (for example, paying off a bet once a winner is determined or authorizing payment to an online merchant as soon as a purchased item has been accepted for shipment). Smart contracts could have an especially large impact in the developing world where corruption is widespread and contract law is weak. But they could also have some big impacts in advanced economies like the U.S. For example, if block chain technology is used to automate many tasks that now require legal services, the role of lawyers might eventually shift from providing transactional services “to producing smart contract templates in a competitive market.”vi

Steven Gillett of Symantec commented that he had asked for his bonus for this year to be paid in Bitcoins (though he did not say whether his request was granted). He sees Bitcoin as a “breath of fresh air” in an environment in which more and more companies are basing their businesses on their ability to collect and “monetize” information about their customers. He pointed out that it is simply wrong to assume that companies like Google or Facebook are giving people anything for free. They are, in fact, selling their users’ personal data to others for a profit. Google’s chairman, Eric Schmidt was quoted as saying that if you want to protect your online identity, you should change your name—which is not exactly a user-friendly solution. By contrast, Bitcoin is not a monetization scheme but a highly distributed payment system with built-in privacy protections. Gillett concluded by observing that Bitcoin today seems to be in much the same place that the Internet was in 1997—poised on the brink of explosive growth.

Today, however, Bitcoin and other crypto-currencies are still an “edge phenomenon.” If companies want to be prepared for future challenges, they need to be scanning the horizon for both threats and opportunities. Unfortunately, many individuals and organizations that should be on high alert are instead in a state of denial that coming changes could have a direct bearing on them and what they do. For many enterprises, the real choice is between being disrupted and disrupting themselves. At heart, according to Mumtaz Ahmed, being prepared to react to future changes is a talent problem.

ENDNOTES
i Satoshi Nakamoto, “Bitcoin: A peer-to-peer electronic cash system,” Abstract, October 31, 2008, http://article.gmane.org/gmane.comp.encryption.general/12588/Back to article. ;

ii “Bitcoin price falls to 11-month low,” BBC Technology News, October 6, 2014, www.bbc.com/news/technology-29507443.

iii Carmen Medina, “The Birth of Bitcoin,” DUPress, March 12, 2014, http://dupress.com/articles/everything-know-money-change/?coll=9331.

v Tiffany Wan and Max Hoblitzell, Bitcoin: Fact. Fiction. Future, Deloitte University Press, June 26, 2014, http://dupress.com/articles/bitcoin-fact-fiction-future/.

vi Jay Cassano, “What Are Smart Contracts?” Fast Company, September 17, 2014, www.fastcolabs.com/3035723/app-economy/smart-contracts-could-be-cryptocurrencys-killer-app.

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