What is Preventing Mainstream Bitcoin Adoption?

Arguably Mid 2014 was peak Bitcoin in both the major news outlets as well as in the price.  Since then the price has fallen, competitors have emerged and the hype as dipped.

Despite Microsoft and others are “adopting” Bitcoin and actual transaction volume increasing, this is not at nearly the exponential rate required to upset incumbent payments players.

Therefore something is either holding back Bitcoin or this is a temporary bump in the road.  I believe this is evidenced by the two narratives dominating  discussion in the industry:

  1. The price fall is temporary and it’s a matter of time before it comes back and goes past 10,000 USD vs
  2. The technology is interesting not the currency.

Chart  shows Searches for “Buy Bitcoin” (Blue) vs “Blockchain” (Red) (credit  for chart to @Pierre_Rochard)

buy vs blockchain

The chart above shows that interest in the technology is outstripping interest to buy bitcoins.

What’s really going on here? This post explores a number of ideas and attempt to establish what is actually happening.

Why did the Price Spike?

There are a number of theories on this, my own opinion is the following were key factors

  • A belief (championed by Marc Andreessen) that the technology will eat institutions and open up the trillion dollar financial services industry to competition from start-ups.
  • A virtuous circle of press releases about “Merchant X” now accepts Bitcoin (at least til mid July) and link with price
  • A dollop of Tulip mania as the main stream took notice
  • Technology enthusiasts and those who generally had an issue with banks investing to try and “beat the banks” out of existence

Why has the price dropped?

Rationally the price should be going up because the price drop reduced reward for miners and has led to less mining hardware being added to the network.  In turn reducing the supply of coins in the market.   Less supply + sustained demand (as shown by the flat blue line in the chart above) = increased price right? Not exactly, there are two issues, which are related outlined below:

Issue #1 – Bitcoin isn’t particularly liquid, with the vast majority being hoarded or held on to. (70% of Bitcoins have not moved for 6 months or more)

7-hoarding-chart

Issue #2 – Perhaps controversially – regulators and existing banks have been effective in preventing bitcoin from becoming mainstream due to a lack of identity and consumer protection capabilities. The cause of #1 may in fact be #2.   Bitcoin needs to be widely adopted for it’s price to continue increasing.  So this point bears exploring.

If Bitcoin Forcefully Disrupts Banks the Price WIll Rise

I believe this is highly unlikely.  There’s a school of thought that says banks will be forcefully disrupted. Consumers can use bitcoin by simply managing their own PGP keys without the need for the slow, painful and poor service provided by banks. Why wouldn’t consumers and corporates want this yesterday?

Whilst I think this pays a huge compliment to the majority of humanity it also misunderstands it. The vast majority of humans  want services that are super simple to use and require almost no responsibility to manage.  This is why we historically centralised trust, to make complex things someone elses problem.

Banks and Regulators play a Useful Role – Understand and Protect the Consumer

To the credit of the bitcoin and start-up ecosystem, I think bitcoin is focussing more on the rails and leaving the consumer experience to others. There also start-ups such as Circle, coinbase and Xapo providing strong consumer experiences. Whilst this is imperfect from a bitcoin libertarian perspective, it is pragmatic from a human context perspective.

Yet experience alone isn’t enough, start-ups like bitstamp are learning the hard way that as much as people hate banks, they are generally quite good at the basics like not getting hacked for individuals or corporates own funds (and where they are, mechanisms exist to rectify it quickly).  Start-ups that focus on this will create a well protected consumer experience, but there still needs to be a compelling reason for consumers to adopt their products vs using a bank account.  “Not being a bank” isn’t a good enough reason.  The protections and the functionality of banking need to exist in full.

This would suggest for Bitcoin to gain adoption it might be optimal for banks to adopt the Bitcoin rails.

If Banks Adopt Bitcoin the Price WIll Rise

This has potential, but is unlikely until a number of problems are solved (discussed in “Future Foundations” below). Banks and regulators are reflecting consumer and corporate demand by taking responsibility for protecting money under an understood regulatory and legal framework.

Yet banks and regulators have proven ineffective at driving out cost or improving customer experience in the same way a start-up would (or Bitcoin could).  I believe this is because

  1. Banking has limited shared infrastructure – it is a mesh of proprietary technology trying to interoperate
  2. The shared infrastructure it does have requires a lot of change at member banks (e.g. SWIFT)
  3. This change is typically very slow because many banks have to change, and the way change is implemented involves lots of paper and committees.

Paper and committees are very 20th Century solutions,  and not conducive to change at pace. Imagine if a blockchain (like bitcoin) could bake into it’s protocol some of the regulation for example.

The concept of a decentralised payments rail could be very advantageous for banks, but to meet the needs of consumers (taking responsibility for their money) there are three main things that need to happen to increase adoption.

Future Foundations for Increased Adoption

1) Solve for Identity and KYC

Silk road a, Mt Gox and other headlines created the perception that the technology “cannot do KYC or protect money” has created a perception that Bitcoin (the brand) is “poison”.  Yet banks and institutions can see benefit in moving to shared clearing and settlement system for money.

The major barrier for banks and regulators alike is how do you prevent, detect and report on Money Laundering, and who has responsibility for doing so?

There are solutions out there from the likes of www.matrixvision.eu and others, and many exchanges have examplary KYC (Know Your Customer) processes to eliviate these issues. The gap is in creating consensus about who needs to do what, and who’s responsible for what in a decentralised system. In bitoin it’s perfectly possible for a bank customer to send money to a bitcoin wallet. Who’s responsible if money laundering occurs at the wallet or beyond?

2) Build Regulatory consensus
Regulators like the CFTC, EBA and central banks such of the Bank of England have been surprisingly open to discussion on how to adopt the technology, and equally underwhelmed by solutions coming from the digital currency businesses. It is entirely possible to be regulated within existing frameworks. The onus isn’t on the regulators to create new regulation, it’s on the industry (start-ups and incumbent banks) to figure out how to implement existing regulation… and that’s really hard, dull and slow.

3) Build industry consensus
The banks are coming off a decade of having their balance sheet hit by the regulators, leading to an ever decreasing appetite for risk from the compliance departments. Nothing is more risky than an unknown quantity, that has a very bad reputation. In the banking fraternity, perception is everything, regardless of reality. The banks themselves are hugely motivated to reduce their cost base, if they can figure out how to collaborate in this space and create the global highways of tomorrow they may be able to do just that.

There Appears to be Limited Desire to “Fix” KYC for Bitcoin

Current regulation fits the the architecture banks have today making banks responsible for being the police of money, whilst money is on their system.

No equivalent exists for Bitcoin. Whilst banks are looking for ways to reduce cost as an alternative to the current banking model
bitcoin remains incompatible without a solution to this problem.

Perhaps though, that isn’t the fault of bitcoin but it’s current implementation. I’ve been using the metaphor lately, it’s like blaming the inventors of the car for not creating traffic lights. The types of people who would create a traffic light (regulators and silver haired bankers) are typically not technologists and see many of the consumer protection issues the technologists do not.

Perhaps Bitcoin itself shouldn’t solve for identity, but the users of it (banks, regulators and start-ups) need to be more proactive in doing so.

What has any of this got to do with the Price of Bitcoin?

If bitcoin (or it’s competitors) had the foundational backing outlined above the price in mid 2014 will look cheap. This may be why whilst
Bitcoin has dropped in price, over the same time period Ripple (XRP) is up 16x. Perhaps the Future Foundations I point out above are unpalatable to Bitcoin purists, and in all honestly, I don’t think it’s up to Bitcoin the protocol to solve alone. I would encourage it’s developers and enthusiasts to reflect on how they might meet those challenges, especially given the traction the alternatives are getting with institutions by doing so.

One thing is for certain, there is no lack of belief in the potential for the technology, there are just a number of very real problems before you can do so.

If you solve these, you’ll increase adoption and liquidity, which in turn will increase price.

What are your thoughts?

  • http://www.adopthelp.com/ kendracyrus007

    Thanks for the article. It’s very good analysis.