Think The Blockchain is Interesting But Bitcoin Isn’t? Think Again

Whilst the “Blockchain is interesting” narrative has merit, it created a dismissive approach to Bitcoin that misses a trick.  If you don’t want to miss that trick, read on.

Banks have gotten into this “Blockchain” thing like it’s the new snake oil,  a conversation about “Blockchain” will open any door and liberate a little budget.  As this Dilbert remix excellently sums up

dilbert chain

This isn’t the first post to explore “Bitcoin bad, Blockchain good”, but there are some things I felt still needed to be said. There is an excellent post by Richard Brown (which I recommend reading as pre-text to this) and another by Chris Skinner. Both make the point that saying “Blockchain not Bitcoin” is dangerous.

The subject has become too binary, either you believe Bitcoin will eat the world, or it is incompatible with current banking regulation and practices.

It may be helpful to understand why the banks instinctively warm to the Bitcoin bad narrative. There are three main misconceptions and one thing I agree with fuelling this:

  1. The Misconception: It’s easier to launder money with Bitcoin
  2. The Misconception: Bitcoin is not secure
  3. The Misconception: Bitcoin would not be profitable for banks
  • The Interesting Truth: There are valid, exciting and profitable use cases for the technology outside of Bitcoin’s architecture

I’ll tackle the misconceptions later in this post, but first it’s worth a quick refresher on what’s interesting about Bitcoin.

Bitcoin’s Got Talent

Perhaps the reason there are so many misconceptions because so few people understand Bitcoin. It has a number of unique properties that banks are seeing as a threat, rather than an opportunity.  Think about the problem of Cash for banks…

Cash Got Problems (yo)

When you have money in your bank account, it’s not actually yours legally. The bank owe’s it to you (as ever there’s an excellent Richard Brown post that goes into more detail on this). They’re using that money on the stock market to make a profit.

The more you use debit and credit cards, the more profitable you are. If you draw out your entire wage as cash every month you’re one of the least profitable customers.

Paper cash is expensive. There are an army of vans moving cash around the country, from supermarkets to vaults and back again.  A logistical nightmare that adds a ton of cost compared to digital money.

Paper cash is also risky, it’s near impossible to trace because it exists physically and carries its value as it moves. Do you know where the cash in your wallet came from or who had it last? What about before then? If you ran a drug cartel, it would be very helpful to have a network of chicken shops to take all of that cash and get it into the banking system.  In developed markets cash is slowly being displaced (not nearly as fast as you might think!)

cash is king

But in developing economies it’s a different story

Cash Can Reach Where Banks Can’t

220 Million Agricultural Workers are paid in cash. If you live on a remote farm, or are urban poor, there’s a good chance you’re not profitable as a current account customer. You wouldn’t put enough money in the account per month to make the cost of giving you an account make sense for the bank.  Banks have to maintain branches, servers, data centres… all of that cost makes you expensive unless you’re giving them a significant amount of money per month to profit from.

If you get paid in cash, you’re trapped in a cycle of cash.

Recent years have seen the emergence of mobile airtime being used in place of cash… this helps, but only solves part of the problem. You’re still getting paid in cash and you still can’t save or borrow. You’re still not financially included.

Bitcoin As Digital Cash

When I send you money from my bank account to yours, my bank owes me less, your bank owe’s you more.  I haven’t paid you, my bank paid your bank.

This isn’t a possibility for under 18s or billions of unprofitable potential customers. This is where Bitcoin has huge potential. As a digital token that holds value, it can transact as cash. When I send you a Bitcoin, you receive it, not your bank.

Can a Bank Make Bitcoins Make Sense?

Regulation aside (for a moment), the mechanics for a bank to accept Bitcoins instead of cash would be relatively trivial. They’d just need an exchange capability. As soon as the “Bitcoin cash” is collected, it wouldn’t have to be physically moved anywhere.  If you look at it purely as a cash replacement, it actually makes sense.

Sure Bitcoin is a bearer asset (your bank can’t use it on the stock market – yet), but it reaches where the bank can’t.  It’s also got another trick up its sleeve…

Bitcoin is Permissionless

Permissionless innovation was a phrased coined to explain how the internet changed the telecom industry and created opportunity. Before the internet, all of your communications had to be compatible with the telecoms operator you used. The internet created a new set of rules. In a different way, Apple did this with the “App Store”. Inviting the world in to build whatever they like with a set of lego bricks.

Bitcoin similarly is an open set of lego bricks, that will always work no matter who you are. This property does not apply to the bank use
cases of what they call “Blockchain”.

A closed distributed ledger system has many advantages over today’s technology, but it’s not permissionless. It will therefore, never reach the types of customers truly permissionless innovations can.

To use Bitcoin you needn’t go to a branch and provide a birth certificate (which is quite difficult if your nearest branch is 5 hours away and you don’t have a birth certificate!) A mobile network operator tomorrow could decide that their airtime will be tradable for Bitcoins on a Bitcoin exchange.

It would then simply require someone to wrap these two things into a proposition for remittances (like say BitPesa) to make it really easy for Ex-Pats to send money home to their family to be received as airtime.

 

Bitcoin As a Customer Acquisition Opportunity

Perhaps then Bitcoin is the technology equivalent to the student account. A loss leading outreach programme to win a new generation of customers because they’ll be valuable over their lifetime.  This might actually be feasible if local regulation allowed it.

Because the Bitcoin blockchain (ledger) is so very transparent,
you could actually watch Bitcoin wallet behaviour and use that to build risk models.

In other words, you’d be able to identify customers who may be low risk for a savings or loan product.

Granted, there’s a number of sizeable challenges before that could be possible, like consumer acceptance or the regulatory acceptance.

To make any of this a possibility will require a little imagination, a lot of opportunism and overcoming some key misconceptions…

Overcoming Misconceptions

Won’t People Launder Money With Bitcoin?

The recent Silk Road arrests suggest the FBI found it relatively trivial to collect evidence and arrest those involved. The issue is the network itself doesn’t require an identity. In itself, not having an identity to transact digitally is incompatible with existing regulation.

Yet if you see Bitcoin as cash-like, that doesn’t compute. I don’t need to identify myself to hold a small amount of cash. I just need to identify myself to put it in the bank. Which is why we’re seeing regulation focus on wallets and exchanges.

I think this is where regulators need some imagination, or to resist to the urge to look at new technology as if it is something existing
regulation can work with. It’s a hybrid of digital money and cash. So a risk based approach would say the regulation too should be a hybrid.

Regulation focussing more on what CAN be done with the technology, rather than what CANNOT be done will lead to the most innovation.

Is Bitcoin not Secure?

Mt Gox isn’t a Bitcoin problem, it’s a Mt Gox problem. The metaphor would be, if everyone in the room gave their cash to say – Chris Skinner – and Chris left the wallet outside in the street. That isn’t the fault of the bank, it’s the fault of Chris (or in Mt Gox in this case). Actually, Bitcoin has never been hacked. That is a remarkable achievement for a public utility and open source software.

Something that can’t be said for the very expensive Payment Card Industry (PCI) with all its regulation, pain and cost, we still see things like the TARGET hack.

Each day we build a higher wall and each day the attackers get closer. With Bitcoin there are no walls. The funds are so distributed it’s harder to find points to attack

If it’s Cash Surely It’s Not Profitable?

Because it’s digital cash, because it’s permissionless and because it’s transparent I think there are opportunities there. Those opportunities require imagination. They’re not based on the same business model the banks are comfortable with or used to.

If the banks have the imagination to see an internet like world of people who could be potential customers of savings or loan products.  Bitcoin could be very profitable as a customer acquisition tool.

The Alternatives to Bitcoin

The points above don’t suggest that what Ripple, Eris or Ethereum are doing is wrong. If anything some of these new entrants may have a better short term impact on traditional finance than Bitcoin does as regulators struggle to get their head around Bitcoin. There are huge potential cost savings and opportunities with distributed ledgers and smart contracts that don’t require Bitcoin.

However, just because a narrative is comfortable and fits your world view doesn’t mean it’s right. If the Telco’s had said “We like the
internet technology, but think it should be closed for just Telcos to use” – people would rightly think it’s crazy talk. Technologies that
treat value as a liability (an IOU), will never be able to displace cash in the same way Bitcoin does.

I don’t see why this argument has to be binary. Either you’re for Bitcoin or against it, it seems.  I’m for Bitcoin AND for it’s alternatives.  They’re both interesting.  Arguably the alternatives more so to traditional banks in the short term.

Prediction Time

We’re going to see banks adopt some permissioned distributed ledgers in the coming years and it will be largely invisible to the end customer.  Most of the action will be in those large contract movements between banks.  Banks will see major benefit from doing so, and doing so aggressively.

During that time we’ll also see non traditional wallet players and remittance companies gradually warm to the open / simplicity of Bitcoin (and / or it’s competitors / upgrades). For this long tail of airtime users and cash users having something that is interoperable and global will be a huge advantage.

The question then is how will PayPal react? Or Alibaba?

The Opportunity Cost for banks of not at least considering Bitcoin could be huge.

  • Dave Birch

    I’m still unconvinced about Bitcoin as currency, so to me “blockchain is interesting but bitcoin isn’t” makes complete sense as I’m only interested in bitcoin as a transport mechanism not as money. And I’m far from convinced that the Bitcoin blockchain is either the only or the best blockchain.

  • http://www.banking4tomorrow.com/ Brett King

    Sy, all good points. The issue bitcoin has isn’t really any of these issues in my opinion. Bitcoin was on fire until the point that people started talking about XBT/BTC hitting USD $1 million equivalent for 1 BTC. At that point the inflationary characteristic of Bitcoin and the mining limitations in terms of supply, meant it was potentially more valuable to horde Bitcoin as an asset, than to spend it as a currency. At that point in time, Bitcoin’s effectiveness as a challenger currency was massively harmed because circulation was decimated, and no one was spending it. The only way for Bitcoin to become an effective competitor to other currencies is purely adoption and utilization – if you’re holding your Bitcoins you’re not spending them, and the currency is not circulating, thus it’s not going to get enough critical mass to build widespread trust and adoption.

    The blockchain concept, however, works independently of Bitcoin. It doesn’t make Bitcoin less impactful or less revolutionary, but as a tech it has more promise than Bitcoin which has had the wind taken out of it’s sales because the designers and the community didn’t factor in speculation and hoarding into the equation.

  • http://www.sytaylor.net sytaylor

    Agree Brett – in fact Tim Swanson (@ofnumbers) has some excellent charts that show Bitcoin isn’t liquid, it’s just being hoarded or used as profit for miners and is a circular economy.

    My follow up will be “things wrong with Bitcoin” or what it needs to do to go mainstream or something to that effect.

    I also didn’t ham up enough the role of a Ripple, Stellar or Eris in the short term for banks :)

  • http://www.sytaylor.net sytaylor

    But then – what else is there that has the hashing power (Scale) and permissionless nature of Bitcoin?

    Those properties are at least interesting. Granted, they’re not proven.

  • fmastr

    both interesting – but that doesn’t mean one won’t be far more relevant than the other.

  • http://financialcryptography.com/ iang

    As with any uncertain future, an intelligent person can likely argue it both ways convincingly. What separates discourse from action is making a bet on which way it goes.

    Luckily, it seems that this time such a bet is neither costly nor exclusive. A large institution such as a bank can happily invest in blockchain, bitcoin and alternate methods. One, a few, or all, without serious costs! Better yet, most or all of their learning will be readily transportable across the different technologies, because the real lessons are in what you can do, not in how good each offering is.

    The real reasons why the banks argue that the blockchain is interesting and bitcoin will fail are simple knee-jerk competitive considerations. We can ignore those, as they won’t markedly effect the landscape. Or surface them for what they are. Once said, let’s move on and look at your bet.

    “Where do you want to transact today?”

  • http://www.innopay.com Douwe Lycklama

    Good post! Bitcoin as currency still holds a future but we need imagination, the other angle of ‘technology side’ is easier to see for banks. EBA just published last week a good information paper on this, giving this angle some structure, framed from a payments & transaction banking point of view. https://www.abe-eba.eu/downloads/knowledge-and-research/EBA_20150511_EBA_Cryptotechnologies_a_major_IT_innovation_v1.0.pdf

  • Pinar Emirdag

    Good post indeed. Liking blockchain but not bitcoin is easy for some for sure – due to a variety of reasons which include convenience. Feels like a very fast train with all the buzz around bitcoin, blockchain, cryptoledgers etc! Someone recently told me that this whole thing could be a good case study in group-think. I think these concepts will start converging soon enough, as the real applications emerge, real life advantages/challenges surface, and the need for dismissing one or the other becomes irrelevant.

  • Gideon Greenspan

    Hi Simon. Great post. I agree that the bitcoin blockchain and alternative systems are both interesting, but will likely have very different use cases for the next decade at least.

    But there’s another hybrid I’d like to suggest – a blockchain which is managed (i.e. created, maintained and mined) by some kind of banking consortium, but which still permits anonymous permissionless participation at the transaction level. The network of full nodes runs on a bunch of servers belonging to banks. But anyone who wants to use the network can download a lightweight SPV wallet onto their mobile, creating their own key pairs, and receive and send tokenised assets with other network participants.

    This may sound like a no-go area for regulation, but as soon as the blockchain is managed centrally, the problem can be resolved by the administrators refusing to confirm/mine transactions they don’t like. Essentially it’s just a much cheaper way to manage a banking network, with zero onboarding costs for new customers, and no need for reconciliation/settlement and the like. For small transactions anonymity can be allowed, but once customers want to transact beyond a certain amount, they need to go through regular AML/KYC checks to get those larger transactions accepted. Fees and/or rate limits can be configured to make it impractical or unattractive to use many accounts in parallel in order to perform large aggregate transactions.

    Of course, I’m biased, because this is a possible deployment scenario for what we’re building :)

  • http://www.cryptorats.com/ @Bitcoinrat

    The problem that needs solving for any “blockchain without bitcoin” Dave is how do you ensure that those who verify the transactions and
    secure the ledger have no incentive to affect the nature and/or acceptance of the transaction?

    The bitcoin blockchain achieves this by separating the security nodes (miners) from any relationship to the provenance of the transaction that they incorporate into their computations to receive their reward for progressing the packet. (payment for their time/costs)

    The genius of the satoshi protocol is precisely this disconnection.

    Any blockchain that relies on centralised permissions, and “trusted” third party nodes for verification , will not only fail to deliver any real innovation in future economic models as we enter the new age of p2p and decentralised capitalism but will also layer whole rafts of oversight, large player scrutiny and costs onto transactions that are passing through the blockchain. Banks almost certainly will set up their own “permissioned entry” blockchain ledgers to gain traction from the technology but these will not drive any real innovation or economic growth.

    Bitcoin may not be perfect, and as a “currency” it may fall short of mass public adoption, but as the transport token that drives the only really independent blockchain it is unique, permissionless and – in the Rats view – unstoppable.

  • Bitcoins and Gravy

    wind taken out of its SAILS.
    Like on a sailboat that moves using the power of wind.

  • ytzpzvgk

    Uh, cash is not a trap. Ask anyone who’s watched a bank delete funds from an account for any reason, legit or illegit. Cash is power. It may be a terrible responsibility too which is why many people trust banks, but you can’t deny the power of controlling the cash yourself.

  • ray

    i want to buy bitcoin just contact me if you wanna to sell me on nitinbandia@gmail.com