Saturday, December 11, 2010

Why Bitcoin Matters

E-commerce in 2008 amounted to $3.7 trillion dollars. That's 12% higher than 2007 while the entire economy increased only 5% during the same period. As online commerce increases, the fundamentals of electronic exchange become more important. Bitcoin is an electronic currency issued without a central bank. It has remarkable properties making it important for an age of electronic commerce.


Transaction Fees Set by a Competitive Market

If all 2008 online commerce had been paid for with PayPal, the fees would have been $62 billion (Amazon and Google charge identical fees). Payment processors provide some additional value but it's largely an expensive system for subtracting numbers in a database.

The Bitcoin network essentially charges no transaction fees. Participants can pay to expedite their transactions, but it's not mandatory. Any network participant is welcome to process any transaction on the network. This makes Bitcoin transaction processing a commodity whose price is likely to remain permanently low.

No central point of failure

Recent attacks against PayPal, MasterCard and Visa remind us how centralized electronic payment processing is. A single PayPal outage can cost 25-30% of an online retailer's sales. It seems unwise to put so many economic eggs in so few baskets.

When was the last time you heard of a BitTorrent outage? Despite the U.S. government, the recording industry and various ISPs trying to destroy it, the BitTorrent network has prospered. Bitcoin's peer-to-peer network is similarly resilient. Failing components are quickly ignored and the network continues processing payments without a hitch.

No chargebacks

Credit card fraud is a challenging problem for large businesses who spend much effort building fraud detection systems. Small businesses can't justify such expensive systems. For them, a bad weekend of fraud can mean a missed payroll. The net effect is to increase the barrier to entry for online commerce which decreases competition and innovation and increases prices.

Bitcoin payments are not reversible by a third party. Just like cash given to a street vendor, Bitcoin payments can't be contested after the hotdog is eaten. If a buyer wants a refund, he must persuade the vendor. This places a greater burden on buyers to beware, but in an era of ubiquitous product and vendor reviews, it's easier for a consumer to find the reputation of a vendor than vice versa.

No long-term inflation

Bitcoin's money supply is strictly limited by the protocol. The total number of bitcoins available approaches 21 million over time. The currency's first decades allow for limited, predictable inflation. Automatic, bi-weekly adjustments recalibrate the system toward these goals.

Mr. Bernanke's helicopter full of cash has highlighted how dangerous a centralized, unpredictable money supply can be. As long as the power exists to inflate a currency, it will be done.

Conclusion

Perhaps Bitcoin itself won't dominate the market, but certainly it shows the way toward a future of low-cost, predictable, digital currencies resilient in the face of disaster.

2 comments:

Travis Hendricks said...

This is a really intriguing concept. I haw doubts it has a great chance of succeeding with the power of banks in this world but maybe the increase in peer-to-peer comunications will help move it along. Being open source usually tends to help.

mike said...

Wow what an amazing account of a real alternative payment and exchange mechanism.

Fascinating and without doubt the future. Surely this will revloutionise retail, amongst other things?