Bitcoin and Disruptive Currencies

by Ross Schulman on July 30, 2012

Ars Technica reported earlier this month that Bitcoin, the open source cryptographically secured alternate currency, was back to trading at 9 US dollars per bitcoin. The currency had experienced a bubble last year, trading as high as almost 30 USD before crashing spectacularly. Since then, however, it has regained stability and traded within a fairly small range around 5 USD. If Bitcoin can keep its stability, what might it mean for disruptive competition?

Bitcoin is an online currency, but not one that should be confused with prior attempts at the idea. While companies in the past have tried to create their own online currencies, they all more or less relied upon the US Dollar as an underlying base, and were centrally controlled. Bitcoin operates without both of those factors and in the process disrupts what we think we know about money. It rewrites the value rationale for money itself, and undermines the ways in which we think we have to pay for goods over the Internet.

Money today mostly has value because governments say that it does. The scarcity that gives a dollar its value is controlled by the US Government who dictates its supply (if only tangentially through the Federal Reserve) and ensures that it must be accepted as legal tender. Bitcoin, on the other hand, is dependent on no central authority to control supply, instead using cryptography and math to make sure that the volume of bitcoins remains appropriate.

The even more interesting feature of Bitcoin, from a disruptive competition perspective, is that transferring currency from one private party to another using the Bitcoin system is free and instantaneous over the Internet. When one person gives another paper cash or coins, it is easy to see that the giver no longer has the dollar that has been transferred, because there is a physical object that has been exchanged. When you move away from physical objects it becomes much harder to prove that the dollar that was given to one person wasn’t also given to another person at another time. This is known as the double spending problem.

Credit cards and banks overcome this problem by creating a central repository (essentially a big database) that keeps track of who has which dollars and which is checked every time someone tries to purchase something to assure the seller that the buyer has enough money. Paypal performs a similar service in the online world and Western Union does the same couched in terms of sending money long distances. All those services charge a fee for the privilege that can range depending on many factors. This is why many stores will not accept credit cards for transactions smaller than a certain amount.

Bitcoin, in contrast, uses a peer-to-peer network to keep track of payments. When a payment is made, it enters the network and is propagated immediately to clients around the world. The payment is then certified by many different computers in the network using an ingenious cryptographic algorithm. This process ensures that the bitcoins being sent actually belong to the person sending them, and that they haven’t been spent elsewhere first. Having the network as a whole manage this process means that a central arbiter is not required.

This simple fact makes Bitcoin potentially incredibly disruptive to a number of financially centered industries. Credit cards, Western Union, and companies like Paypal exist because of the fact that it is hard to transfer money over the Internet cheaply and securely. Bitcoin, to the extent that it is usable, completely changes that regime. People can use it to connect directly with peers, whether they are friends sitting around the same dinner table, or complete strangers across the globe, and send money cheaply.

Bitcoin, of course, is not perfect. There are problems with its supposed anonymity (many people believe that Bitcoin is perfectly anonymous when that was never a design goal of the system), and with the built-in deflationary aspect of the currency that discourages spending and investment. With that being said, however, it has the potential to cause massive disruptions in the online financial space and could pave the way for real advances in how we move money around.

  • http://twitter.com/ggrandval Gonzague Grandval

    Bitcoin is as disruptive as Email was 20 years ago

    • Peanut

      Potentially more-so, I reckon.

  • e_ducat

    Interesting article ! Beware of the deflation fallacy though: deflation of prices is detrimental to an economy based on a single,monopolistic central money. With monetary diversity, like that introduced by bitcoin, the economy will not stop even if the price of bitcoin vs fiat money keeps going up. Bitcoin’s quasi infinite divisibility ensures liquidity: only smaller fractions of bitcoin are being traded. There will always be enough bitcoin float to enable transaction processing over the bitcoin network.Bitcoin exchange rate volatility is completely manageable when processing a transaction denominated in another currency over the bitcoin network because two-way currency conversion happens in a mater of seconds.

  • http://twitter.com/stevenwagner stevenwagner

    Check out the Deflationary Balancing section over at http://stuffexists.com/bitcoin/

  • Dfuller299

    e_ducat – I think the author meant that no literally, as the coins are generated, there are pre-set points at 1/4, 1/2, 3/4, and all the coins that their value will simply cut in half because the block reward halves upon generation from those points forward.  I think I see what you meant though.

  • Davinci Jeremie

    Has everyone on this planet been infected with Keynesian flawed logic?  ”and with the built-in deflationary aspect of the currency that discourages spending and investment.”

    This logic assumes that I want bitcoins to save forever because I never want or need anything… EVER.  

    With the bitcoins, I have said to myself when the prise goes to X I will by Y.  It’s the same as saying when the price of LED TVs come down I will buy one.   Also investment can not work without savings, I need to save to invest in my business or someone else’s business. 

    If the money is going up in value I can buy more stuff for myself and more capital equipment for my business to expand and grow with out debt.

  • http://buzzcoastin.posterous.com BuzzCoastin

    Bitcoins will be less disruptive to the present financial system
    until it is easy to turn “money” into Bitcoins and back into “money”
    or until there is a wide acceptance of BC for payments
    right now most of it uses are in the shadowy world of TOR

    how would one get a $1 million into or out of Bitcoins
    not very easily, that’s for sure

    PS: transfers aren’t free on the BC system,
    there’s always some kinda fee for transfers

    • Bs

      “PS: transfers aren’t free on the BC system, 
      there’s always some kinda fee for transfers” – bullshit, try to read something about the topic you are commenting. 

      • http://buzzcoastin.posterous.com BuzzCoastin

         ”The even more interesting feature of Bitcoin,… is that transferring currency from one private
        party to another using the Bitcoin system is free and instantaneous over
        the Internet.

        Neither is true.
        even if you exclude the currency conversion fees
        the Bitcoin wallet has a network charge of something like .01 BC
        so it’s not free and
        it’s not instantaneous
        most transactions take about an hour to clear
        and 10 15 minutes to even appear in the confirmation record

        so I guess you use Btcoins a lot huh?

        • Hacknoid

          Currency conversion is not part of Bitcoin.  There may be fees involved for anybody that provides a service, just as in every other part of life.  

          Banks, DWolla, etc. are not primarily part of Bitcoin, although they are currently a necessary evil on the route of conversion.  I will grant you that the process of converting cash to Bitcoins is not simple, but its not hard either.The network charge that you are talking about is voluntary, and you can choose not to pay it.  For a pure Bitcoin transfer to another wallet, there is no charge if you don’t want there to be one.And the transfer IS virtually instantaneous – its the confirmations that take time.  PS – the proper abbreviation for Bitcoin is BTC, not BC.

    • Philosopher Rex

      “Bitcoins will be less disruptive to the present financial system
      until it is easy to turn “money” into Bitcoins and back into “money”"

      In fact it is just as easy to convert several national currencies into bitcoin as it is to convert them between each other. There a few larger exchanges and you can also find people (often miners) who will trade you directly on various forums.

      “right now most of it uses are in the shadowy world of TOR”

      No, silk road isn’t that big, and most trade is open and occuring on many sites like bitmit.net

      “how would one get a $1 million into or out of Bitcoins”

      Seriously?  Not many people have that kind of cash to move, so it’s not a relevant example.

      “transfers aren’t free on the BC system, there’s always some kinda fee for transfers”

      In fact there is a ‘cost’ for all bitcoin transfers. A cost however is not a fee and you are not, currently obligated to pay any fee at all. The cost is being absorbed by the large number of miners and it shall continue to be absorbed for some time to come – so long as bitcoins are well valued.

      • http://buzzcoastin.posterous.com BuzzCoastin

        easy huh
        right now the easiest way to get Bitcoins is
        Bank account> Gowala> Exchange> Wallet
        or send a certified check to an exchange
        far from easy or convenient

        when Amazon takes BC it’s disruptive
        till the its geek coin

        Kim Dotcom needed to put several million into BC
        he couldn’t
        it is a major factor in making BC disruptive
        when one can stash millions in BC

        the process cost is expensive compared to alternatives
        and very far for user friendly or disruptive at this point

        • Philosopher Rex

          “right now the easiest way to get Bitcoins is
          Bank account> Gowala> Exchange> Wallet
          or send a certified check to an exchange
          far from easy or convenient”

          The easiest way is to use: 
          https://localbitcoins.com/
            OR
          http://www.tradebitcoin.com/

          And find peeps to trade directly with. (I am not affiliated with either of them). Also you can look on various bitcoin forums and you will find people willing to sell them. It’s a free market, but the big shops are regulated by governments – So if you don’t like the added complications, go local.

          “Kim Dotcom needed to put several million into BC
          he couldn’t when one can stash millions in BC it’s disruptive”

          If ease of use for a handful of millionaires is what you call disruptive, maybe you should check a dictionary. I’m not sure that word means what you think it means.

          Furthermore, bitcoin is in it’s infancy but growing quickly.  It takes a long time for people to change their habits and it will take some time for the market to find the real value of bitcoins. Doing the math on my end, it seems very reasonable that one bitcoin could be worth well over ten thousand US$ in the future. At which point even your second concern becomes moot.

          “the process cost is expensive compared to alternatives
          and very far for user friendly or disruptive at this point”

          What do you mean by “process cost”. If you are referring to the transaction costs, such is minuscule and shall remain minuscule. All that’s happening is data is being shared and verified on an electronic network – this is a tiny cost. And what alternatives are you speaking of which have a lower cost?

          As for user friendly, the current bitcoin clients are very user friendly – perhaps you should try it before you make baseless allegations? If you have tried them, please explain what is unfriendly about them.

          • http://buzzcoastin.posterous.com BuzzCoastin

            try and be concise
            I’m not against Biitcoins
            I’ve bought and sold thousands of dollars of Bitcoins
            I’d like it to be more widely used
            without some major improvements to the BTC process
            it will remain an obscure underworld currency

            a disruptive technology completely replaces old systems
            driven by easy of use, price and feature specific variables
            CD replaces tape
            iPod replaces CD
            iTunes replaces record stores
            Amazon replaces bookstores
            iPhone replaces Nokia

            Bitcoin replaces Visa?
            not anytime soon

          • http://buzzcoastin.posterous.com BuzzCoastin

             The easiest way is to use:
            https://localbitcoins.com/
              OR
            http://www.tradebitcoin.com/

            seems like a good way to meet Federal Agents
            and maybe a few nice people
            how quaint

  • http://gary-rowe.com/ Gary Rowe

    Good article. The author has clearly spent the time doing their research.

    Bitcoin offers tremendous opportunities for people to conduct secure and reliable trade directly with each other. This is a hugely disruptive force in terms of giving people control over their own finances in a way that has not been possible before. 

  • Fellow Traveler

     ”and with the built-in deflationary aspect of the currency that discourages spending and investment.”
    Because Bitcoin gains value over time, I am more likely to hold it instead of spending it, and thus it’s deflationary.
    Of course the same is true with “inflationary” currencies. I earn more if I stick the money in a CD or bond, than if I spend it. So I have the same incentive not to spend, either way.

  • Anonymous

    deflation of prices occur when you increase money faster than the goods and services on the market.

    If you buy a TV for bitcoin that you otherwise would have bought for another currency bitcoin will make that other currency less valuable and make the prices for goods in that currency lower.

    But if you buy a TV with bitcoin that you otherwise would not have bought your purchase will in fact make that goods higher, because you increase demand for the product.

    The second option means you expand the goods being traded on the market thus the over-established rule that more money means inflation of its value do not apply, but are in fact false.

  • http://vitamind3info.blogspot.com/ Adrian

    Bitcoin may have theoretical limitations or downsides, but then, what would be the perfect currency, I think if you consider that question you will arrive at Bitcoin.

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