A look at the disruption in digital transactions, and the possible future for systems like Bitcoin.February 24, 2014
Bitcoin can seem like a strange toy for computer geeks, but it may ignite the biggest change in the way we pay for things since the first credit cards in the 1960s. Much of the publicity has focused on Bitcoin as a currency, showing it as a bizarre form of money that comes from no country and can be "mined" by computers. But the currency angle misses the deeper point. Underneath, Bitcoin is actually an extremely clever payment system much more suited to an era of digital transactions than anything that's come before.
A Bitcoin-based payment system would, for instance, make it feasible for an online news operation to charge a couple cents to read a story, or provide a way for parents to use a smart phone to beam spending money directly into their teenager's smart phone -- a digital version of taking a $20 out of your wallet and handing it over. Sometime in the future, Bitcoin-driven payments could be a way for your robot butler to settle up with the drone that delivers your pizza -- one device to another.#66: Currency For The Internet Of Everything Era by The Network Podcast
"Bitcoin at its most fundamental level is a breakthrough in computer science – one that builds on 20 years of research into cryptographic currency, and 40 years of research in cryptography, by thousands of researchers around the world," investor Marc Andreessen wrote in a blog post. "The consequences of this breakthrough are hard to overstate."
To see why, go back to the beginning of credit cards. The modern plastic cards -- the beginnings of Visa and Mastercard -- were launched in 1966. Computers filled a room. No one but science-fiction writers even dreamed of online transactions. With their raised numbers and signature on the back, credit cards were built for a system with no smarts in it. A store clerk would "read" a customer's credit card by running it through a device that imprinted the numbers on a piece of paper. The store collected its money by sending stacks of these receipts to the credit card company.
In that system, the credit card issuers charged merchants fees of perhaps 3% on each transaction -- necessary when the process required lots of people physically handling paper. Because the cards were made for a time when the purchaser was in the store in person, the security was that the signature on the card and on the charge receipt had to match. When credit cards moved online and signatures were no longer possible, anyone who stole the numbers on a card could use it to make purchases -- quickly and undetectably.
In the late-1990s, Robert Levitan was among those who saw that credit cards had flaws in an online universe, and that some sort of digital money would be useful. Levittan created Flooz and famously recruited Whoopi Goldberg as a pitchwoman. Consumers could use a credit card to buy a certain amount of Flooz, then use Flooz to buy stuff on sites that accepted that as payment. Consumers wouldn't have to give every site their credit card information. Purchases could happen faster and easier, with less chance of credit card numbers getting stolen.
But now Levitan -- a believer in Bitcoin -- realizes Flooz didn't go far enough in breaking from the credit card system. It's a reason Flooz ultimately failed in 2001. "Having a physical credit card that some company with big offices gathers and clears these transactions and prints statements to send to you so you can pay it -- there are all these extra steps in that process," Levitan says. "If transactions are going digital, we need a digital wallet that's clearing transactions right away, not later."
The Bitcoin system is a big step in that direction. There is no central clearinghouse, no big computer where all the data is stored, no credit card numbers. Bitcoins are tallied and tracked by distributed computing. Embedded in the digital money is an ability to know where it is and what it's worth. This allows Bitcoin to be used like cash -- you can hand it over to someone else without getting a third party, like a bank or credit card issuer, involved. Currency is just digital, existing as code in the cloud, accessed only by you through any device -- smart phone, smart watch, smart robotic butler.
As Andreessen explains: "Bitcoin gives us, for the first time, a way for one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer."
Take the old credit card system out of the middle of digital transactions, and a few things happen. Most importantly, the fees merchants pay largely go away. That either means more profit for merchants or lower prices for customers.
But with no fees, it becomes worthwhile to sell stuff for a few cents online -- or, for that matter, fractions of cents. A new model for journalism or entertainment could emerge, requiring people to pay a tiny amount for a story or video. A Bitcoin-based system would nearly eliminate fees and hassles when making international transactions, like buying a dress from China or sending spending money to a family member overseas.
Since Bitcoins know who owns them, it would be pretty tough to steal them. That's not to say hackers won't find a way, but it would be much more difficult than swiping tens of millions of card numbers from Target in one shot.
Is Bitcoin a currency? Sort of -- in the sense that once it's widely accepted, people will be able to buy and sell using Bitcoin and maintain Bitcoin accounts. But for the foreseeable future, Bitcoins will ultimately get translated back into dollars or yen or Euros. It's very possible that "Bitcoins" will disappear from view and just become underlying code that lets machines talk money, while users just see their local currency on whatever screen they're using.
So at this point, Bitcoin is to credit cards what VOIP must have at first looked like to the long-distance telephone industry. When VOIP first came out, it was balky and difficult to use. But VOIP calls turned out to be phone calls built for the Internet era -- a classic disruption of the old guard.
Could happen again -- whether it's Bitcoin or something like it. If Bitcoin is the next Flooz, another better version will follow. The idea is right, and it's a classic disruption. Unless the credit card companies respond, your electronic butler is unlikely to be handing a Visa card to the pizza bot.
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