Bitcoin transaction volume through merchants is the single most important metric in the Bitcoin economy

The future of Bitcoin as an alternative currency is tied to one simple metric – merchant acceptance and the velocity of money through those merchants.

 

Bitcoin has potential as a) a payment network, b) a store of value that you can invest/speculate in and c) a currency. This article is only about bitcoin as a currency.

 

Like others before me, I have become more positive about the future of bitcoin the more that I learn about it. A few months ago I would have leaned to the view that Bitcoin the payment network had a great future but that bitcoin the currency would be a footnote in history. Today I am more positive, because the trend lines and motivations around merchant acceptance are positive.

 

If mainstream merchants accept bitcoin, it will thrive. If not, anybody owning bitcoin will need to first transfer bitcoin into Fiat currency and the regulatory off ramp problem will kill it as an alternative currency. Without mainstream merchant acceptance, bitcoin the currency will live on only in the shadow economy and become a footnote in history. Forget the headlines about bitcoin price fluctuations or the latest VC deal; these are “noise on the line” compared to merchant acceptance.

 

We have been through two phases of merchant acceptance and we may be about to start the third phase (phases overlap i.e. one does not have to end before another one begins):

 

  • Phase 1. Illegal online transactions, made famous by Silk Road. This got some media attention and confirms the old saying that, “there is no such thing as bad press”.

 

  • Phase 2. Attracting rich Bitcorati for legal products. This is the phase we are in today. The merchant logic here is very simple. If a rich person wants to pay me in some unusual currency, I am motivated to accept that currency. Enough people got rich speculating in bitcoin or mining bitcoin in the early days for this to be a real niche market. These Bitcorati are bitcoin enthusiasts, so if they see two objects they desire equally and one says “we accept bitcoin” then that rich Bitcorati will choose the merchant who accepts bitcoin. This is fundamentally different from phase 1 because a) it is legal and b) we will start to see merchant success stories akin to the merchants who were early adopters on the Internet.

 

The enabler for phase 2 is the elimination of the volatility problem. The same volatility that is a boon for speculators is a showstopper issue for merchants. There is no value in getting rid of those hated 2-3% Credit Card fees if the bitcoin price moves more than that before you can use it to pay your suppliers and live your life.

 

The two leaders in processing Bitcoin for merchants are Coinbase and Bitpay. At time of writing both claim 35,000 merchants. Both have raised a lot of money from top tier investors. Their pitch to merchants is that accepting Bitcoin is as easy as accepting a credit card – with lower fees. Coinbase’s pitch to merchants for example:

 

“When a sale is made, you can instantly sell the bitcoin received to Coinbase to avoid exposure to bitcoin volatility.”

 

A leader in merchant adoption could be the first VC backed Bitcoin success, analogous to the Netscape moment. An IPO would give the venture mainstream visibility and kick-start the next wave of Bitcoin innovation, funding and adoption. It’s a pity that the bar is so much higher for an IPO than it was 20 years ago, but that is another story.

 

The tipping point is simple. It comes when merchants switch from asking, “why should I bother accepting bitcoin?” to, “is there any good reason not to accept bitcoin?” When that happens and consumers see the bitcoin symbol on more merchants checkout (online or offline) they will be more interested in paying by bitcoin.

 

2014 has been a good year so far for merchant adoption with the following big e-commerce players announcing that they are accepting Bitcoin – Overstock, Dell, DISH, TigerDirect and Newegg. Overstock was the bridge from Phase 1 to Phase 2. Patrick Byrne, the founder CEO of Overstock is known as a critic of the establishment while running a large mainstream business.

 

We have to move beyond the Bitcorati to get to the tipping point. Somebody who has not got Bitcoins from mining or speculating early in the game has to be motivated to buy using bitcoin instead of a credit card. I have been talking to some small merchants to ask them what might trigger them to accept bitcoin. These are merchants who do not have an obvious Bitcorati customer base; some may do so and the merchant won’t know until they try which speaks to the “is there any good reason not to accept bitcoin?” story. Most had been totally put off Bitcoin due to the volatility issue and the story that the volatility problem has been fixed has not yet reached them.

 

However in their busy lives, there still has to be a good reason to take the time and trouble to accept bitcoin. One story that made these merchants think about accepting bitcoin came up a couple of times and this could become Phase 3 of bitcoin merchant adoption:

 

  • Phase 3. Micro-multinationals who want to accept international customers. Big businesses have already got doing business globally nailed. Small businesses don’t have very good solutions that are a) easy to implement b) inexpensive. Getting international payments via credit cards is easy but expensive; you pay a lot for the currency transfer back to your home currency. You could accept payment in foreign currencies but that gets complex. First, you have to decide which foreign currencies to offer and Murphy’s Law says that the one currency that you omitted is the one that your ideal customer wants to use (an American merchant may enable EUR and GBP and miss the Swiss customer who really wanted that high margin upmarket product as long as she can pay in CHF). Then you will have the hassle of getting your bank to accept multiple deposits in foreign currencies and when they do that you will find that you lose a lot when your bank converts it back to your home currency.

 

Doing this via bitcoin won’t be simple, but at least Bitcoin will be solving a real problem for merchants. Nobody has sized the micro-multinational market, but anecdotally it is large and tools such as VOIP now make it more natural to transact across borders, so this is likely to increase. This Phase is important because it will get more consumers (who have not mined or speculated) to use bitcoin. Lets say a consumer wants to buy something online that is priced in a foreign currency. If consumers see a simple calculator that tells them how much cheaper it is to pay via bitcoin than their credit card or debit card and it looked as easy as using their credit or debit card, consumers may give it a go.

  • Phase 4. When Bitcoin becomes universal, just another option alongside cash and the usual Credit Cards in main street shops and e-commerce sites. To look at how could Bitcoin to cross the chasm from early adopters (Bitcorati and Micro-multinationals) to a universal payment option, we need to move into some speculative futurology and understand the switchover to EMV Chip and Pin cards in America. This switchover happened in Europe before merchants had any interest in Bitcoin, but will be happening in America just as the Bitcoin story gets more mainstream attention. The switchover to EMV Chip and Pin cards will happen in America for the simple reason that merchants will become liable for fraud from October 2015. Magnetic stripe cards are terribly insecure, particularly if merchants don’t even check the signature. When the POS terminal vendor comes calling about the dreaded switchover, a few merchants will ask them “can I accept Bitcoin with this new device?” It is a logical question. Merchants don’t know if Bitcoin will take off but they would feel annoyed if it did and their neighboring store was taking orders from their Bitcoin-enabled POS terminal while they were stuck in the past. So it is likely that some POS terminal vendors will add bitcoin to their functional checklist. If this happens we will cross the chasm, go past the tipping point or whatever other analogy we use for Bitcoin changing the world. There is a lot of money at stake in this switchover and the established payment companies will be torn between lowering their fees in response to the Bitcoin threat and fighting it at the regulatory level.

 

Moving from speculative futurology to real traction today, there may be a hoarding problem. Adoption is one thing, but what really matters is transaction volume (what economists call velocity of money). I asked both Coinbase and Bitpay to point me towards any data on this. Coinbase responded quickly saying “we don’t share stats around bitcoin transactions”. Bitpay revealed that they “process over $1 million per day in bitcoin transactions” and pointed me towards the Coinmetrics site which shows Daily Transaction Volume ($ value) and Daily Transaction Value. The Daily Transaction Volume at about $44 million is tiny compared to $16 BILLION for Visa; its no surprise that Bitcoin has a long way to go. Looking at the trend-lines shows some spikes that I will be digging into in a future post (I want to find out what triggers these spikes).

 

My next post is about bitcoin as a store of value ie as an asset that you invest in/speculate in hoping that it will go up in price. This is related to transaction volume because one reason for lack of volume is hoarding by people who own bitcoin.

The real value of Bitcoin is in the P2P stack

This is one of a series called Explorations down the BItcoin rabbit hole.

Will developers use Ripple, Ethereum, Maidsafe or Open Transactions or some combination to build the killer apps of the Bitcoin era?

As I started down the road to understanding Bitcoin, one of the most confusing things was distinguishing between a payment network (“Bitcoin” upper case) and a currency unit (“bitcoin” lower case). That is now the first thing I explain to people who ask me about bitcoin.

It is lower case bitcoin – the currency – that has the media attention. It is simple enough to understand; it could be like gold or tulips or a reserve currency that replaces the US$ for international trade. It could be a currency or a commodity. Whatever it turns out to be (probably none of the above because the future always surprises) everybody understands the concept of a currency or a commodity.

It is possible that lower case bitcoin – the currency – may not change the world. For the bear case, read Felix Salmon’s post and for the bull case read Ben Horowitz’s rebuttal annotated to his post. They set up a bet:

Five years from now, in January, 2019, we’ll poll a representative sample of Americans. If 10 percent or more say they have used Bitcoin to buy something in the past month, Ben wins. If it’s fewer than 10 percent, Felix wins.

Even if bitcoin the currency becomes a footnote in history, it is possible that Bitcoin the payment network based on Blockchain technology may change the world. This is what has VCs excited. A new payment network could not only disrupt the global financial services business (for good or bad depending on your point of view). It could also return the Internet to its roots as a decentralized P2P system (aka “re-decentralization”). A decade from now, centralized cloud servers may be seen as a footnote in the history of the Internet.

For this to happen, we will need to see platforms that make it really simple for developers to create applications that reside on the unused cycles of all of our machines in order to deliver value to us in the way that Skype or Bit Torrent does.

The emerging P2P Blockchain technology stack

This got me exploring technologies that are sometimes tagged Crypto 2.0 or Bitcoin 2.0, such as Ripple, Ethereum, Maidsafe and Open Transactions. I prefer to think of them as an emerging Bitcoin stack (capital B, used for more than bitcoin the currency). If Bitcoin is as revolutionary as many believe, this stack will be at least as important as the Wintel stack that ushered in the modern digital age.

Before diving into these platforms and the sometimes-heated debates between the adherents, it is worth reading the original Satoshi White Paper. He envisaged:

“a solution to the double-spending problem using a peer-to-peer network”

“Double-spending” is the problem created by the fact that anything digital can be copied (for almost no cost). Many ventures have used this perfect copy machine capability; it’s great for communications and media. However, for anything involving financial assets, this is a problem; if I own this asset, you do not own it. If you can simply copy the record that says that I own it, then I regard that as stealing. As anybody involved in cybersecurity will tell you, anything digital that is connected to the Internet can be copied i.e. stolen.

Satoshi’s solution was to have a cryptographically verified record of each transaction stored on every computer in a P2P network, which he called the “Blockchain”. The Blockchain is fully distributed; it sits on every machine in the network. That is how the double-spending problem is solved and trust is enabled. You can “see” all the transactions. The “mining” concept is simply a way to financially motivate people to use their compute cycles to verify transactions.

Many consumers have a strange image of peer-to-peer networks. They either see something illegal and piratical like Napster or they use something every day like Skype without realizing that it is peer-to-peer. That is probably the way that the Internet will return to its peer-to-peer roots; consumers will trust the Cloud and the Cloud will move from centralized servers to peer-to-peer networks. What is a seamless transition for consumers – the same product but just cheaper – will be a revolutionary change in the IT industry. Bitcoin and the Blockchain will play a key role in this as people start to grasp the strange notion that it is trustworthy precisely because it is peer to peer. This goes against all our 20th century faith in centralized institutions.

Who will be the Red Hat of the Blockchain era?

Any platform will have to be open source. Thus the question is who will be the Red Hat of the Blockchain era?

Nobody wants “one Blockchain to rule them all”. Nobody wants to see this critical layer of the new financial services stack dominated by one company. Yet the logic of peer to peer will tend towards network effects and a winner takes all market (just like it did in the Wintel, Google and Facebook eras). Consumers will have to trust something enough to accept a download of code that will have control over their machine; this is a scary proposition and a level of trust that people won’t give to many companies.

So the prize at this platform layer is huge.

Building Internet scale decentralized P2P systems is technically really, really hard. Ask the guys who built Skype. Building a payment system is far harder than a VOIP system because the risk of loss is so much higher. Some noise on the line that forces you to ask your buddy to repeat something is OK and a small price to pay for getting something free; losing some money through a technical glitch is not OK. It is a hard technical problem because you have to deploy to millions of machines of varying power and type that are only intermittently connected to the Internet and deliver a service that is as fast and reliable as the centralized server based competition. This is not something that your average Ruby on Rails or Javascript developer can do. Yet, for the Internet to return to its roots as a decentralized P2P system, we will need the platforms and tools that make it as easy to build and deploy to a decentralized P2P network as it is to build and deploy to AWS or the machine in your closet.

To understand this emerging stack, I started by interviewed people from two decentralized development platforms that use Blockchain concepts: Ethereum and Maidsafe. Warning, bleeding edge alert, these platforms are not yet ready for live applications; despite this they have many developers spending time on them because the prize, if they can deliver on the promise, is very big.

First, I wanted to know if Ethereum and Maidsafe are competitors. It’s an obvious question that is being asked in Google searches and Bitcoin related forums, because they are both positioned as Blockchain related tools. Ethereum pitches itself as a full stack platform with a “logic layer” and a “storage layer”. However, as the Ethereum storage layer is based on Bit Torrent, Ethereum see their core competency in the logic layer and so they make friendly noises about Maidsafe which positions itself at the storage layer. Maidsafe concurred on this point about being complementary, not competitive. This sounds like a classic “stack” emerging and that’s OK, as long as layers in a stack don’t create programming complexity or latency.

This does not mean that all is happy talk in this Blockchain platform space. Asked to comment about Ripple (funded by big VC money), Stephan Tual of Ethereum put it down as “14 lines of code in Ethereum”.

I did not have time to interview Ripple before publication and I am sure that they would dispute Ethereum’s view. My perspective from online research is that Ripple is positioned higher up the stack than Ethereum. You might not use Ripple to build a whole new system but you might use it to power a consumer-facing mobile app. It seems that Ripple positions itself more to serve existing banks than it does to serve new ventures. To be fair in any discussion of Ripple vs Ethereum one should point out that Ripple has already got a product in the market, while Ethereum is hoping to release at the end of 2014.

The “sharing economy” is built on trust and that should be distributed

The most obvious competitor to Maidsafe technically is Cleversafe. Both “shred” your data and put it on computers controlled by users in the network; the data is reassembled when you need it. This enables lower cost services, because the provider does not need to pay for servers; in fact Maidsafe promises to pay users for the privilege of using their computer’s storage. Imagine a Dropbox type service that paid you!

Seen in this way, Maidsafe and Ethereum are really a part of the sharing economy, like AirBnB or Uber. You share your compute cycles like you share your spare bedroom or your car. When pressed to come up with the sort of applications that people are building on top of Ethereum, Stephan Tual talked about these kind of sharing economy services. This makes sense because the Ethereum logic layer is all about Smart Contracts (something that knows about a financial asset as well as changes related to that financial asset, such as a change of ownership) and the sharing economy is all about lots of contracts that need to be managed efficiently.

The lower cost of storing data in P2P networks has not been compelling, because Moore’s Law has ensured that costs are falling anyway; there is not the kind of massive cost arbitrage that enabled Skype to thrive. The other driver is privacy/security, because there is no centralized server to attack and sniffing the network will only get the shredded pieces of data. However, while many consumers feel like they should be concerned with privacy/security, few are willing to pay in money or time to ensure greater privacy/security. The compelling use-case for P2P decentralized storage has yet to emerge; both Maidsafe and Cleversafe have been working on this for nearly 10 years.

However, Blockchain related applications must have strong privacy/security because they relate to financial assets. A pragmatic mainstream consumer reaction goes along these lines:

“I am really not too worried if somebody wants to snoop on my chatter with friends and family or to understand my shopping habits; but I am concerned if they can steal my financial assets”.

Blockchain applications are all about financial assets, something that you own that has value. Banks currently store these assets and spend a lot of money on privacy/security. The promise of the Blockchain is that anybody can build systems that store financial assets; for that to come to reality they must have strong privacy/security controls.

There are many financial processes we go through as consumers that are klunky, paper-driven, time-consuming and expensive. Which of these could be replaced by systems using Smart Contracts? Will we see more efficient (aka lower cost) versions of existing services such as AirBnB or lending applications? Or will totally new services emerge that are only possible because of the Blockchain? The history of innovation indicates the latter scenario, but as always only time will tell. In short, the killer app for the Blockchain is out there but if anybody knows what it is, they are not telling.

There is so much at stake that developers looking to commit to one of these platforms spend a lot of time figuring out whether the platform is truly open

This led me to look at Open Transactions. I did not have time to interview them. I suspect that I would need more technical chops to understand it. I come at this as a Fintech entrepreneur and adviser who is comfortable working at the intersection of bleeding edge and leading edge, but I am not a hands-on developer. It is possible that a technical developer would opt for Open Transactions rather than Ethereum and it is possible that they serve different needs. There are usually trade off decisions between time to market and flexibility and from my perspective Ethereum looks like they have the trade off about right.

But, it is still really early days in this game and we are all learning every day Please tell me in comments if you have had experience with any of these technologies or know of any other platforms that I have missed.

This is one of a series called Explorations down the BItcoin rabbit hole.

The Bitcoin off-ramp regulatory problem.

Will the Bitcoin off-ramp regulatory problem limit it to transactions within national borders?

Technically, converting Fiat to Bitcoin (on-ramp) and converting Bitcoin to Fiat (off-ramp) is easy. This is an Exchange function and the Internet is perfect for setting up Exchanges.

So, the problem is almost entirely a regulatory problem.

I don’t think there is an on-ramp problem. Regulators want to protect consumers against scams and frauds; they want to make sure that your grandmother does not buy fake Bitcoins. However it is hard to argue that one should prohibit the purchase of any commodity. The American tax authority, IRS, has declared that Bitcoin should be treated like a commodity. You can buy gold or wheat or tulips, so you can buy Bitcoin.

Bitcoin is of course different from all other commodities, because Bitcoin is a digital commodity that can be transferred as easily as an email or any other digital file.

Which leads us to the off-ramp, converting Bitcoin to Fiat.

There are legitimate reasons for regulators to control the off-ramp. This is far too easy for money launderers and other bad actors to abuse. Libertarians can rant against this, but entrepreneurs and investors are wise to treat it as a fact of life. Betting against regulatory control of the off-ramp is a huge speculative risk.

Regulators tend to be happy with a digital currency that only works within the borders of the nation state that they control. There are many of these already such as M-Pesa and and Dwolla. Google has their own currency which you can send as an email attachment – within the US only.

So, regulators will be comfortable with the idea that you can buy Bitcoins in US$ for example and then convert those Bitcoins back to US$. This will be a way for traders/investors to buy Bitcoins in the hope that the price will go up and then sell them for a profit – just like any other commodity.

Regulators are more keen to stop cross border transactions. That is hard for regulators because digital bits don’t stop at borders and present their passport. That is why regulators seek to control the off ramp.

It is possible to imagine a fully regulated global money transfer business that allows you, for example:

1. Buy Bitcoins with US$

2. Send those Bitcoins to the UK.

3. Convert the Bitcoins into UK £

This hypothetical fully regulated global money transfer business would have to go through all the usual KYC (Know Your Customer) checks that regulators have put in place to prevent money laundering and other illegal activity. In that case it cannot offer free exchange and existing money transfer businesses will be able to do exactly the same thing. Consumers who want to change currency only care about a) price and b) speed/convenience. If adding Bitcoins as an intermediate step makes it cheaper and quicker to change currency then this will happen. However, given a regulator/KYC level playing field, it is unclear how adding Bitcoin as an intermediate step makes the transaction cheaper/easier.

This is one of a series called Explorations down the BItcoin rabbit hole.

Why I created this blog

I sold a lot of software to banks, but that Traditional Fintech game got old. Emergent Fintech makes it fun again.

Media likes to talk about “disruptive fintech”, but I prefer to think of this more simply as “Fintech for the rest of us”:

  • Customers don’t care about disruption. Customers care about good service at the right price.
  • Banks will be partners with born-digital ventures. This is different from Banks as our only source of financial services. For all the talk of disruption and battles (good for page views and conferences) the more usual change is evolutionary and driven by partnerships.

I started this blog because I could not find anything that covered this patch/space/beat/territory the way that I wanted. Most blogs monetize through advertising, so there are lots posts that riff off a hot news story. I want more background analysis, which you cannot monetize through advertising. I am an entrepreneur. I blog in order to get my thoughts straight and to connect with people who are fishing in the same waters.

Many blogs that do cover Fintech miss the big disruption coming from people outside the current financial system. This is because most blogs are written by people who are over-banked. For example, few blogs cover the huge opportunity among the 70% of the global population that have no bank account at all (the “unbanked”). I won the genetic lottery, I was born in the developed world, but I have lived and worked for enough time in the developing world to have some appreciation of the needs of the unbanked.

It is not just the unbanked in the developing world. There are plenty of people in the West who have been left in the cold by the current financial system. Consider the 25% of Americans who have no FICO score and so find it hard to borrow. Or ask a small business owner how much they like using Factoring or pledging their home as collateral in order to get working capital. Or ask any consumer or small business how much they love paying a lot of money to change currency.

Daily Fintech is about making money by empowering people, not just papering over the cracks of the existing system.

All I want to do is learn more and connect with others who also want to learn more. The monetisation opportunities will flow from those conversations; the Emergent Fintech opportunity is so massive that there will be plenty of monetization opportunities.