In early 2012, right after my 10th anniversary as member of the non-depository financial industry known in the United States as money services businesses, I was invited to give a talk about the financial crime vulnerabilities of emerging payment systems in the Dominican Republic.
Given the rampant growth in mobile telephone use and the resounding success of M-Pesa in Kenya, mobile money transfers were all the rage back then. Oddly enough, I remember thinking that mobile telephones were just another self-service channel slightly different from the Web, and therefore discarded them as only incrementally innovative or risky.
But when I stumbled upon a new anonymous virtual currency that was not controlled by any third party and allowed individuals with connected mobile devices to send and receive value in any amount, from pennies to millions, globally, instantaneously and almost for free, I saw the writing on the wall.
Doomsday, anxiety and disbelief
An anonymous value transfer mechanism that runs on the Internet? It would be easier and cheaper than ever to facilitate cross-border remittances, helping millions of people across the globe, but also to finance terrorism and facilitate illicit commerce, helping millions of criminals around the world. Such was my instinctive reaction when I read about Bitcoin for the first time.
Having spent a decade trying to create better financial products and services for the millions of underserved immigrants and disadvantaged Americans known as “unbanked” or “underbanked,” I knew too well that remittances, bill payment, prepaid cards, checks and money orders had extremely long and costly supply chains. Bitcoin was an autonomous, self-governing technology that operated on a node-to-node basis, much like the Internet.
That meant that, just as in the publishing and music industries, middlemen would probably be bypassed. And shorter supply chains meant lower costs. How could this possibly work? I also knew too well that anonymity was anathema to the international law enforcement community, and that regulation was therefore in place to ensure that senders or recipients of payments were fully identified. How could such a system be allowed to exist?
Then I learned that this new technology – Bitcoin with a capital “B,” featured a native, digital token, confusingly known too as bitcoin with a lowercase “b,” that was bought and sold in the open markets like any other currency either in person or via an exchange. Interestingly, this technology had embedded, unchangeable rules dictating that a specific number of units of this token would be minted through a very complex and energy-guzzling process, until only 21 million of them were in existence.
Having grown up in Argentina, it did not take me long to realize the implications of a new form of currency, at this point known generically as a crypto-currency, having a predictable inflation rate and fixed monetary supply. Could this become the currency of poorly managed economies?
I also learned that this new technology was open source, and free for anyone with programming skills to download and create applications with it. In addition, the bitcoin tokens could be programmed to represent and store in an immutable database anything of value – including securities, property titles and even votes. Could this technology do away with corruption and facilitate the creation of capital from hitherto unrecorded assets?
Old vs. new ways
However innovative and transformative, I did not linger in the monetary or programmable aspects of this technology and its native tokens. My mind kept coming back to Bitcoin, the payments and value transfer system, and how it could disrupt banking and my own industry, the payments and remittances industry.
Think for a moment about how financial intermediaries work. Their raison d’être is precisely to mediate between two endpoints, to provide secure custodial, payment and settlement services and help us keep track of what we own and spend.
Our bank provides us with a ledger where all credits and debits are recorded, hopefully accurately and our assets stored, hopefully securely. Financial institutions also offer products to facilitate payments and the exchange of value, like checks, debit cards and credit cards. Bitcoin flatly turns many of these functions and services on their head.
To begin with, Bitcoin itself performs a custodial function without the need for buildings, personnel, processes and access control. All transactions except the personal identifiers of the person executing them are recorded in a database where additional entries cannot be inserted between previous entries, only appended in clusters to the latest block of transactions.
Once an additional block is added to this database, which is aptly called the blockchain, it cannot be reversed or revoked, thus forming a virtually immutable and incorruptible chain of transactions.
What is more, the blockchain is replicated and shared with all participants in a globally distributed network of thousands of computers and is therefore available for the world to see. So the first big difference with the current paradigm is that today both transaction records and the full identity of the asset owners are known yet kept confidential by a trusted third-party. By contrast, “accounts” and transactions in Bitcoin are public, while the identity of bitcoin owners is not recorded or shared, only pseudonyms are visible.
This alone has paradigm-shifting implications for financial institutions and law enforcement alike.
Let’s think about what happens when we shop and pay with a credit card. First of all, both the consumer and the merchant are required to have an account with their respective banks – the former to make and the latter to receive payments.
Having an account implies having passed the customer due diligence protocols imposed by regulation on financial institutions, which results in a full record of a person’s personally identifiable information or PII being stored on their respective databases. For decades, an account holder’s PII has been encoded on the magnetic strip on the reverse of plastic cards. So when we make a payment, we are effectively transmitting to a merchant the keys to our bank account and our personal identification and instructing it to pull money from our account on our behalf. This is the reason the entire scheme is known as a pull system.
And we do that every time we pay, which means that our PII is constantly traveling across cyberspace and being stored and verified by a multitude of merchants and financial institutions. No wonder there is so much credit card fraud in the world.
By contrast, Bitcoin is a push payment system. This means that the payment as executed by the user and, once confirmed by the Bitcoin network, it is final and irrevocable. If Bitcoin were the payment system of choice for all consumers, credit card fraud would disappear. And so would another kind of very insidious and costly fraud – illegitimate consumer chargebacks.
Credit card and banking rules hold merchants accountable when consumers dispute charges with their banks even after having received the product or service purchased, thus leaving merchants out of the money and out of the merchandise. Given Bitcoin’s finality and irrevocability, the risk of illegitimate chargebacks would also disappear.
Instead, a Bitcoin-specific mechanism known as multi-signature escrow would protect consumers by requiring two of three signatures to be present before the payment is released. Could this be a new commerce paradigm?
A valid criticism of Bitcoin as a payment network is the relatively lower speed and amount of transactions that can be processed when compared with existing systems. With the exception of the ACH system, which takes several days to settle, most modern payment networks can process many orders of magnitude more transactions than Bitcoin.
Some segments of society, however, might trade off speed for other benefits. Speed and volume are the most salient benefits of closed, proprietary, or consortium-managed payment systems, and because they are all managed by intermediaries all payments running on existing rails are subject to interdiction and censorship. That is not possible with Bitcoin. This clearly poses challenges for regulation and law enforcement, but it also creates opportunities.
Anonymity and other myths
How many times have we read in the press that bitcoin is anonymous, untraceable and “invisible to the tax man?” Nothing could be further from the truth. Granted, personally identifiable information does not travel along with a Bitcoin payment and is not required to be registered on the blockchain to prove ownership or transfer value. The system simply cannot do that.
However, every transaction that has ever occurred is publicly viewable in the open ledger known as blockchain. Even when one’s identifiers are not recorded on the blockchain, who in their right mind would use a system that leaves an indelible digital footprint to move dirty money?
In reality, Bitcoin provides a relative amount of privacy but only limited anonymity, as was demonstrated by various academic studies revealing that it is possible to “de-anonymize” accounts. The recent indictment of two federal agents allegedly caught stealing bitcoins while investigating the illicit online marketplace Silk Road is proof that law enforcement investigations could be facilitated by Bitcoin’s indelible and fully traceable database.
In sum, Bitcoin’s transparency by design provides unique opportunities for surveillance and control that are simply not available with other payment instruments and value transfer systems.
Leaner infrastructures, safer, cheaper and transparent financial services, improved surveillance, governance and control, access to savings, credit and payments for billions around the globe. These are some of the promises of the blockchain revolution prompted by the invention of Bitcoin.
A catalyst for innovation
The Internet, and technology in general, has had a powerful effect on humanity – it has made the vertical, horizontal, and sent to the periphery what was at the center. It has disrupted entire industries through the democratization of knowledge and information, greatly contributing to globalization and at the same time positively impacting local economies. The natural next frontiers in this process seem to be financial services technology and money.
Bitcoin is not the first digital value transfer technology and it may not be the last, but it is an undeniable fact that it is being the catalyst for a boom in finance, payments and money innovation. Although still a fledgling, five-year-old experiment, it has already sparked a gold rush of investment and creativity similar to the pre-browser years of the Internet.
Regardless of the initial, almost requisite, association of new technologies with crime and abuse, the emergence of crypto-currencies like Bitcoin and their underlying blockchain-based technologies is having a salutary impact on smart incumbents, who are beginning to do serious research into many financial and non-financial uses of blockchain technologies that are potentially enormously transformative and beneficial for both developed and emerging economies.
I believe my personal experience is illustrative of the fairly standard process that most people go through when discovering Bitcoin: doomsday, anxiety, disbelief. Later, curiosity.
Still later, self-interest and eventually, I hope, the inspiration to make a difference and transform our world.