Bitcoin, Blockchain, or Banking?
This article was originally posted on LinkedIn, but here is the fun version. I look at what the heck Bitcoin is, and how it could impact the banking industry. Extremely speculative, but I enjoyed learning about Bitcoin. It was about time I helped both myself and my friends out from Bitcoin ignorance.
So it has been awhile since posting articles. But I remember slaying several sarcastic Bitcoin jokes previously. I am committed to admitting when I am incorrect, so Bitcoin, I am sincerely sorry I underestimated you. You were a joke years back, but now you are a powerhouse with serious financial industry implications.
Yes, it already has serious financial industry implications. The core Bitcoin technology, “Blockchain” is currently undergoing experimentation with several companies dealing with commodity futures contracts. I won’t try to explain the multiple steps involved, but the big picture trend you need to realize is that Blockchain allows people or companies to skip banks as the middle man, and speed things up. Here’s the original article which focuses on Bitcoin itself. Just know that the core technology, Blockchain, can be applied to almost any transaction in any market at a much faster speed for significantly cheaper amounts.
First mention of the Knights of Templar brings to mind the Crusades, fabled empires, cryptic secret societies, and (unfortunately) the National Treasure movies. The Knights of Templar developed something much more everlasting – the bank. Following the First Crusade, the Warrior Monk group assembled to protect and enable European Christians to travel to the newly-conquered Jerusalem. The long journey created the need for developing letters of credit for Christian pilgrims to fund the trip without carrying large amounts of money and risk being robbed. As a result, the first banking system was developed in the twelfth century. Listen to BBC’s “50 Things That Made the Modern Economy” for more.
Fast forward to the present- banks and financial institutions remain pivotal to the economy serving as the intermediary for most transactions, lending money, and currency exchanges. Banks and financial institutions have experienced vast improvements integrating technology. Yet banks remain the middle-man for individuals, businesses, and the entire world economy.
As technology drove innovation in the early 2000’s; an anonymous person or group with the alias “Satoshi Nakamoto” posted a revolutionary paper outlining Bitcoin. Bitcoin is an e-commerce system enabling individuals to transact while bypassing the financial institutions central to our current financial system.
What is Bitcoin? Currently, Bitcoin is a decentralized digital payment system using a highly volatile currency. Imagine your bank account is digital and uses currency that changes an average 25% in value every single day. Instead of dollars, your savings account holds unstable currency with volatility equivalent to a highly risky investment. Further, your bank account-risky investment-currency combination is not actually held or secured by an actual bank. As with many other sources of data, your savings account is “in the cloud”.
How does it work? Bitcoin is a digital payment system that is open-sourced, meaning the entire network is managed by people using Bitcoin. Bitcoin is one of several “cryptocurrency” payment systems, but is the most popular and most-used, therefore, most supported decentralized separate from any institution. Cryptocurrencies are relatively new inventions, but are still considered to be a payment method as opposed to standalone currency.
Bitcoin’s growth can be attributed to its simplicity and integrity. Bitcoins can be purchased by anyone anywhere in the world with any currency- effectively consolidating users’ transactions into a single unit of account. In addition to decentralization bypassing institutions; Bitcoin’s system is designed such that the number of Bitcoins in circulation are set constant, and cannot be hacked or re-coded to create more Bitcoins – not even by the creator Satoshi Nakamoto. Decentralization is key because there are no supporting parties or government can print additional currency at will. Security is top-tier with advanced encryption to protect users’ information, Bitcoin wallet balances, and transactions.
Open-sourcing for Bitcoin acts as a compliment to its decentralized platform. Essentially, the entire network of users verifies and monitor the integrity of the system. All transactions are transparent yet private. Transactions are listed on a public ledger, known as the “blockchain” for the entire network to review, without revealing personal information of parties involved. There are people on the network known as “Miners” acting as security guards by monitoring transactions and ledgers to reinforce the system’s integrity. Miners are incentivized to verify transactions because they are rewarded Bitcoins for confirming transactions are correct on the blockchain. Bitcoin’s open-sourcing makes transactions more simple thus, minimizing transaction fees. Open-sourcing creates endless innovation opportunities, as we have seen with the internet becoming a staple for everyday life. Here is a good video outlining Bitcoin’s open-source similarities to the internet.
Good investors always weigh pros with cons for investments, so it is important to note the issues associated with Bitcoin. Bitcoin is still an experiment with many inherent questions. Governments have only just begun to recognize and consider how Bitcoin could impact the financial system (mostly for tax purposes). Additionally, Bitcoin transactions are still fairly slow to confirm and take anywhere from a few seconds to a few hours. It is relatively difficult to withdraw money from your Bitcoin wallet. This illiquidity makes the price of Bitcoin very volatile, so we would not choose Bitcoin over brick and mortar banks to deposit savings.
Bitcoin’s implications for devouring banks and institutions as third parties are significant. Financial institutions’ profitability, ability to loan money, and entire role in the financial system may be diminished if Bitcoin were to become a cheaper, faster, and more efficient bank. Additionally, Bitcoin could consolidate currencies globally. Banks could potentially remain a source for lending, but Bitcoin’s open-sourcing may very well integrate a lending system into the platform. Currency consolidation and diminished bank lending would also trickle into governmental effectiveness, and international relations. Further, Bitcoin’s potential growth feeds into globalization trends and brings question to defining state’s sovereignty.
Disclosure: all financial information obtained from public sources and links referenced. These opinions are my own, and have no positions or plans to position with any mentioned investments in the next week.