SMEs, Bitcoin, cryptocurrencies, and the future of money
SMEs, ‘cryptos’, Bitcoin, and the future of money – why you should be thinking about it now.
By John Clamp.
Yes, we’re going to be talking about Bitcoin, cryptos, and all that jazz.
Tech Cache author Joe Albano has called Bitcoin ‘the Napster of digital currency’ (an initial product soon to be superseded). Sir Howard Davies, chairman of the Royal Bank of Scotland, referenced Dante’s Inferno when talking about it (‘Abandon hope all ye who enter here’). Nobel laureate economist Joseph Stiglitz has called for Bitcoin to be banned. UBS economist Paul Donovan compares the current Bitcoin craze to the infamous ‘tulip bubble’ of 1637. Still others, such as specie (gold) trader and advocate Roy Sebag, say the currency’s very intangibility dooms it to failure (a poor argument, since most money these days is made of worthless cotton paper or, in some cases, plastic fabric).
However, the Chicago Board Options Exchange,
which deals in derivatives (essentially, betting on future commodity prices), has initiated a futures contract on Bitcoin. After weeks of crazed trading that included $2,000 falls in Bitcoin’s value in a single day’s trading, its current price is $13,700 (it’ll keep on yo-yo-ing, so that price is as of the time of writing, which is December 10, 2017).
Opinions on Bitcoin fluctuate as wildly as the currency itself
Some say ‘cryptos’ are the future of money, while others say the rise in value is being driven by hedge funds piling in to a lucrative investment. Others say the rising value reflects the developing ‘blockchain’ technology that underlies the Bitcoin, which has enormous implications for data security and could power a potential cornucopia of applications. Many say the current valuation is a classic ‘bubble’ waiting to burst.
Well, are Bitcoin, the current market leader, and its many stablemates, such as Ethereum, Litecoin, and Ripple, a ‘Ponzi’ scheme, as some assert? Or could they represent a new direction in peer-to-peer payments that will massively reduce the cost of financial transactions?
Whatever your view, as a businessperson running your own enterprise, digital currencies are something to watch. You can’t really ignore them altogether. One London café accepts payments in Bitcoin, and the proliferation of exchanges that will ‘convert’ your cryptos to fiat currency are garnering business.
However, doubts remain about one of Bitcoin’s core unique selling points: its security. Not the core technology, but the security at the point of conversion, (in other words, at the exchanges). Just this week $64m of Bitcoin was stolen by hackers who accessed the NiceHash exchange based in Slovenia, which also acts as a ‘mining’ hub for the currency. Other exchanges have been ‘robbed’, too, including the Japanese Mt Gox exchange, shuttered in 2014 after ‘losing’ 850,000 Bitcoins (current value: more than $11bn, but back then a tiny fraction of this price).
Money: a (free) primer
The concept of money
What is money, anyway? I’d argue that a good definition is ‘a portable, current, trusted, exchangeable store of value’. In my view you can’t really omit any of these attributes of the paper you have in your billfold, which in itself is worthless. Its value is socially constructed.
Money is only useful because we all agree that it has value. And that value must be agreed. You can’t just tell a store clerk that you’ve decided to pay for your groceries with spent batteries. Not only will he not agree with you, he may call an ambulance for what he might deem a mental health emergency. So the ‘trust’ element comes from the commonality of the agreement as to what constitutes money. In The Ascent of Money, economic historian Niall Ferguson calls money ‘trust inscribed’ (i.e., ‘written down’ or ‘recorded’).
Okay, so no one in their right mind would view spent batteries as money. Today, that is. There may come a time when they are commonly accepted as money, who knows? The example merely serves to illustrate the fact that literally anything can be money. In the past, many things have been ‘money’, but today, we can’t use the vast majority of them to buy anything in the real world. Cowrie shells, for example, were an early form of money, but you never see anyone with a bag of them out shopping. So money must be ‘current’.
Cowries and stone
Paper money’s portability has made life easier for money launderers (you can fit a million dollars in 100-dollar bills into a smallish valise), but it’s also made life easier for everyone else. Money wasn’t always so portable. A round-the-world trip staying in Four Seasons resorts would set you back more cowrie shells than you could carry, no doubt (if they were legal tender). In fact, past societies have agreed to use the craziest things for money, including limestone discs several tons in weight (a former currency in what is now Micronesia).
Once human beings started smelting metals, though, everything changed. From the earliest Lydian coins minted in 600 B.C. to the Congolese copper ‘Katanga’ crosses (an unwieldy shape and weight), to today’s gold sovereigns and Krugerrands, money has been metallic. Until, all of a sudden, it wasn’t: paper money, invented in ancient China, is now our ‘cash’. Meanwhile, money that exists only on computer hard drives as derivatives and other financial instruments has far outstripped the value of cash in circulation, and even the total value of the world’s stock markets.
My core argument in this post is that money tends towards ‘utility’. This means that the easier and cheaper any form of money is to use, and crucially, exchange, the higher the pressure will be for its adoption, and the more people will end up using it. It’s an obvious enough point, you’d think, what with the evolution of money from stone discs to cashless swipes in supermarkets). We’re already moving towards a virtually cashless society in any case.
However, the current money revolution, the move to digital currency, has major implications for society at large, and for SMEs in particular. Will ‘cryptos’ take over from so-called ‘fiat’ currencies issued by central banks around the world?
If you’re an entrepreneur or business person, as many readers of this site are, you can’t avoid the future. It’ll come to you, willy-nilly. In fact, the future is already here, though as with most potential innovations it’ll take time to become universal. Perhaps this is preaching to the converted: you may already have a PayPal account or accept payment in Bitcoins. Plenty of trendy juice bars in Palo Alto are.
That said, what’s changing in my view is not the core concept of money itself. That’s still a medium of exchange, a store of value, and all the other things. What’s going to happen, with any luck, is that our stock of cash will for the first time be totally under our individual control. Sure, even Bitcoins have to be stashed somewhere. But as David Birch argues in his recently published Before Babylon, Beyond Bitcoin, the newfangled thing that will change everything is that people can directly pay each other. In fact, the mysterious (and thus far unidentified) inventor of the Bitcoin, (pseudonymously dubbed Satoshi Nakamoto) actually invented the cryptocurrency for that specific purpose: unmediated, person-to-person transactions.
I’ll use myself as an example. As a writer, I have a number of clients. One pays me via PayPal. Rather than withdraw my fee in cash, I merely send it straight on (for a very small fee) to an innkeeper in my home city whose tuna carpaccio rocks. No bank is involved in the individual transaction itself, though at each extremity of the process some banking does take place. As far as I am concerned as an individual, the bank has disappeared from the process.
There remain, of course, intermediaries. If you’ve a stock of Bitcoin, you’ll need to be a member of an exchange, such as Bitsamp, Coinpay, Bithump, Kraken or any number of other conversion exchanges. If you want to accept Bitcoin as payment at your place of business, some exchanges will convert the Bitcoin to your local currency instantly (though as we’ll see below, there are pricing issues with cryptocurrencies that can cause headaches for SMEs).
So long PayPal? (perhaps not quite yet)
Could Bitcoin and its ilk mean the end of PayPal, which is a clunky system whose current existence is probably due to its relatively early invention (in 1998) and its purchase by eBay in 2002. That buy-out certainly helped eBay become broadly trusted by buyers and sellers alike. Some argued that PayPal was (and is) a crucial element in eBay’s business model.
However, if history shows us anything, it is that there are innumerable dead-ends and diversions which will make a stab at tackling the ‘exchange’ and ‘trust’ issues involved in buying stuff from halfway across the world. Most of them will fail, and any early attempts at solutions (including PayPal itself, and potentially even Bitcoin) must adapt to the fast-paced change in the financial marketplace, or die.
Escrow (otherwise known as financial constipation)
One blockage in the financial transactions process that PayPal does not solve, for example, is that of ‘escrow’, the storage of cash in a ‘pending’ account before it’s then transferred to your bank account. You can transfer PayPal cash to a friend immediately at low cost, but to transform it to cash, or to send money via an ‘e-cheque’ to a merchant takes days. There’s still simply no good reason for this. Banks have been getting better at speeding up their processes, but they still charge exorbitant rates for instantaneous transfers which cost them, essentially, nothing but a few minutes of a clerk’s time. Likewise, Western Union and other money transfer operators provide recipients with immediate access to the sums sent, but they charge hefty fees for doing so.
Businesses such as PayPal attempting to offer financial transfer solutions are one side of the coin, but there’s another: the consumer. The dozens of major system hacks each year and the theft of extremely sensitive personal information from institutions such as credit agencies (Equifax, see elsewhere on this site) have already eroded consumer trust in financial institutions. Yes, Bitcoin exchanges have been hacked, but only where the vulnerability in the system lies: in the ‘exchange’. If each person had their own personal encrypted ‘exchange’, with future biotech powering biometric ATMs that were unhackable, the ‘intermediary’ issue would be solved. Whatever you’ll hear about iPhone’s new facial recognition vulnerabilities, there are new more powerful biometric tools on the way through the innovation pipeline (one involves ‘reading’ each person’s totally unique chemical signature). Combined with other methods of authentication, these tools could be at our disposal in a matter of years rather than decades.
A question of trust
American non-profit organization the National Association of Retirement Plan Participants found that where in 2015 13 per cent of people had faith in banks and consumer institutions, one year later that figure had dropped to eight per cent. Take another look at those figures. They’re astonishingly low, aren’t they? There was a time, after all, when banks were among the most respected and trusted major institutions created by human beings. Yet that was a long time ago, and we can safely say those days are over.
Exchanges, financial instruments (such as the ‘Bitcoin futures’ mentioned above), and fees for administration may remain. But personal and even business banking could well be on the way out. If we don’t have to pay banks to look after our money for us, then it’s a virtual certainty that consumers will make that saving. After all, who foots the bill when irresponsible traders blow vast sums on credit default swap insurance? Us, that’s who: ordinary Joes and Josés and Josephines. However, there’s one piece of the financial jigsaw that must be in place before citizens take control over their money: security. That’s the elephant in today’s room, and we’ll come on to that later.
If we can maintain control over our own money, we’ll surely do so. Where do bank bonuses come from? Us. Who complains about the exchange-rate gouging at foreign ATMs? We do. The normal elements of banking infrastructure (high-street branches, ATMs, etc.) are expensive, sure, but it’s conceivable that they’ll soon be obsolete. Who likes paying seven or eight U.S. dollars to take your own money out of a wall abroad at an insultingly low rate of exchange?
The oversized profits of banks result from customer charges, among other things. Extracting money from an ATM outside the U.S. will cost you twice over. First, the banks slap up to three per cent onto the exchange rate. Then there’ll be a transaction fee, which again may be up to 3 per cent of your withdrawal. What’s more, the transaction fee may operate at both ends of the chain. The local bank will take their cut, and your own bank (or alternatively, an organization such as Visa or MasterCard), will also take theirs.
Banks may end up losing their so-called ‘retail’ business, and be forced to concentrate instead on selling us home loans and other financial products. As long as digital currency can be made secure, that’ll be a good thing, because bank bail-outs are often justified by the need to insure customer deposit balances (the U.S. government has a huge deposit guarantee back-up fund just for this purpose). Instead, a market will develop to insure our own, personal digital currency deposits.
What’s here? And what’s coming?
Anyone who says they can predict economic shifts, or that they know the future of money is gas-lighting you. How many people predicted the crash of 2008? Check for yourself: you can count them on one hand. Mostly, those that did were mavericks, too. They weren’t all economists, by any means. Take a look at The Big Short, Michael Lewis’s book about the crash. It’s also been made into a movie (an excellent one too, by the way). Hardly anyone saw it coming.
As with the crash, so with the future of money: who can say where today’s trends will lead? What’s important for you, as a businessperson, is that you’re ready for shifts when they come. So what we’ll do next is take a look at what cryptocurrencies really are. We’ll also examine some of the downsides to these forms of money, because there are aspects to them that should give us pause.
Right across today’s media environment you’ll find people discussing and writing about ‘cryptos’, or digital currency generally. It’s a white-hot topic. As you’d expect, though, a lot of what’s being said is useless verbal fluff. Here at seorw.com, though, we’ve done our research thoroughly. That means what you read here is backed by trusted sources, so you can have real confidence in it.
Back in 2015, the Bank for International Settlements, which is based in the delightful Swiss city of Basle, tasked their Committee on Payments and Market Infrastructures to research the phenomenon of cryptocurrencies. They completed their work in November of that year, and the report was published under the simple title ‘Digital Currencies’. The committee did a thorough job, as you’d expect. Their conclusions included an acknowledgment that cryptocurrencies such as Bitcoin were indeed based on a novel, and pretty cool, idea. That idea was the ‘blockchain’.
What’s a blockchain?
Simply put, the ‘blockchain’ is a kind of distributed database. Everyone who owns Bitcoin is part of it. The key thing, though, is that while the blockchain is ‘distributed’, it’s not broken up in any way. Everyone who has a Bitcoin ‘node’ has a copy of the entire database of who owns which Bitcoin, at all times. The other key element of the blockchain is that it’s encrypted. This means that no one can ‘break into’ the Bitcoin database and steal what’s there (they can get into exchanges, though, but we’ve covered that issue already. The public key encryption used to secure the blockchain is currently uncrackable through any known technology we have, because the computing power necessary to decipher the code is simply too huge to contemplate.
So, everyone has the blockchain, at all times. It’s like a ‘public ledger’, where the account book is open to everyone. It’s just that no one can read it, because even though it’s ‘open’, it’s also encrypted. Any transaction undertaken in Bitcoins is processed by every ‘node’ in the network. In other words, everyone who is part of the chain is required to process and ‘agree’ to the transaction.
The distributed nature of the blockchain makes the database very secure indeed. Much more secure than major institutions such as Equifax, for example.
Where’d it come from?
The concept of the blockchain originated in 2008, when someone (or a group of people) calling themselves Satoshi Nakamoto worked out the extremely complex mathematics involved. In 2009, Bitcoin went live. ‘Nakamoto’ set an upper limit of Bitcoins of 21 million. No more than that would ever be created. What’s more, they weren’t created all at once. They were made little by little. And anyone with a large stack of computers could ‘create’ Bitcoins by solving complex mathematical puzzles using higher-order computing power. As of June this year, the number of Bitcoins in circulation totaled 16,366,275. So even though in theory anyone has been able to ‘create’ Bitcoins for the last eight years, we’ve not even reached the total number designated for creation.
However, the mathematical ‘puzzles’ are so complex that ‘creating’ new bitcoins is fantastically wasteful of electricity. Currently, the total energy usage of bitcoin mining exceeds the electricity consumption of Ireland. It’s hardly the ‘greenest’ way to make money.
Are Bitcoins the only cryptocurrency?
As you’d expect, they’re not. Once people grasped the concept of the blockchain and made it replicable, they started creating their own cryptocurrencies. However, many were (and possibly still are) fraudulent money-making scams which fleeced unsuspecting buyers of their hard-earned genuine cash.
There’s no evidence thus far that the Bitcoin itself is a scam, and there do exist one or two other cryptocurrencies that command widespread trust (such as Ubiq and Litecoin). However, you couldn’t by any means regard the totality of coin offerings as safe investments. There are at the time of writing (early December 2017) more than 1,100 separate coins, and many of these will either be fraudulent, or they’ll die out at some point in the future.
What are the downsides?
The key downside to cryptocurrencies happens to also be one of the things that owners like about it. Bitcoins and their ilk are not created by governments. They’re not ‘fiat’ currencies. Let’s go back to that BIS committee report and see what they had to say.
‘These assets [cryptocurrencies] typically have some monetary characteristics (such as being used as a means of payment), but are not typically issued in or connected to a sovereign currency, are not a liability of any entity and are not backed by any authority.’
A ‘fiat’ currency is one issued by a sovereign state. Usually, that state will ‘back’ the currency. That means, for example, that in most modern states your bank deposits are ‘insured’. The U.S. Federal Deposit Insurance Corporation, for example, set up after the 1929 Wall Street Crash, will refund you up to $250,000 of your bank deposits in the event that the bank holding them goes bust.
As independently created media of exchange, there is no government in the world that’ll insure or guarantee your Bitcoin or cryptocurrency balances. So if the currency disappears or goes under (which many have), you lose the lot.
A further point to remember is that Bitcoin’s very anonymity and ease of transfer makes it the ideal medium of exchange for criminal enterprises (see below).
Ups and downs
Another downside to cryptocurrencies as they currently operate is their extreme volatility in value. If you take a look at this chart you’ll see why many investors are scared of Bitcoins, quite apart from the fact that it’s not a fully backed ‘fiat’ currency. (The chart ends just before the recent spike in value to $19,000 in December 2017, which was followed by a 40 per cent downswing the following month).
Even though the trend in value has been upwards, the rate of volatility remains high even today. Having started 2017 with a value of $966, Bitcoin has risen in value by well over 1000 per cent since then, breaking the $15,000 dollar mark well before Christmas. What’s more, it’s been up and down like a yo-yo (though generally when it goes down, it doesn’t go down to historically low levels).
Governance and the black economy
Another downside to cryptocurrencies is that governments hate them. They’ve good reason to, as well: the ‘crypto’ aspect of Bitcoins and their ilk makes them ideal for illicit financial dealings. Remember the Silk Road drugs market that operated on what’s known as ‘Tor’, or the ‘Dark Web’? Bitcoin facilitated the illegal transactions on this site because the sources and destinations of its financial transactions are impossible to trace.
Governments also hate cryptocurrencies precisely because they’re not ‘fiat’. Governments like to have control over the currencies that circulate in their polities. China recently shut down all its digital currency exchanges, and it’s not the only county to have done so. Some economists, however, think that fiat currencies are regressive, believing that government control over a single currency prevents its economy from achieving its full potential by reducing that nation’s creative ‘fluidity’. The great Austrian-British economist Friedrich Hayek, for example, argued passionately for the denationalization of money. In fact, before the Bank of England nationalized the issuance of fiat currency, regional banks were free to produce their own, branded notes (and did so).
The third key downside to ‘cryptos’ is (currently) their lack of convertibility. As with the spent batteries mentioned earlier, there aren’t many stores you can walk into and spend your Bitcoins. There are, though, lots of exchanges which have opened up to solve this problem, and through which you can link your Bitcoin exchange account with your normal bank account. But by and large, Bitcoins and other cryptos are, at the moment, not very ‘convertible’. When you recall our definition of money, this issue with convertibility affects the value of Bitcoins as a ‘medium of exchange’. However, it’s worth noting that ‘instant exchange’ apps used by the growing number of businesses which accept bitcoins charge handling fees which are a fraction of the cost of Visa or credit card transactions in stores. Those transaction fees are, of course, built in to the prices you pay when you’re shopping.
The penultimate downside to ‘cryptos’ is the issue of trust. Although Bitcoin has been around for eight years, it hasn’t generated (so far) universal trust. Some trust it, others don’t, and yet others don’t even know what it is. Among those who do trust it, it’s viewed as the future of money. Among those who don’t, it’s viewed as a kind of Ponzi scheme that’ll eventually end in tears in all cases.
Finally, there’s one key downside to cryptocurrencies that needs mentioning. It’s time. Contrary to what you’d expect in today’s hooked-up world, transactions in cryptocurrencies actually take some time. They’re not instant. The time taken for distributed blockchain networks to process transactions varies, and can take up to ten minutes. This limits their utility, since you could in theory walk into a shop, buy something with a segment of Bitcoin, then walk out and cancel the transaction. While this currently limits the utility of cryptocurrencies, though, it’s not an insuperable problem. As computing power and network speed increases (which it will) delays of this sort can be minimized almost to zero. However, we’re not there yet.
So why, as business owners, should we know about them?
As a businessperson or as an ordinary citizen, there are several good reasons why you should know about cryptocurrencies.
Whatever you think of the actual currencies, there’s no doubt that the concept of the blockchain is a game-changer. These distributed, peer-to-peer, encrypted databases offer numerous institutions a potential solution to a very big and fast-growing problem: data security. The fact is that anything which can be digitized (rendered as binary 1s and 0s) can be distributed and secured in a blockchain. Right now, the concept of the blockchain is being considered as a solution to data security problems in a vast array of sectors. Medical records? Check. Financial records? Check. Tax records? Check. Personal data held by any company or agency? Check. Indeed, any data that needs securing is potentially rendered safe by deploying a blockchain.
Another good reason you ought to at least know about cryptocurrencies is that, as with other good ideas that arise from the pool of human creativity, governments are prone to jumping on the bandwagon. Speculation is rife in tech circles that at some point (and it could be very soon), a sovereign government will issue its own cryptocurrency. Now, that speculation may be wide of the mark, but it shouldn’t be dismissed out of hand. Very recent reports have suggested that Venezuela may issue its own cryptocurrency. In the meantime, though, financial authorities in the UK and EU have stated their intention to regulate cryptocurrencies as part of their fight against money-laundering and tax evasion.
A third good reason to know about cryptos is that they can be created by anyone, as long as they deploy the correct algorithmic code. How will this fact change the financial landscape? Well, consider the concept of ‘local’ or ‘community’ currencies. Localized currencies have a very long history, of course, but in their current incarnation they were born as soon as individuals got a hold of more powerful personal computers which could store databases. Vancouver resident and computer expert Michael Linton designed the LETS system in 1982.
LETS stands for Local Exchange Trading System. It enabled the members of a community to trade commodities (including time) with each other in a closed system. Since then, cities, towns, and even specialized communities of like-minded people (members of a club of any kind) have designed and implemented their own LETS. These allow people, for example, to ‘swap’ or trade babysitting services for auto repair services within a community. Now that cryptocurrencies are around, it’s a fair bet that localized ones will (and are) popping up all over the place. 2014 saw the release of the Hullcoin, a cryptocurrency for the city of Hull. This is thought to be the first cryptocurrency generated by a local government authority (in this case, the UK city of Hull, in Yorkshire). Since then, localized cryptos have been created on a regular basis.
There’s a final impact that cryptocurrencies will have on the marketplace in goods and services. This will be their impact on the cost of transactions. Where Visa and other card payment companies charge hefty fees and make fat profits from each purchase, in theory at least, cryptocurrencies are much cheaper to administer. There’s no need for some centralized bank of servers to store transaction or balance details, since all that is done across a distributed network of independent ‘nodes’. There’s also no need for a clerk in a bank to verify or approve a financial transaction. Even today, in many cases this has to be physically done by stamping a bit of paper.
What about me?
Here at seorw.com, we’re not in the business of handing out investment advice. We can’t say whether cryptocurrencies will die out altogether, or whether they’ll become the next big money thing. What we can say is that they’ll change the financial landscape in some fundamental ways. In fact, they already have.
As a businessperson, what does this mean for you? Well, you can expect transaction costs to go down for starters, and that may be the case even when it comes to banks dealing solely in fiat currencies (they’re currently making fat profits out of you and your customers).
If you’ve done your research and cogitated on the issue, you may end up deciding to allow your customers to pay you in cryptocurrencies. However, one thing you should keep in mind is that at the moment, cryptocurrencies change in value every day, and often by wide margins. Their convertibility is highly variable, and some might disappear in a puff of digital smoke. This fact makes it difficult to put stable values on commodities. For example, that lovely Trek mountain bike you sold yesterday for 0.1 Bitcoin? That Bitcoin portion might have been worth $800 at the time you sold it, but when you get around to trading it for greenbacks you might find you receive only $650. In the end, the volatility of cryptocurrencies make them highly problematic as media of exchange on today’s high streets. That’s not an insoluble problem, though, as of course, there are now apps that convert Bitcoins into fiat currencies immediately.
A parting shot
As an individual, or as a businessperson running an SME in Tampa, you may choose to enter the world of cryptocurrencies. But be forewarned and forearmed: don’t expect it to a world that’s either stable or easily navigable.
This primer on cryptocurrencies was informed by many dozens of sources. In researching the topic, I’ve found lots of excellent resources which I deem to be trustworthy. I’ve also found a whole stack of articles and commentaries which are, to put it mildly, ‘bull’. So if you’ve a yen (excuse the pun) to get into this topic and research it further, the few hand-picked resources listed below will get you started. The list includes topics I’ve not touched on here, such as the status of virtual currencies relative to the IRS. The list also includes reputable think-tank reports on the underlying technology of cryptocurrencies, the blockchain.
Hayek, Friedrich (1978) Denationalisation of Money (2nd edition), London, UK. Institute of Economic Affairs