Traveling with bitcoins
In the past 20 years, all industries have felt the impact of technological innovation. In some cases, this impact has been so great that disruption has occurred. A clear and often used example is the travel industry, where companies that did not exist 20 years ago, like AirBnB and Booking.com, are now major players.
So far, the impact on the financial industry has been relatively limited. Although innovation has brought about changes like mobile banking, the business model and key players have remained unchanged. In general, savers still take their money to the bank and not all of them will withdraw that money at the same time. Banks know this and use part of the savings to issue loans. For many banks, the debts (savings) are therefore short-term and liquid, while the assets (loans) are long-term and largely illiquid. This makes banks inherently unstable. For mitigation, a lender of last resort is needed, which is the government that helps and rescues the banks when things go wrong. Supervision takes place to counteract the moral risk that this entails. This model is still applied today. Most people still receive their salary through the bank and still pay their rent through the bank. Furthermore, banks still offer solutions for larger questions such as mortgages or student loans.
This may change since interesting developments are taking place that could also disrupt the financial industry. One such development is the rise of payment apps and neobanks, which I have previously written about. Another development is the rise of virtual currencies.
Virtual currencies serve as a means of making payments in a specific virtual community. The issuer of the virtual currency can be a non-financial party or a private party, and the issuance process is not supervised by the government. For each virtual currency there are rules for how and where it may be used, as well as through which infrastructure the payments are made. These rules are inherent to the virtual currency and not established by the government. Bitcoin is perhaps the most well-known example of a virtual currency.
Bitcoin functions independently of governments, banks or other institutions. Payments with bitcoins are not made via a bank, but through required software, the wallet. Each user has a public key and a private key. The public key can be seen as an account number while the private key represents a PIN code. To illustrate: If person A wants to send three bitcoins to person B, person A carries out the transaction via the wallet by filling in person B’s public key and signing it with their own private key. This transaction is then submitted to the bitcoin community for verification.
During the verification process, special bitcoin community members (called miners) retrieve all transactions that have taken place in the past 10 minutes, once every 10 minutes. The retrieved transactions are called “blocks”. These miners verify the transaction by adding the block to the ‘blockchain’, a list of all registered bitcoin transactions. Because the blockchain contains all historical transactions, it can be used to determine how many bitcoins each wallet should have. In practice, a lot of computing power is required to be able to perform this verification. The incentive for the miners to carry out the verification is that they can get bitcoins for it.
If the bitcoin community grows and the number of institutions that accept payments in bitcoins increases sharply, a lot of transactions will no longer be done via the bank, but in parallel via another infrastructure. In that case, the bank’s traditional business model faces a challenge, as consumers no longer need a bank account to receive and make payments. Governments are also losing influence, because monetary policy does not reach all consumers through the banks.
In the short term, bitcoin will not be used as a generally accepted medium of exchange. The main reasons for this are that the price is too volatile, there is little or no supervision, the verification process takes too long (it can take 30 minutes before a payment is successfully made), the verification process takes a lot of energy, and payments in bitcoins have not been accepted by governments or central banks yet. It is a good thing that bitcoin is not quickly accepted as a medium of exchange, because decisions about people’s savings should be accompanied by supervision and trust; the government guarantees.
This does not mean that the increase in popularity of bitcoin and other virtual currencies can be ignored. It is a signal that should encourage banks and governments to investigate what fuels people’s need to buy virtual currencies. By providing this, the system that has developed over the course of a few hundred years is not thrown overboard, but improved through technological innovation.