Warren Buffett correctly identified there is no cash flow from holding Bitcoin1. Therefore, buying Bitcoin cannot be classified as an investment. Others have called Bitcoin a pyramid scheme or outright the biggest price bubble the world has ever seen.2
In this series titled Cryptocurrency Investment Theses, I want to explore why I believe Bitcoin and other cryptocurrencies will continue to generate and capture value.
The First Online Payment
To understand the value proposition of Bitcoin and other cryptocurrencies, let’s start at the beginning of the internet.
The first data packets transversed the then ‘new’ internet in 1969 (ARPANET). It took around 25 years to reach the capable world wide web (1989-1991) with its web browsers (1991-1993), to share images (1992) and the first online payment (1994-1995).3
The first online payments worked by logging into the banking system and instructing regular bank transfers. Soon after, credit card payments were possible online. To pay by card, a user has to submit their credit card information to a merchant. The merchant, as before the internet days, contacts their bank, to contact the card issuing bank to verify the card. Upcoming payment processor PayPal soon combined both methods in one company.
It took 25 years from the invention of the internet to put card payments online. Since then, another 25 years have passed. During these last 25 years, little has changed in how we pay online. Credit card payment gateways have matured with Stripe and PayPal payments. But the process has not changed at all. Customers need to input their sensitive data, which is then forwarded and checked between the payment gateway, card issuing bank, merchants bank and possibly other intermediaries.
For 25 years, the way we pay online has remained stagnant. Bitcoin’s invention however, changes everything. Paying online is now a protocol.
Being able to shop online using cards is a significant achievement. But if I’m being honest, most online payments are annoying. Let’s examine why.
Paying Online Today
Today, most of the internet is built around commerce. One of the biggest web companies, Amazon, sells goods online to customers. The biggest online video platform, YouTube, generates revenue from ads that largely entice viewers to buy products online too. Even free, non-profit services, like Wikipedia, ask for donations using online payments in the form of credit card or PayPal payments.
Virtually all online businesses use online payment systems. But the payment systems in use are unsatisfactory.
Card payments are Lousy
42% of online shoppers prefer to use credit cards when paying online. 4
However, there are three big problems that occur when paying online with credit and debit cards.
3. Card Payment UI
The card payment user interface requires users to fill in 5 separate fields. Additionally, an address, a postcode or additional verification code are often required.
Ideally, there should just be one box to fill out with authenticating information. Or a single button to press on a hardware device. Some browsers support saving and auto-completing card information, but this introduces extra security risks. Europe moved to the IBAN system for bank accounts, a step in the right direction. 5
2. Card Payment Processing Time
When a webpage doesn’t load within 3 seconds, half of all users abandon the site.6 Email and text messages arrive globally in seconds. But a card payment takes days to arrive in the merchants account.
Why are we waiting days for payments to arrive?
1. Card Payments are Insecure
Security is of utmost importance for any payment system. Yet the dominant card payments are highly insecure. This is largely due to payment authorization information for card payments being static. Every payment uses the exact same data: your card numbers.
Due to this poor design, anytime a payment is made, there is a risk of the information being stolen. To handle card payments, special infrastructure is needed. But even those services get hacked regularly.7
Frequent hacks lead to frequent and costly refund demands from customers. They also require the issuance of new cards. Due to poor card payment design, the costs incurred are immense.8
Online card payment troubles
Paying online with credit cards is cumbersome, slow, costly and risky.
I am sure we can all agree: If online payments worked better, online commerce would increase at a faster rate, benefiting everyone.
Why Card Payments are Lousy
Card payments are unsatisfactory because they are the first attempt to port existing payment and banking ideas onto the web. Taking old systems and copying them onto the a online infrastructure causes these hurdles.
Online card payments work just like paper cheques did in the early 20th century, except that phone calls are replaced with API calls. For a payment, the customer, the merchant, both of their banks, the card issuer, a payment gateway and a payment processor all need to communicate. Time is spent at each point, fees pile up, and delicate information can be exposed at every point.
The remedy for this convoluted infrastructure with all of its downsides is a new way to do online payments. No more trying to put old ideas online. We desperately need new ideas for web payment services that use the full capabilities of the web.
How Online Payments should be
What’s your favorite online service? Perhaps it’s GMail, Airbnb or Netflix. They are pleasant to use. They are services built exclusively on the internet, for the internet. The have seamlessly replaced letters, travel agents and movie rentals.
Cryptocurrencies are money on the internet, for the internet. They are leveraging the infrastructure of a connected web to create a seamless payment infrastructure. They will replace existing payment solutions.
How Bitcoin makes Online Payments better
Bitcoin was designed for the new infrastructure: the internet. It works without the limitations and constraints of the old paper-based infrastructure. Thus, Bitcoin is able to remedy all online card payment woes.
3. Bitcoin Payment UI
Bitcoin payments can be implemented in various ways. One of the easiest is to present an invoice as a QR code, which the user then scans with their phone. A single click on the phone pays the invoice.
The invoice contains the recipient, the amount, as well as miscellaneous data.
2. Bitcoin Payment Processing Time
Bitcoin payments are pretty much instant.
Lightning payments are settled as quickly as messages can be exchanged online. On chain transactions are not finalized instantly, however this is only relevant for payments with insufficient fees or very large transfers. In those cases, waiting for a confirmation is recommended, which takes about 10 minutes.
In Bitcoin Lightning, as soon as the button to confirm the transaction is pressed, payment is received.
1. Bitcoin Payment Security
Bitcoin payments are public by design, no hidden information is contained within a transaction. Each transaction is completely unique. Due to this design, payments are completely safe.
Users must keep the devices that authorize transfers safe, for example via their smart phone wallets. This can be done with PINs, fingerprint scanners or any variety of typical security measures.
Bitcoin Payment Advantages
Bitcoin payments are easier to complete, faster and a lot more secure than other online payments. They are also much cheaper.
Merchants are incentivized to accept cryptocurrencies because they’ll be paid a lot more quickly and incur fewer processing fees. Users are incentivized to use cryptocurrencies because they are much easier to use and a lot more secure.
Bitcoin Payments are the Future
We know that Bitcoin payments are easier, faster, cheaper and more secure. But this is only the tip of the iceberg of what cryptocurrency payments are capable of. The real power of cryptocurrencies is enabling new features that are not feasible with current technology. I want to highlight four of them.
4. 100% Uptime
Bitcoin, like the internet, is available 24/7/365. There are no office hours and no banking holidays. Hardly a revolutionary concept. But it’s fundamental and not a feature. Bitcoin can’t be paused or stopped by anyone.
3. Dynamic Fees
Economists rejoice when they see dynamic pricing in practice. For example, Uber taxi ride costs react in real time to demand spikes. The price for identical rides may double or even triple in price when demand is high.
Similarly, Bitcoin’s fee market operates in real time. During times of full blocks, transactions compete for space and pay higher fees. On the other hand, a lightning network transaction that balances out lopsided liquidity in channels will be paid to complete. That’s right, a transaction can get paid to execute for its service to the network!
2. Millions of Payments per Second
When the only way to send a message was by handwritten, slow mail, we’d only send important letters. With printed letters, effective communication about small issues become possible. With virtually free email and texting nowadays, every small Detail can be discussed as it comes up in real time. This generates tremendous value.
Bitcoin enables virtually free payments. As payments cost almost zero to send and receive, new applications become feasible. For example, instead of workers being paid monthly, they can be paid daily, or even in real time. The current aggregation of payments into monthly invoices hinders economic development. In an increasing digital world, faster payments will spur faster growth.
For machine to machine payments in IoT devices, real time payments are essential for some services to exist. Solar cells may sell their generated electricity to nearby charging electric cars without intermediary corporate structures. As the devices can be anonymous they have to pay each other immediately.
1. Smart Contracts
Money on the internet is programmable. The easiest programs of the type IF THIS THEN THAT can already increase financial flexibility. For example, if my merchant account clears a sale, it will automatically send the sales tax to a designated tax account. It is quite easy to imagine this type automatic taxation being required by law in the future.
There are no limits on the complexity of a smart contract – anything is programmable. The interactions of many such smart contracts can replicate corporate structures. Such structures are called digitally autonomous organizations.
Automatically executing payments in the form of smart contracts is a hugely innovative. For a fully autonomous organization they remove the need for controllers, auditors, lawyers, courts and law enforcement.
Amazing Features or Gimmicks?
Cryptocurrencies enable better payments and new autonomously operating financial services. But of course, Bitcoin and other cryptocurrencies are far from capable yet of what many enthusiasts dream about.
For now, the economic value of the new features Bitcoin and other cryptocurrencies make available is highly speculative. Some might argue that most projects will never work, scale, or be usable outside the lab.
However, a plethora of applications trying to take advantage of these new features are in development. Some will succeed and shape the future. If just a single feature of a single cryptocurrency finds market fit, usage and price of the underlying crypto asset will increase by orders of magnitude very quickly.
The investment thesis for the Bitcoin protocol being online money states: New payment features provide immense value to consumers and merchants over traditional online payments.
When more and more people use Bitcoin for its superior payment functionality, part of the generated value is captured by the Bitcoin network, expressed in its native assets valuation.
Are you ready for a world where payments are as easy, cheap and fast as messaging?
3 First draft of the www 1989: Information Management: A Proposal
First image on the web 1992: Les Horribles Cernettes
First web browser 1993: Mosaic
First online payments 1994-1995: Stanford Federal Credit Union
5 The EU improved online banking by merging account number and routing number into one: the IBAN. It also includes a checksum. Excellent move! Next would be adding the payment amount and other information all into a single string that can be copy-pasted, making paying bills even easier. IBAN explained.
6 Google research: Mobile users abandon sites that take over 3 seconds to load.
7 Globally leading ticket sales company Ticketmaster credit card database hacked: Ticketmaster admits personal data stolen in hack attack
8 Credit card fees are enormous: Credit Cards cost Americans $400 per year in hidden fees.
Smart ideas are likely copied from someone else. Mistakes are all my own.
Paul Otto is a managing director at F5 Crypto Capital GmbH. The views and opinions expressed by Paul are solely his own and do not necessarily reflect those of F5 Crypto Capital GmbH. This post is for informational purposes only and should not be relied upon for investment decisions.
The author may hold long or short positions in the securities discussed.