Why I’m interested in Bitcoin

2013-12-31

Some people assume that all Bitcoin advocates are motivated by a libertarian political agenda. That is certainly not my agenda. I’m a lifelong Democrat who supported Obama in the last two elections. I think the Federal Reserve plays an important function, and I don’t agree with people who think inflation should be our nation’s primary economic concern.

It is true that many early Bitcoin proponents were libertarians. But it is also true that almost every significant computing movement had early proponents who were ideologically motivated. The developers of the first personal computers were closely aligned with the 60s counterculture movement. Open source software was originally created by people who believed that all software should be available for free. Early advocates of blogging and collaborative systems like Wikipedia were trying to democratize the production and dissemination of information. This isn’t coincidental: broad-based technology movements have depended on non-economic participants early on since it often took years for commercial participants to get involved.

If not for political reasons, why am I interested in Bitcoin? Like a lot of people, I was disturbed by the aftermath of the 2008 financial crisis. I thought the government did what it had to do at the peak of the crisis but missed an important opportunity afterwards to reform the financial system. It seemed to me that there were two ways to improve the system: from above through regulation (which I support), or from below through competition.

I wrote a blog post about this issue about four years ago. My argument was that if the technology industry wants to change the financial services industry, it can’t just build new services on top of existing financial services companies. That would be like trying to disrupt Google or Apple by building services on top of their platforms. To actually have an impact (and create large businesses) you need to create services that completely bypass incumbent financial companies. I gave a series of examples including payments:

Charging 20% interest rates (banks) and skimming pennies off every transaction (Visa and Mastercard) is a very profitable business. Starting a new payment company that doesn’t depend on the existing banks and credit card companies could be disruptive.

Since then I made a number of financial services technology investments, all of which were consistent with this thesis.

I started getting interested in Bitcoin about two years ago. Like a lot of people I initially dismissed Bitcoin as a speculative bubble (“Internet tulip bulbs”) or a place to stash money for people worried about inflation (“Internet gold”). At some point, I had an “aha!” moment and realized that Bitcoin was best understood as a new software protocol through which you could rebuild the payments industry in ways that are better and cheaper.

The payment industry is a $500 billion industry (or larger, depending on how you measure it). That means banks and payment companies charge $500B per year in fees to provide a service that mostly involves moving bits around the Internet. There are other services they provide like credit, security, and dispute resolution, but in any reasonable analysis these services should cost dramatically less than they currently do. The payment industry should be at least an order of magnitude smaller than it is today.

Another thing that informed my view was seeing what a huge headache payments were for startups I was involved with. Let’s say you sell electronics online. Profit margins in those businesses are usually under 5%, which means the 2.5% payment fees consume half the margin. That’s money that could be reinvested in the business, passed back to consumers, or taxed by the government. Of all of those choices, handing 2.5% to banks to move bits around the Internet is the worst possible choice. The other main challenge startups have with payments is accepting international payments. If you are wondering why your favorite technology service isn’t available in your country, the answer is often payments.

But the most exciting aspect of Bitcoin (and this is admittedly more speculative) are all the interesting new business and technology models that “programmable money” could enable. For example, I am very bullish on micropayments (this is a longer topic which I plan to write about separately). The world recently ran its first large-scale micropayments experiment – so called in-app payments on iOS and Android – and despite some serious design flaws (centralized control, 30% fees), it was a smashing success. I think Bitcoin could enable a micropayment system for the open web, and thereby provide a business model beyond banner ads for many important services such as journalism.

I’m not claiming that Bitcoin (or any new technology) can save the economy or the world. The technology industry is in the business of creating products and services that either enable new activities or make existing activities less expensive. Venture capitalists are in the business of funding entrepreneurs who run experiments to try to create these new products and services. I believe the only way the technology industry can offer meaningfully improved financial services is by building new services that don’t depend on incumbent companies. Bitcoin is a serious proposal for dramatically improving the payments industry. There are plenty of open questions but I think it’s an experiment worth running.

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