Bitcoin, the Two-and-a-Half Party Model, and New Payment Rails
One of the immediate applications for Bitcoin and the math-based currencies that are emerging in its wake is its potential as a new set of payment rails. Rather than the incumbent industry’s reliance on the four party model and its hierarchy of providers, authorization messages, and settlement steps that are necessary to connect the payer and the payee, Bitcoin and other math-based currencies promise a simpler cash-like push payment.
It’s not quite that simple of course but it’s not far off. Call it the two-and-a-half party model. There are, of course, the payer and the payee. The other half provides services such as currency exchanges, cash-in services to purchase bitcoins, trading desk, secure storage, and more.
Bitcoin is all about push payments between two end points. The facilitators of the Bitcoin ecosystem avoid settlement risk because of Bitcoin’s funds push nature. There’s no authorization message and settlement lag. Once value is converted into btc, transactions run over the peer-to-peer communication protocol that provides the payment rails. This works because every device, from the Internet Protocol’s point of view, is more or less equal. Despite our reliance on huge intermediaries like Google and Facebook, the Internet is a peer-to-peer scheme. Bitcoin and other digital currencies are simply using that Internet DNA in value exchange.
Putting aside the “bitcoin as store of value” discussion, payments professionals should consider how these math-based currencies could function as payment rails. As a Mashable article put it, they have the potential to function as the currency equivalent of Esperanto, an intermediate lingua franca in the service of value exchange.
International Remittance Rails
The potential for this approach in international remittance is squarely in the sights of multiple startups, from BitInstant to OpenCoin. While merchant uptake is tiny, use cases are already in the market. Expensify has added an interface supporting bitcoin transfers between its accountholder and independent contractors performing project work. Other than providing the capability, Expensify has no involvement in the transaction. Remember, this is person-to-person payment. And it is a no to very low cost transaction within the Bitcoin ecosystem. What it costs to convert bitcoin to the local fiat currency is another matter.
A scheme (surprisingly) omitted from the Mashable article is OpenCoin, Inc’s Ripple currency. Ripple’s designers, as with other digital currency builders, have taken more than a few pages from the Bitcoin book but they are all trying to improve on Bitcoin’s limitations. While transaction speed is one (more on that in a later post), Ripple also includes a trading market capability for multiple currencies. Ripple “gateways” or exchanges will need to exist, of course, to move the value across the Ripple network’s border but the protocol allows value to be stored in individual currencies.
Getting Onto the Rails
As a payment vehicle, Bitcoin is largely useless without practical currency exchange capability. For first time Bitcoin participants, performing the currency exchange function is confusing at best if not baffling. Most exchanges ask for one’s banking information, an immediate stopper for most of us.
Using a cash-in facility is one way to begin. LocalBitcoins.com is a market maker that connects buyers and sellers. My nearest contact operates out of a Starbucks about 15 miles away.
Another is BitInstant, an outfit that facilitates transfers among various exchange accounts including Mt. Gox. The firm also offers cash loading services at over 700,000 locations through its affiliation with Zip Zap. You can go to a local CVS and have your purchased bitcoins sent to your public Bitcoin wallet address for a 3.99% fee plus a $3.95 fee to the ZipZap cash loading network. BitInstant has coverage in the US, Turks and Caicos, Puerto Rico, both the U.S. and British Virgin Islands, Cayman Islands, Bahamas, and in the slightly cooler Russian Republic, Kazakhstan, and Ukraine. Not cheap at an 8% FX cost, but it can get you in the Bitcoin game.
Bitcoin’s impact on the foreign exchange market is infinitesimal compared to the nearly $4 trillion in daily spot or cash foreign exchange markets. From that perspective, there’s only upside.
Merchant Transaction Privacy
An intriguing issue and potential downside for using Bitcoin payment rails, given its publicly available transaction ledger, is a merchant’s ability to keep its transaction flow private. If the merchant’s public Bitcoin address is not thoroughly obfuscated (at extra cost), it is possible to determine the transaction volume going into and out of that bitcoin wallet, revealing not only a coffee shop’s customer receipts, for example, but potentially revealing some portion of its supply chain partners. Since a merchant’s supply chain is often a closely held secret that provides no little competitive differentiation, the block chain’s lack of privacy could be a real concern for merchant uptake.
There are ways, of course, to programmatically obfuscate these transactions by breaking them up into random sizes and sending them to programmatically generated wallets belonging to the merchant. Such services already exist in the Bitcoin ecosystem. However, unless the merchant is savvy enough to understand the privacy implications of the block chain, it’s not an obvious step.
There are other concerns about Bitcoin, transaction speed within the Bitcoin ecosystem is among them that we will address in an upcoming post. In the meantime, we continue to evaluate the potential for what some consider to be an open source payment gateway that speaks Esperanto. We look forward to your questions and comments.
We’re using the emerging convention of capitalizing the Bitcoin ecosystem and leaving the currency bitcoin in lowercase. The currency is abbreviated as btc.