Episode 83 – Settlement Systems in Detail – Carol Coye Benson, Glenbrook
Considering Bitcoin as a Payment Network
Wikipedia says, “Bitcoin is a software-based online payment system.” But what sort of payment system is it? We get this question all the time when we talk about Bitcoin in our workshops.
At Glenbrook we like to start each Payments Boot Camp talking about payments systems fundamentals and the common attributes that can be used to understand and position any payments system. In every workshop someone will raise their hand in the first ten minutes and ask about Bitcoin. They are always thinking that Bitcoin is so revolutionary it must somehow invalidate how to think about payments systems. We love this because Bitcoin doesn’t refute how payments systems work — it illustrates and reinforces how all payments systems work. Let’s look at some of the specifics:
Sender and Receiver. Slide one in our workshop defines a payment as an exchange of value between a sender and a receiver, denominated in a currency. So far, so good for Bitcoin. Not a government-backed (or “fiat’) currency per se, but a currency nevertheless.
Virtual, Not Centralized or Distributed. We go on to define a payments system as what manages payment between end parties. Payments systems are usually characterized as centralized (e.g., Visa), distributed (e.g., checks), or virtual (e.g. cash). Designed as a form of digital cash, Bitcoin is clearly a virtual payment system — one that lies on top of the global Internet instead of laying on top of the local economy.
Open, Not Closed. We also talk about the importance of distinguishing between open loop and closed loop payment systems. Here, Bitcoin is best described, I believe, as an open loop system. It is not a bank transfer system (which is sometimes a synonym for an open loop system) but it uses the same relationship model as an open loop system –– meaning that end parties can exchange value in the payments system without sharing common relationship with an intermediary. I can use my favorite Bitcoin provider, you can use your favorite Bitcoin provider, and we can exchange Bitcoins without anything else in common. There may not be an actual “loop” involved but it still sounds open to me. Plus participation in Bitcoin is open to anybody or any business that wants to provide services within the ecosystem.
Glenbrook likes to stress that all payments systems can be defined by three core groups of functions – transaction processing, brand management, and rule making.
- Processing – Bitcoin has a well defined processing model. It’s based on the use of cryptography, peer-to-peer networking, and the public block chain. Most articles on Bitcoin focus more on its processing model than anything else, focusing on how the so-called “miners” use cryptography to validate transactions and earn Bitcoin as a reward.
- Brand – Bitcoin has a multi-faceted brand that means different things to its advocates than it does to its detractors. But either way, everybody has heard of Bitcoin and there is no fragmentation of terminology. When a customer asks if they can pay their vendor in Bitcoin, both parties know what that means. Not a verb yet — “Can I bitcoin that to you?” — what the word bitcoin connotes is clear – and that’s what a brand does.
- Rules – Here’s the surprise. Most people think there are no rules. They have read that Bitcoin has no central authority, no “deity in the sky”, no central rule making body, etc. But there are plenty of rules in Bitcoin. There are all expressed through math, through the original Satoshi Nakamoto white paper, and through open-source software.
Bitcoin’s rules are fairly straightforward and include simple ideas like:
- “No more than 21 million Bitcoins will ever exist.”
- “All transactions are final, there are no chargebacks or reversals.”
- “The default transaction fee is 0.0001 Bitcoin.”
It would be interesting to actually write out the Bitcoin operating regs! They wouldn’t go on for a thousand pages, for sure, but there would be more rules than you might think. And in contrast to most payment network rules, every Bitcoin rule is inherently enforced in software.
When Glenbrook talks about payment systems, we also differentiate between “push” payments and “pull” payments as way to indicate whether funds transfer is initiated by the buyer or the seller. Bitcoin clearly is a push payment system with no way for sellers to pull funds out of Bitcoin wallets on a pre-authorized basis. There are lots of other parameters that can be used to compare and contrast payment systems – ownership, control, regulation, processing model, settlement mechanism, economics, liability, etc. More than we can possibly get into here.
So back to that original question. What sort of payment system is Bitcoin? I’d say it is most similar to an open loop payment system that uses the push model. It offers close to real-time processing between end-parties and uses real-time gross settlement to complete each transaction. It is a virtual payment system with no centralized ownership or point of control. The rules of the system are expressed and enforced through software. Within the ecosystem, system economics are based primarily on currency conversion and secondarily on transaction fees. The periphery of the ecosystem is regulated on a country-by-country basis, the actual Bitcoin payment transaction is not.
If you are interested in learning more about Bitcoin, we have a full-day workshop coming up this fall. Our “Bitcoin: Basics and Beyond” workshop will be offered November 19th in New York. It will be a great opportunity for you to learn more about Bitcoin and the use case specifics that we see across all the major payment domains. We also plan to spend a lot of time in the workshop positioning and handicapping the major players in the Bitcoin ecosystem.
Please join us. These workshops are designed for interaction. It should be fun!
This post was written by Glenbrook’s Russ Jones.