Why would anyone use Bitcoin when PayPal or Visa work perfectly well?

A common question among smart Bitcoin skeptics is, “Why would one use Bitcoin when you can use dollars or euros, which are more common and more widely accepted?” It’s a fair question, and one I’ve tried to answer by pointing out that if Bitcoin were just a currency (except new and untested), then yes, there would be little reason why one should prefer it to dollars. The fact, however, is that Bitcoin is more than money, as I recently explained in Reason. Bitcoin is better thought of as a payments system, or as a distributed ledger, that (for technical reasons) happens to use a new currency called the bitcoin as the unit of account. As Tim Lee has pointed out, Bitcoin is therefore a platform for innovation, and it is this potential that makes it so valuable.

Eric Posner is one of these smart skeptics. Writing in Slate in April he rejected Bitcoin as a “fantasy” because he felt it didn’t make sense as a currency. Since then it’s been pointed out to him that Bitcoin is more than a currency, and today at the New Republic he asks the question, “Why would you use Bitcoin when you can use PayPal or Visa, which are more common and widely accepted?”

He answers his own question, in part, by acknowledging that Bitcoin is censorship-resistant. As he puts it, “If you live in a country with capital controls, you can avoid those[.]” So right there, it seems to me, is one good reason why one might want to use Bitcoin instead of PayPal or Visa. Another smart skeptic, Tyler Cowen, acknowledges this as well, even if only to suggest that the price of bitcoins will fall “if/when China fully liberalizes capital flows[.]”

Another reason why one would use Bitcoin instead of PayPal or Visa is that it’s cheaper. Posner disputes this, arguing that Bitcoin’s historic volatility makes it risky to hold Bitcoins, necessitating hedging, and therefore making it no less costly than traditional payments systems. (Cowen was one of the first to make this argument.) But this is not true.

First of all, I would argue that there’s nothing inherent in Bitcoin that makes it necessarily as volatile as it has been; its volatility to date comes largely from the fact that it’s thinly traded. If its adoption continues apace, and its infrastructure continues to be developed, there’s no reason to think it will forever be as volatile as it has been to date. But that’s conjecture. More to the point is the proof that’s in the pudding: There are tens of thousands of merchants accepting bitcoins for payment today (and growing), and the number of transactions accepted by those merchants has been exploding as well, setting a record on Black Friday. Can it be that even with the necessary hedging, Bitcoin is cheaper?

At least for some types of transactions I think the answer is unquestionably yes. Take international remittances, which is a $500 billion industry. Sending money to Kenya using Western Union MoneyGram or some other traditional money transmitter costs around five to ten percent of the amount being sent, and can take days for the deposit to take place. A new startup, BitPesa, is looking to charge only three percent, and to carry out transfers virtually instantaneously. So hedging costs would have to be more than five to ten percent to make this not worthwhile. It’s an empirical question, but it seems to me the fact that so many are jumping in helps give us a hint as to the answer. Perhaps we can look to Bitpay’s 1% fee as a market estimate of the cost of hedging.

Well then, so far I count two things that Bitcoin can do that traditional payments systems cannot: it is censorship resistant and it is cheaper. Oh, wait. I actually mentioned another one: it’s faster. Traditional wire transfers can take days or even weeks to clear, while Bitcoin takes minutes. And yet there’s more.

As Eli Dourado just pointed out in a previous post, built into Bitcoin is a facility for decentralized arbitration. Essentially, Bitcoin allows for transactions that require two out of three signatures to verify a transaction, thus allowing payer and payee to turn to an arbitrator if there is a dispute about whether the payment should go through. Paypal and credit card companies essentially provide this service today, but as Eli points out, decentralized arbitration would likely be cheaper and would certainly enjoy much more competition. That’s four things Bitcoin can do that traditional payments networks cannot, but let me quickly add a fifth. There’s no reason that the arbitrator must be a human; using Bitcoin’s scripting language the arbitrator can be a trusted automated source of information that on a regular basis broadcasts facts such as the price of gold, or price of stocks, or sports scores. Make that data stream your arbitrator and, voila, you have a decentralized predictions market. (Ed Felten at Princeton is working on executing the concept.)

One more before I sign off and go drink with the rest of the Tech Liberation gang at our 15th Alcohol Liberation Front this evening, to which you’re all invited. Bitcoin allows for microtransactions in a way that’s never before been possible. First of all, because bitcoin transactions can be cheap, you can send incredibly small amounts (say five cents or half a cent) that would be cost-prohibitive using traditional payments systems. There’s a start-up called BitWall that essentially allows publishers to easily charge tiny amounts for their content. Now, believe me, I know all the arguments for and against micropayments for content. My only point is that Bitcoin has the potential to further reduce the friction of such payments. But that’s not the exciting part. More interesting are really, really small microtransactions.

Bitcoin transactions are cheap, but you wouldn’t think they’re cheap enough that you could conduct hundreds per second. But the thing is, you can, using the micropayments channels feature of the Bitcoin protocol. It’s not yet been widely exploited, but it’s there in the spec waiting to be. I won’t go into the technical details in this post, but essentially you transmit one large transaction to the network (you can think of this like a deposit, say of $10), then you conduct as many tiny transactions between payer and payee not broadcast to the network (therefore ‘free’), and finally you broadcast how much of the initial amount remains with each party. What this means is that you can now offer metered services based on microtransactions.

One good example of how this would be useful is Wi-Fi access, which Mike Hearn explains in this video. Today we are surrounded by wi-fi hotspots, but we can’t use them because they are password protected, in part because there’s no good way to charge for their use. When you can pay to use a wi-fi hotspot, it usually entails creating an account with the provider and then purchasing a block of time, perhaps more than you need. Now imagine if you could connect to any open hotspot, without first creating any kind of account, and paying your way by the second or the kilobyte. That’s possible today with Bitcoin, it’s just going to take some time to be implemented. And think of all the other as-yet unimagined ways that this ability to meter could be put to use!

That’s six ways to answer the question, “Why would you use Bitcoin when you can use PayPal or Visa.” There are more. Hearn discusses a bunch in the video. These are all very real in the sense that they are all technically possible today, but certainly speculative in that there remain regulatory and market hurdles ahead. I can certainly understand why some would be skeptical of Bitcoin’s long-term success (I for one am not certain of it), but I really hope we can get to the point were that skepticism is based on more than misunderstandings about what Bitcoin is or what it can and cannot do.