A financial network is a technological platform that people build businesses on top of. And the traditional banking and credit card networks are closed platforms. If you want to build an e-commerce site, a payment network like Paypal, or any other service that deals in dollars, you need to convince incumbent financial institutions to do business with you. Getting such a partnership is difficult and involves a lot of red tape.
There’s a good reason for the high barrier to entry: electronic transactions in the conventional banking system are generally reversible. If someone makes a fraudulent charge to your credit card, you can dispute the transaction and in most cases the bank or the merchant, not the customer, will cover the cost. That’s convenient for consumers, but it requires the financial system to be a fairly close-knit web of trust. Allowing a new member into the club creates risks for everyone else. So the incumbents are understandably reluctant to deal with anyone who isn’t well-known and well-capitalized.
Bitcoin is different. Because transactions are authenticated cryptographically and cannot be reversed, there’s no need to restrict access to the network. There’s no risk to accepting payments from complete strangers. That means people don’t need anyone’s permission or trust to go into business as a Bitcoin-based merchant or financial intermediary. Accepting Bitcoins also allows merchants to avoid much of the administrative overhead, like dealing with chargebacks, that come with a conventional merchant account.
Of course, what looks like a plus for merchants can look more like a minus for consumers. Consumers generally like the conventional banking system’s strong consumer protections. We like the fact that we’re not on the hook for fraudulent banking transactions, and that the FDIC will make us whole if the bank holding our money goes bottom-up.
And Bitcoin looks inferior to the conventional banking system in other ways too. Visa and Mastercard are accepted at millions of locations around the world. Only a handful of merchants accept Bitcoins. Conventional banks have elaborate websites with features like direct deposite of paychecks and automatic bill-paying. Dealing with Bitcoin is too intimidating for all but a tiny minority of tech-savvy enthusiasts.
If you’ve read Clay Christensen’s The Innovator’s Dilemma, the last three paragraphs should ring a bell. The book’s argument helps to explain why a seemingly inferior payment network like Bitcoin has generated so much excitement.
The term Christensen coined, “disruptive innovation,” has become so overused as to become a cliche. But he gave it a fairly precise meaning with a lot of explanatory power. A disruptive technology is one that’s simpler and cheaper than what’s already on the market. Often, disruptive technologies are also inferior to what’s already on the market. They tend to be dismissed as impractical toys by industry incumbents.
The PC is a classic example of a disruptive innovation. The first PCs were much less capable than mini-computers and mainframes that were already on the market at the time. They had less powerful hardware and software and little if any customer support. And if you’d asked a hobbyist circa 1978 what PCs were good for, he probably wouldn’t have had a good answer.
But the low cost and simplicity of PCs meant that a lot more people could play around with them. One of those tinkerers, Dan Bricklin, invented the spreadsheet, the PC’s first “killer app.” And over time, people gradually figured out how to use these cheap, simple computers to perform functions that had previously required a computer that cost ten times as much. Most “servers” today are just souped-up PCs, and they’re orders of magnitude cheaper than computers that existed before 1975.
The Bitcoin economy today looks a lot like the PC market circa 1978. Most people today look at Bitcoin and see an impractical curiosity. They’re happy with the banking services they’ve already got and can’t imagine why anyone would want to use an alternative currency that’s much less widely accepted and offers many fewer consumer protections.
But a minority of nerds are playing around with it. Interesting applications keep popping up. There are Bitcoin-based banks, casinos, drug emporia, derivatives markets, retailers, and much more. Many of the new applications seem weird or marginal, and most of them probably won’t amount to anything. But one of them might prove to be Bitcoin’s Visicalc.
When people dismiss Bitcoins because they can’t think of how they’d use it, they’re missing the fact that Bitcoin is a platform, not a product in its own right. When ordinary users started buying computers, it wasn’t because they thought it would be cool to own a computer. They did it because they wanted to do spreadsheets or word processing or email. Similarly, ordinary users aren’t going to start using Bitcoins just because it’s a cool technology. If normal users start using Bitcoin, it will be because they’re interested in gambling, or cheap international money transfers, or some other applications that hasn’t been invented yet. And Bitcoin’s intermediary-free architecture means that many more people can try their hand at building the platform’s killer app.