What is Bitcoin and how can it change the world?

(Virgin) When you type a website
address into a browser you might have noticed that the letters ‘http’ appear at
the front. ‘Http’ stands for Hypertext Transfer Protocol. In typing a web
address you are actually sending an HTTP command to transmit that website to
you. Hypertext Transfer Protocol is the means by which information is shared
across the Web.

Similarly, when setting up
an email account, you might have noticed the letters ‘smtp’ – for example,
‘smtp.gmail.com.’ SMTP stands for Simple Mail Transfer Protocol. SMTP is the protocol
by which we send emails to each other.

A protocol is the means by
which information is shared across a network. Bitcoin – with a capital ‘B’
– is another protocol. The function of the protocol is to send and receive
payment. The unit of money on the protocol is the ‘bitcoin’ – with a small
‘b’.

You earn a bitcoin by
doing or selling something in exchange for bitcoins – just as you would earn
normal money. If I do this job for you, you pay me in bitcoins. You buy
bitcoins just as you would buy and sell foreign currency. You pay some money to
someone, usually at a Bitcoin exchange, for which you receive some
bitcoins. And you can make your own bitcoins by mining them – more on that
another day.

You keep your bitcoins in
a wallet. There are hundreds of places to get a wallet, just as there are
hundreds of places to get an email account (blockchain.info is as good a place
to start as anywhere). Often people will have more than one wallet – one on
their computer, another with a Bitcoin service provider.

So how can Bitcoin change
the world?

The reason the Bitcoin
technology is potentially so disruptive and transformative is that it’s a new,
efficient form of money. And money, which has been, inexplicably, ignored by
mainstream economists for so long, is, of course, at the heart of almost
everything we do. Bitcoin could change the way the way we make and receive
payment, it could change the way we store money; it even has the potential to
change the actual money we use.

Think about the
possibilities of that for a second. We no longer need banks to store our
money – we store it on our computer with a Bitcoin service provider. We no
longer need banking networks to send or receive money – we just send money as
we would send an email. We no longer need governments to issue our money.
Forget pounds and dollars, we’ll use bitcoins instead. The social implications
of governments and banks losing control of money are considerable. This is
all very well in theory. What will make Bitcoin irresistible in practice is its
sheer efficiency.

Goldman Sachs IT analyst,
Roman Leal, has calculated the savings that Bitcoin could have made in
electronic payment in 2013, if Bitcoin had been used. Let’s start with simple
money transfer – sending money from one person to another.

Consumers currently pay a
fee of about 10% of the total amount transferred if they use a traditional
money transfer network such as Western Union. This fee covers agents’
commissions, forex and access to the network. With Bitcoin, that fee would be
zero – or 1% if you use a Bitcoin service provider. There
were $550 billion of remittances in 2013 generating $49 billion of transaction
fees. With Bitcoin those fees fall by 90% to just $5.5 billion. That would
mean an extra $43 billion actually makes it into people’s pockets.

As for electronic payments
in retail, currently retailers pay from about 2.5% to 3% in fees. In 2013,
global transaction fees were $260 billion on over $10 trillion of sales. Had
Bitcoin been used (again using a 1% estimated figure) the number would be $104
billion – a saving of almost $150 billion.

Leal notes that all
‘merchants would realize sizable savings’ by using Bitcoin, but small merchants
will benefit most. They ‘can reduce their payment processing fees by at least
half’. For a business that runs on low margin that is a compelling
number. These kinds of savings are irresistible.

Then there are those who
are currently shut out of the current financial system. 53% of the world’s
population is still ‘unbanked’ – they have no use of formal or semi-formal
financial services. Most of them will have a mobile phone before they have a
bank account. With Bitcoin – and other forms of digital payment – these people suddenly
have means to make and receive payment over distance. How much untapped
potential is there waiting to be freed when the unbanked start to get access to
basic financial services?

We’re not there yet

The core protocol of
Bitcoin is sound. In fact, it has unprecedented reliability and security. The
edges, however, are vulnerable. Third parties, such as Mt. Gox, have not
figured out how to act like proper financial institutions. Certain operating
systems using the protocol are insecure, rendering bitcoins vulnerable to
theft. There are also issues with programmers who have failed to understand how
the blockchain – the Bitcoin central database – works.

But these are all issues
that will be dealt with as the technology develops. The point is the core
protocol is sound. It – or some replication of it – could send banks to the
same forgotten part of town that the Internet has sent newspapers, as well as
freeing up the possibility for many millions of people to better their lot
through trade and exchange.