Bitcoin: The Next Big Thing Since Internet?

In his January 2014 NY Times article, Marc Andreessen, co-founder of VC firm Andreessen-Horowitz and widely recognized as a key figure in Silicon Valley, stated that “Bitcoin offers a sweeping vista of opportunity to reimagine how the financial system can and should work in the Internet era, and a catalyst to reshape that system in ways that are more powerful for individuals and business alike”1. Andreessen backed his vision by making substantial investments (~$50 million) in Bitcoin related startups2.

Despite strong support by Industry experts like Andreessen and an almost linear growth in number of Bitcoins in circulation (~13.5m in November 2014)3, Bitcoin environment is struggling to overcome negative media and consumer perception, and has been unable to reach consumer and merchant adoption levels many expected when Satoshi Nakamoto published a  paper laying the underlying framework for Bitcoin infrastructure over 6 years ago.

So is Bitcoin just a fad, or is it truly the most exciting technical innovation since the Internet? I would argue it’s the latter, and my reasoning is based on the following overarching principles:

1. Greenfield technology adoption is never smooth

Technology adoption often involves a similar, repetitive pattern. A mysterious new technology emerges, seemingly out of nowhere. Early adopters and tech enthusiasts who see potential in it become completely obsessed and start painting a vision of a new world order where things are done differently. Establishment elites like media, government regulators, and incumbent players who are threatened by this potential disruption heap contempt and scorn on the technology.  Gradually, the technology evolves beyond its intended use case and starts to gain mainstream adoption. Eventually, it permeates into our day to day lives and we wonder why this wonderful potential wasn’t completely obvious from the start.

This cycle happened with Personal Computer in the 1970s, Internet in 1990s, digital content distribution in 2000s, and now Bitcoin in 2014. Remember the first time you logged into the Internet – did you truly envision the profound effect it would have in your life, or did you dismiss it as just another novel technology? Or the first time you sent an email – did you predict that the technology would fundamentally change the way people work and communicate all around the world?

For majority of the folks the answer is no – a revolutionary technology faces major barriers to adoption at the onset from consumers unwilling to change instilled behavior, and from incumbent companies with deep-rooted business models. Bitcoin is fighting the same uphill battle right now, but I compare this to users using dial-up for the first time who were not able to unravel Internet’s true potential.

2. New technology tends to emerge as an improved replacement, but what about the unknown use cases?

Thinking back to the early days of the Internet, the most common use cases were just replicating what happened in the offline world. For example, early Internet startups like Craigslist took the newspaper classified model and put it on online. It took a while for companies like Wikipedia to emerge, that enabled distributed collaboration – a use case made possible only by the Internet.

Similarly with Bitcoin, initial use-cases just involve using it as a replacement of existing currency, for example, enabling Bitcoin holders to buy products on Overstock.com using Bitcoins instead of dollars. However, the true revolution will come when innovative companies start exploiting Bitcoin to serve use cases previously impossible. Here’s a brief list of potential use cases of Bitcoin that go beyond what traditional infrastructure can do:

a.Micropayments: Allow vendors to charge micropayments to the 8th decimal point without any transaction cost. For example, an online publication can charge users 0.5 cents to read an article, instead of having to leave money on the table by having the cheapest subscription model be around $20/month, as enabled by the existing credit card infrastructure.

b. Verification: the major innovation Satoshi Nakamoto contributed to was the public distributed ledger (also known as the block chain) – not a virtual currency. In addition to currency exchange, the block chain can be used to implement online verification systems. Imagine having your passport be stored online4, or being able to vote online using your unique blockchain ID – now that’s truly a game changer.

c. B2B transactions: Businesses all across the world transfer huge sums on money to other businesses using existing banking infrastructure, and have to take on exchange rate risk and pay transaction fees. For a company operating in a low margin business, the positive ramifications on the bottom-line of saving on the 1-2% transaction fees are massive!

3. Strong network effects

Bitcoin is a classic example of an ecosystem with extremely strong network effects. The more consumers and merchants start using Bitcoin, the more attractive it is for a new user to join the system. The same property also extends to Bitcoin miners and entrepreneurs building add-on services for the ecosystem, further consolidating its position as the premier online, distributed currency system.

In fact, I would argue that the lead and market share that Bitcoin has gained over its competitors in the past 6 years makes it extremely tough for a new competitor to displace it. The strong network effects can easily carry Bitcoin to dominating the online P2P cryptocurrency exchange space.

4. Reduction in transaction costs

Going back to the comparison to Internet – before widespread adoption of the Internet, there was a huge cost of publishing data or information to a user; and there were large incumbent gatekeepers like newspaper, radio stations, TV channels etc. Advent of Internet brought this cost down by order of magnitudes, and democratized information publishing to the point that anyone could publish information instantaneously at almost no cost. Bitcoin is doing exactly the same to the world of payments – whereas before large proprietary payments network charged fees to move currency around, now there are thousands of Bitcoin startups that can move payments for no additional fees.

Only time will tell if Bitcoin will get uniquely integrated in our society and have the same profound effect on our lives that Personal Computers and Internet have previously had. I truly believe that all the signs are pointing in the right direction!

References: 

1 – http://dealbook.nytimes.com/2014/01/21/why-bitcoin-matters/?_r=0

2 – http://www.coindesk.com/andreessen-horowitz-2-8-million-funding-tradeblock/

3 – https://blockchain.info/charts/total-bitcoins

4 – http://techcrunch.com/2014/10/31/your-next-passport-could-be-on-the-blockchain/

 


2 Comments

  1. Yongju Shin

    Thanks Dhruv for the interesting topic. Bitcoins, if adopted en masse, could be the next social phenomenon bringing change to all aspects of the world. Though, theoretically, there should be no barriers in commerce or trade between different countries, many firms struggle due to currency exchange rates. If Bitcoins provide equal currency rates all throughout the world, international businesses would flourish. In addition, the block chain could serve as a virtual ID for all users to utilize online wallet and not carry credit card or cash. It would be sensational. Yet, I believe there is danger as well in relying too much on the digital mechanism. Hackers might game the system by cracking codes, and inimical programmers hired by industrial spies could implant viruses that could literally steal BITCOINS. Where there is money, there is crime. Is there a hedge to address these kinds of problems? If there is, it would reinforce the adoption of Bitcoins.

    • Dhruv Chopra

      Hi Yongju – thanks for the comment!

      I completely agree that the risk of digital crime and hackers getting access to Bitcoin accounts is a very real and grave danger. However, I believe that the risk applies equally to all forms of digital payments, including online banking and credit card transactions. Inherently, I don't feel that Bitcoin is riskier than the more established way of transferring money online.

      Thinking about a hedge to the question of safety, one potential method could be if governments/standard-setting organizations buy in to the promise of Bitcoin and start investing money in the underlying infrastructure to make it more robust. Of course there's the issue of why would any sovereign government be willing to invest in a currency it has no regulatory oversight on, and this is why I compare it to the early days of Internet in the blogpost – just like Internet as we know it would not exist without investment from DARPA, Bitcoin to be truly ubiquitous would need strong backing.