What is Bitcoin and how can it change the world?

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 service provider such as Bitpay or Coinbase. 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.[i] 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.

[i] “All About Bitcoin”, Top Of Mind Issue 21, Goldman Sachs Global Investment Research, March 11, 2014.

Dominic Frisby's latest book Bitcoin – the Future of Money will be out soon. Order your copy here.

This is a guest blog and may not represent the views of Virgin.com. Please see virgin.com/terms for more details.

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