During the earliest days of trade, individuals moved from a barter system to an exchange of promissory notes. Along the way, coinage was developed as a medium of exchange.
The original value of a currency had a clear link to the material used (rare metals) and this developed into an undertaking by the government or bank to honour this instrument.
The so-called ‘gold standard’ established the US Dollar as the standard for international trade in the early 1900s under the Bretton Woods system.
Arguably, we can now consider that the old world order. China has three trillion in cash reserves and is in effect owning the US as a debtor.
This disruption has opened up the opportunity for alternative currencies. Alternative currencies might be both digital and government-approved, as is the case with Hong Kong, where the Octopus card can purchase just everything. Or they can be non-currencies like Paypal, emerging during the dot com boom.
Bitcoin is the latest and most disruptive of these alternative currencies, and this week I sat down with Jason Williams, founder of BitPoS and president of the Bitcoin Association, to get the lowdown on what it means for bankers like me.
DG: What is Bitcoin and why is an algorithm valuable?
JW: Bitcoin is actually two things. Upper case B Bitcoin is generally referred to as the protocol, while lower case b bitcoin is the unit of currency.
Why is bitcoin valuable? In 2009 we marked the first time in history a protocol has been developed that solves the issue of currency issuance without the need for a controlling entity.
Commonly, Bitcoin creates "digital scarcity". What this means is if I give you a bitcoin, I can't give that bitcoin to someone else, unlike say an mp3 which I can give out as many copies as I want. It is precisely for this reason – an absence of controlling entity and the inability for you to spend the same bitcoins twice - that makes the protocol such an important and valuable invention.
DG: The algorithm itself does not have any utility that can be used for any other purpose and thus has no intrinsic value like gold does. But in the digital age as we move bits and bytes around the globe rather than actual cash, does this attain a value?
JW: With things like gold, there are (obviously) lots of different things that can be made with it – everything from electronics to jewellery.
Likewise with bitcoin. There are quite a few applications that are being built on top of the blockchain that are not directly related to transferring units of value around.
A good example in this case is the announcement by Patrick Byrne of overstock.com. He is working with a counterpart to develop an application that will compete with the NYSE and NASDAQ.
We are very early on in the bitcoin lifecycle - the technology is new. As new ideas that are not directly related to shifting units of value around are discovered, the underlying technology will become more valuable.
DG: How does one go about mining for bitcoins?
JW: Back when bitcoin was first released, you could mine with a computer. You can't do that now. Since then, an arms race of sorts has occurred. There really was a massive evolution in mining from CPU's to GPU's to things called FGPA (Field Gate Programmable Arrays) and then on to ASICs (Application Specific Integrated Circuit).
Right now, the ASIC architecture is as good as it gets. With an ASIC chip, the program is etched into the silicon, and can't be changed, erased or reprogrammed, unlike the previous technologies.
Bitcoin mining has really become industrialised. You'll need a bunch of money, access to ASIC miners and somewhere to house them. It's generally accepted to be outside the realm of hobbyists these days, unfortunately.
DG: A rookie question – wouldn’t a Google or Amazon have the firepower to create their own coins then?
JW: Quick answer, yes and no.
What I mean by this is that the computing power these guys have doesn’t even fit into the same ballpark as the computing power that is already employed to secure the bitcoin network.
If Google and Amazon suddenly shifted all their computing power to bitcoin mining, they would still be dwarfed by the hash power on the network. This is because mining has gone way past the inefficiencies of CPU mining and is now firmly in the realm of dedicated single use processors called ASIC processors.
It is a completely different story if Google and Amazon were to dedicate their financial resources to bitcoin.
DG: How many crypto currencies are there? Why is bitcoin the one that will succeed?
JW: There are literally hundreds of "alts" (crypto currencies that are not bitcoin) out there. In fact, there are websites out there where you can go to and create your own personalised alt.
Bitcoin will succeed because it has the biggest penetration, it has been tested the most, it has the largest mining network, the biggest mindshare and is the one that most of the venture capital money is being poured into in order to build out the infrastructure required for mass adoption.
DG: Who needs to be concerned as crypto-currencies disrupt their industries?
JW: There are some obvious candidates here, namely the international remittance sector. Because bitcoin lives on the internet and there are no borders, there is no difference to sending bitcoins to the person next to you, or a person in a different country.
DG: What percentage of bitcoin trade is on the so-called 'dark net'?
JW: I'd like to think that with the advent of payment processors, the percentage of use on the dark net has dropped. There are so many things you can buy with bitcoin, whether it's pizza, beer, meals at restaurants, clothes etc
It is worth saying however, that as with traditional currencies, there are uses that may not be legal, but as with traditional currencies, the bulk of usage will be above board.
DG: My take is that the difficulty of tracing crypto currencies is what I believe makes government institutions concerned. For countries like China, they would be worried about this being another channel to move money fairly anonymously.
JW: As with anything new, there will be a period of adjustment. Governments need to take technology like bitcoin seriously as it represents a real and genuine paradigm shift away from traditional models.
In Australia, just recently, the Victorian police announced the seizure of a substantial quantity of bitcoins. This is an indication that, just by using bitcoin, you’re not immune to police action.
DG: There must be a few events that will be the tipping point for crypto currencies to be accepted as mainstream and not a speculative instrument - what do you think these will be?
JW: I think regulation will play a big part in this. With most regulation in Australia it’s a classic case of square peg and round hole. Once regulation starts to change, you'll see more players from traditional backgrounds adopting bitcoin in their daily lives.
DG: What will it take in Australia to change this dynamic?
JW: The Australian government has already announced a Senate enquiry, it is actions like these that will change the face of regulation in Australia.
DG: What industries or businesses in Australia are actively evaluating using bitcoin?
JW: At this stage there is a lot of interest in the retail sector. Second on this list is the b2b market. It’s so incredibly easy to pay an invoice with bitcoin, its fast, and perfectly secure. There is a real opportunity for business to positively affect their bottom line with bitcoin remittance.
DG: Jason, you are a former techie at a mainstream bank – how did that experience shape your interest in bitcoin?
JW: I worked on a technical team to implement AML [anti money laundering] solutions for a major banking group in Australia. Before that, I didn't really have much of an idea what AML was or entailed. It was interesting to learn the technical processes behind AML, and also some of the business background as to why and why it’s important.
I wouldn't say that experience shaped my interest in bitcoin per se, but more to the philosophy in how my company, BitPOS, is positioned. With the square bitcoin peg and the round hole that is existing regulation, we do our best to comply where appropriate and have great advice from our founding partners.
DG: How do most of your peers back at the banks feel about its potential?
JW: There are a few different reactions to bitcoin from my colleagues back at the bank, ranging from curiosity, to excitement and wanting to know more, to dismissing bitcoin as something like a toy. One thing is certain though, most people don't really fully grasp there is a completely new financial system being rolled out in parallel and independent of the legacy one and how completely disruptive that is.
DG: What will bitcoin mean in terms of system changes for existing applications?
JW: As with any change – such as the move to the Euro, for example - there will be a lot of change required. There are lots of bitcoin companies providing services, and as time goes on, you'll find specialists emerge that can cover system changes with ease.
In terms of accounting-type software, most multi-currency systems should already be able to support something like bitcoin with little to no change.
DG: As Bitcoin is by nature open source and unregulated; how does one overcome concern around the risk of the platform?
JW: It depends on how you define risk. If you define risk as someone being able to steal bitcoins by hacking the codebase, there is little to no chance that will happen. Firstly, the encryption algorithms themselves have been under intense scrutiny by academia for years and have been found to be very secure.
It is also extremely unlikely someone could inject some malicious code into the codebase. There are many smart people who look at this stuff every day, who have the checks and balances in place to ensure this doesn’t happen.
DG: What are the implications for cyber security if a firm adopts bitcoin as a payments platform? I assume that there would be security required for the ‘wallet’ that stores the private key components?
JW: From a technology perspective, bitcoin runs on port 8333, so corporate systems would have to allow that port in. It is also possible for a company network to run an ‘edge node’ in a DMZ and have any local nodes point to that.
Rather than have a single private key signing transactions, best practise for an organisation is to have multisig wallets set up. This could be considered both an accounting and security control.
Multisig relies on more than one key to approve the transfer of bitcoins from one address to another. What this means practically is you could have one key sitting with an approving manager, and one key sitting with an accounts payable clerk with a backup key stored in a vault somewhere.
As I mentioned, not only do you get accounting control, it also raises the bar for any intrusion on the network as they to (in this case) identify and steal two of the three keys.
DG: When do you expect to be the year of Bitcoin to be mainstream?
JW: Ha! My crystal ball has been broken for some time now!
DG: I’ll give you my prediction. I would say it is not going to be 2015, as there are still forces at play which are making Bitcoin more volatile than it should be. Given that real time payments in Australia are due in 2017, that might raise the awareness of the value of a digital currency to move money around instantly rather than using a settlement approach.
However, as there will be resistance to changing the current reward systems that exist in payments, then it's uptake is more likely to happen inorganically. Regulatory acceptance takes longer than we think. As we have seen with mPesa in Africa, it might have to be a consumer lead revolution.
Could I then speculate that the year of Bitcoin is going to be 2020?
JW: I’m a little more bullish on that front. With millions of dollars being poured into development and rollout of the bitcoin infrastructure, I’d hope that Bitcoin would begin mainstream adoption before then.