BANKTHINK

Lightning Fast, Dirt Cheap: Bitcoin Shows What Banking Could Be

It took 11 minutes, tops, after I pushed the button for the equivalent of $5 to travel across the Atlantic. For this service I paid less than a penny.

There were no banks involved. If there had been, it would have cost me at least twice the amount I was sending.

Whoa.

I sent the money using Bitcoin, the decentralized peer-to-peer network that's received a great deal of buzz over the past year or so. People usually think of Bitcoin as an alternative currency challenging the hegemony of government-controlled fiat money, which it is (and technically, the currency is bitcoins, with a small "b"). But Bitcoin is more than that. In addition to being a store of value, it's also a means of exchange, a payment system that can perform many of the same functions as banks and as financial services companies like Western Union, PayPal and Visa. And its efficiency as such is arguably a more important reason for bankers to pay attention to it.

The technology, powered by tens of thousands of users' computers across the globe, lets you move as much of your money as you want, to whomever on the Bitcoin network you want, whenever you want. It sends funds nearly instantaneously, and for almost nothing. Users are identified only by their Bitcoin addresses, a cryptographic string of characters (my receiving address, for example, is "1PFgAJWLJZGSaVDg2rX3XDfTcyd6CpXXXX"), and so can transact anonymously if they wish.

But there are catches. First, anyone you want to send money to or receive it from needs to be on the Bitcoin network also. Then, getting money in and out of Bitcoin is difficult, maddeningly so. Unless you're a "miner" with a ton of sophisticated computer gear, the main way to acquire bitcoins is to buy them for dollars or euros on an online exchange. The biggest is Mt. Gox, based in Japan.

"I tried once to install the software. It took forever and didn't do anything," says Robert Hughes, a senior vice president with the consulting firm Speer & Associates who's been studying Bitcoin.

Getting money to an exchange generally entails funding an account at a third-party service like Dwolla, which can then send your dollars or other government currency on to the exchange. You can cash out your bitcoins for fiat money on the exchanges, too, but sometimes the funds get held up before returning to your account. 

Another disadvantage of Bitcoin is that there are few merchants that accept the digital money. Sure, you can use bitcoins to buy alpaca socks, or illicit substances, or T-shirts and baseball caps emblazoned with the Bitcoin logo. A few restaurants and bars take it. You can even donate bitcoins to WikiLeaks. (I'm not saying you should, so please don't tap my phone, Homeland Security.) But you can't spend bitcoins at Amazon or Wal-Mart or McDonald's or pay your electricity bill with them.

And Bitcoin is a risky place to store large sums of money. Fanatics will argue it's a better long-term investment than the U.S. dollar, because of the predictable and fixed supply – the algorithm that creates bitcoins is programmed to stop once there are 21 million of them – and who knows how many greenbacks the Federal Reserve will unleash upon the world if the economy keeps limping along. (There are currently about 9.8 million bitcoins in circulation, trading at $9.99 apiece. The last bitcoin is expected to be generated years from now.) But even if the devotees are right, the Bitcoin "wallets" that store the currency aren't FDIC-insured. You can keep your wallet on your computer, where security is up to you, or in the cloud – and like in the pre-FDIC banking days, you choose your cloud wallet provider based on trust.

"There is no authority or regulation that says what they must provide, how they must provide it, what to do if something goes wrong," Hughes says.

Wallets have been hacked, and as with physical cash, you can't get bitcoins back once they're gone. On top of all this, the exchange rate between bitcoins and traditional currencies has been volatile – you can see for yourself on sites like BitcoinCharts.com.

It took me months of futzing around in my spare time to acquire my first $60 or so worth of bitcoins on Monday. Yet once I had the coins, I was able to send some to a Twitter acquaintance in London, quick snap and dirt cheap. If entry and exit from the system were easier, this technology could become a more viable alternative to established financial players. 

Easing Bitcoin's choke points is the business of BitInstant, a New York startup. The company's flagship service expedites the transfer of funds to and from the exchanges, for which it charges a commission. Charlie Shrem, the founder and CEO, says that in two to three months it will come out with a reloadable general-purpose prepaid debit card. Each card will come with a Bitcoin address printed on the back and a QR code, along with the MasterCard logo, on the front. Cardholders will be able to convert bitcoins held at the address to dollars stored on the card by scanning the code into a smartphone. The dollars would then be available to spend wherever MasterCard is accepted. In theory, this should make getting in and out easier, and make Bitcoin more attractive as a conduit for funds.

Erik Voorhees, BitInstant's chief marketing officer, says Bitcoin skeptics often ask, "What can I spend them on?" The card, he says, will provide "the ultimate answer…Everything." 

Of course, the banking system will have to be involved here, since only insured depositories can issue cards on the MasterCard network. Shrem would not identify the two banks that will issue the BitInstant card; one will issue it in the U.S., the other internationally, he says. After some of the blogosphere reports about the card this week, BitInstant had to clarify that unlike Bitcoin addresses, the cards themselves won't be anonymous and will comply with anti-money-laundering and know-your-customer regulations. Dollars stored on the U.S. card will be FDIC-insured. Notably, BitInstant is registered as a money-services business with the Financial Crimes Enforcement Network.

Bradley Leimer, the vice president for online and mobile strategy at Mechanics Bank in Richmond, Calif., has been keeping an eye on Bitcoin. Linking it to a prepaid card, he says, is "a little bit of a game-changer," since it's "a much more mainstream way to move the value within your bitcoin collection."

However, using a MasterCard debit card as the exit means someone will still be "incurring a transaction cost at some point," Leimer says. "It doesn't necessarily lower the transaction cost to near-zero." (Shrem says BitInstant will try to minimize cardholder fees by dispensing with the middlemen usually involved with prepaid cards, i.e. "program managers" like Green Dot.)

BitInstant's existing service is the easiest way I know of to acquire bitcoins, which is to say it's the only way that's worked for me. First I placed an order for $60 worth on BitInstant's website and printed out a sheet of paper instructing me to take my cash to a Bank of America branch in the ZIP code I'd provided. The teller looked mighty confused when I read her the script ("I am making a deposit into the account detailed on the invoice"). But after a few minutes she figured out I needed to fill out a deposit slip with an account number for TrustCash, an Atlanta outfit that serves as BitInstant's go-between with the bank. I didn't have to give my name, much less show ID, throughout the whole process. TrustCash knew which order to fill because it sets a unique deposit amount for each order at each branch. Mine was $61.20 including fees.

All of that extra 2% went to TrustCash, by the way – the price of anonymity, perhaps. BitInstant would take another $3.99 plus 1% off my $60. Sounds steep, but the service speeded the process of acquiring bitcoins, which could take a week when dealing directly with one of the exchanges.

Normally, bitcoins would have shown up in my online wallet within 30 minutes of the bank deposit, except I'd goofed. When I placed the order, I'd pasted the wrong character string in the field where my Bitcoin receiving address was supposed to go. (There's a lot of copying and pasting involved in Bitcoin, unless you want to memorize phrases like "1PFgAJWLJZGSaVDg2rX3XDfTcyd6CpXXXX.")

It took me another business day to sort things out with BitInstant. It may have helped that the three guys in the company's New York office knew me. (And they are all guys. According to research by Heather Schlegel of Swift's innovation team, 95% of Bitcoin users are male, which sounds about right given the makeup of the earnest crowds at two Bitcoin-themed Meetups I attended this month, including one hosted by BitInstant.)

Dave Birch, the director of Consult Hyperion in Surrey, England, says Bitcoin "is really interesting because it informs other debates, not necessarily because of what it is itself." It's likely that Bitcoin's "technology and techniques will be part of some future means of exchange," particularly the use of cryptography to protect user privacy, Birch says.

Part of? Bitcoin's most rabid fans would beg to differ. "Bitcoin is the virtual currency of the future and will take over," one enthusiast tweeted to me this week.

It's a tantalizing thought. But I think Bitcoin can coexist with the established forms of money and payment. Competition doesn't have to mean winner-take-all.

I can envision a future where people will sometimes charge purchases to Visa to rack up rewards points and earn special offers tailored to their spending history, enjoying the fraud protection of chargebacks, and sometimes use Bitcoin (or something like it or something that evolves from it) for transactions they don't want tracked, incurring the same risks as they do with physical cash today.

Transacting off the grid should remain an option even after we phase out paper bills and metal coins. Just because the world's going digital doesn't mean we have to fulfill Orwell's prophecy of the telescreen.

The problem with Bitcoin right now is that if it were a car, it would come only in stick shift. When the automatic version arrives, though, watch out.

Marc Hochstein is the executive editor of American Banker. The views expressed are his own.

 

Comments (12)
banking could be just like bitcoin, if it wasn't for all of those pesky Govt regulations that are soooo expensive.
Posted by dahlers | Friday, August 24 2012 at 3:29PM ET
FinCEN doesn't give any licenses. It is where a money service business (MSB) would register, but that isn't a "license".

Individual states give licenses to money transmitters.
Posted by sgornick | Friday, August 24 2012 at 3:39PM ET
@SGornick: Thank you for catching that, it's an important distinction. The relevant passage has been corrected.
Posted by Marc Hochstein, Editor in Chief, American Banker | Friday, August 24 2012 at 3:56PM ET
Sounds like they are taking advantage of avoiding the costs that banks pay for AML/BSA compliance and maintaining the security, reliability, and integrity of the payments system. I wonder whether it will outlive the on-line P2P lending services available on the Internet, that work well until they don't.
Posted by WayneAbernathy | Friday, August 24 2012 at 4:43PM ET
Hhmmm....sending currency anonymously domestically & internationally too? Sounds like a criminal's dream come true....
Posted by Underpaid | Friday, August 24 2012 at 5:37PM ET
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