Bitcoin: It Is More Important Than You Think

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Charles G. Cascarilla, CFAFew topics have captured the imagination of the financial press and the financial community over the last several years more than bitcoin and the tangent subject of alternative currencies. Despite the widespread coverage, alternative currencies remain poorly understood by investment professionals. At the 68th CFA Institute Annual Conference in Frankfurt, Charles G. Cascarilla, CFA, CEO and co-founder of itBit, a global digital currencies exchange, sought to advocate for the future of these money alternatives.

At first, Cascarilla explained, he thought of bitcoin as a global transaction network comparable to those that process credit card transactions. Now he believes it is much more than that.

Understanding Bitcoin and Digital Currencies

Open

Key to understanding bitcoin is the word open. Its open-source code is similar to that of Linux, so it is a living, breathing code base. It is open always. In addition, it is an open network with a distributed ledger where everyone can see what is taking place on the network and what has occurred in the past. By contrast, all previous and current transaction-processing networks are opaque and owned by individual entities.

Rapid Transaction Settlement

Transactions on the bitcoin network are settled every 10 minutes. This nearly instantaneous process removes much of the counterparty risk present in the current orthodox financial system. Also, the open and distributed network minimizes fraud because buyer and seller directly interact. This drives down costs in a very significant way — in a manner similar to how the internet changed how information was distributed. The internet facilitated the vast digitization of text, audio, images, video, and other content and made the exchange of such media nearly instantaneous. Yet, value remained very difficult to transfer. With bitcoin and other digital currencies, that is now changing: value can be instantly transmitted among multiple parties.

Sources of Bitcoin Value

Cascarilla emphasized that thinking of bitcoin solely as a currency is incorrect and leads to misunderstanding and questions like, “What is the value of bitcoin?” or “Is bitcoin a Ponzi scheme?” Cascarilla said that the real value of bitcoin (and other digital currencies) is the open ledger (which he referred to as capital “B”), as well as the nodes on the open ledger (which he referred to as little “b”). In bitcoin’s case, there will only ever be 21 million nodes on the network. The limited supply of these nodes leads to bitcoin’s value (so long as there is demand, of course). Currency is only one way to use the open ledger.

When looked at in this way, investors can recognize the opportunity offered by bitcoin: namely, its ability to disintermediate the closed ledgers of the global payment networks of Visa, American Express, MasterCard, Capital One, and so on — all of which represent $500 billion in market capitalization.

Bitcoin’s structure suggests three natural use cases:

  1. Retail merchant processing
  2. Remittance
  3. Un(der)banked individuals

Retail Merchant Processing

Current closed-ledger payment networks charge 2.5%–3.5%, whereas bitcoin costs less than 1%. These fees are then contrasted with retail gross margins of just 5%–15%. So, the ability to lower the cost of payment network access can improve margins by 16%–50%! In fact, at $289 billion of annual processing, bitcoin is currently moving about as much value each year as the PayPal and Discover networks. However, the potential savings to the network is a whopping $210.9 billion, according to research conducted by Goldman Sachs.

Remittance

Bitcoin also has the potential to change the $550 billion global remittance network that moves moneys between countries via Western Union, MoneyGram, and the like. It is believed there is another $200-plus billion of hidden transactions. Here, the average transaction processing fee is around 10%. So, bitcoin could save the world around $70 billion if used for remittances. Much of that value is due to these networks touching, on average, nine transaction nodes, instead of bitcoin’s likely two or three nodes.

Un(der)banked Individuals

Even in the United States, approximately 20% of people do not have access to a bank account. In other nations, especially in the developing world, unbanked or underbanked communities are likely much larger. But bitcoin allows people to use their smartphones — which nearly everyone in the world has or will soon have available to them — to access a payment system. This is analogous to the situation in many of the emerging markets where people never had a land-based phone line before having a cellular-based phone. In emerging markets, people can now use a payment network without first having a credit or debit card.

Bitcoin and Digital Currencies in the Future

Blockchain technology can be used in many other applications, including the following examples:

  • Smart contracts
  • Certificates of authentication
  • Issuing securities
  • Micropayments

Smart contracts, certificates of authentication, and issuing securities are obvious applications for open-ledger technology. Currently, when buying assets (e.g., securities, real estate, art, and collectibles), it is difficult to assess the original source of these goods and the modifications to contracts and covenants or to ensure provenance. Other applications are copyrights, licenses, and authorship rights. Open ledgers could remove these obstacles.

Micropayments are a very interesting use case and have the potential to change the entire content world. Currently, all advertising is a form of rent on content usage. When you read an article on a non-subscriber site, you are served up advertisements to pay for that content because sites have been unable to ask for a micropayment for the content usage in a fast and convenient fashion. It is possible that, in the future, content will be charged for using micropayments and blockchain technologies. This dramatically changes the business model of content going forward.

Another example is the slow settlement periods of securities transactions. The slow exchange of capital is dealt with by collateral being pledged against trades as they settle over the course of three days. Clearly, having this much capital tied up on the sidelines is hugely inefficient.

Summary

Bitcoin and its blockchain technology are misunderstood by most investors. Specifically, its value lies not in its worth as a currency but in its open-ledger technology, as well as in the fixed number of nodes within that ledger. Ingenuity applied to this technology promises uses that are currently beyond human imagination.


All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Photo credit: W. Scott Mitchell

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One Response to Bitcoin: It Is More Important Than You Think

  1. Mark R says:

    “Bitcoin and its blockchain technology are misunderstood by most investors. Specifically, its value lies not in its worth as a currency but in its open-ledger technology, as well as in the fixed number of nodes within that ledger”

    Important to note that bitcoin(as currency) and the blockchain go hand in hand, without bitcoin there would be no incentive for miners to secure the blockchain, and it would become centralized and worthless. And the number of nodes is not fixed, recently the amount has been dropping