On be used as a medium of

On October 31 of 2008, an anonymous person going by the pseudonym, Satoshi Nakamoto, released a white paper called “Bitcoin: A Peer-to-Peer Electronic Cash System”. The paper introduced an electronic payment system that would allow two parties to transact directly with each other over a communication channel, without a trusted intermediary to perform a clearing and settlement process, using a decentralized ledger, known as the blockchain. In this evolving environment, cryptocurrencies are poised to play a highly disruptive role to the traditional banking system. The technology of the blockchain lowers transactions costs and can widen the net inclusion of people in the financial system. This could help a large proportion of the unbanked community have access to financial services and participate in the global economy, which could also serve as a bridge out of poverty. It would also be a cheaper alternative for international money transfers, especially for international remittance and small business owners. However, as with any new innovation in its embryo stage, it still has challenges to overcome. The largest limitation being that the demand for Bitcoin and its use for commerce has not materialized. For any currency to be viable, it has to be used as a medium of exchange, a unit of account, and store of value. If people do not have faith and are not willing to use it, others will not be willing to accept them, and the system will not succeed. The technology zeitgeist of this era has shifted the economy further into electronic commerce. However, electronic commerce relies on a trust-based model in order to prevent the double spending problem, which is when the same digital token is spent more than once. Double spending is unique to digital currency, because it is relatively harder to replicate physical cash than it is to reproduce digital information. Therefore, in order to prevent fraudulent transactions made over the internet, the community relies on a trusted central authority to oversee the verification process. Bitcoin seeks to achieve the same goals as its currency predecessors, except it eliminates the trusted intermediary in the process by using a “peer-to-peer distributed timestamp server to generate computational proof of the chronological order of transactions” (Nakamoto, 2008). Bitcoin, the technology, is public and accessible to everyone, and any participant of the network is called a node. If the owner of a coin wants to transfer it to another node, the transaction will be added to a digital ledger. However, the transaction on the ledger will only be approved if there is a digital signature from the original owner. Producing a signature involves a function that depends on both the message being sent and the owners private key. The private key varies by owner and is kept secret by each owner,  ensuring that only the owner can produce that signature. Since altering the message even slightly will completely change the signature, one cannot copy a previous signature by the owner and forge it on another transaction. A second function is used to combine a public key, which is used to ensure that the owner of an address (wallet) can receive funds, with the private key signature which tells if the signature matches the destination.  To keep the system decentralized, each node has their own copy of a ledger, known as a block, where transactions are recorded and publicly broadcasted. Before the nodes can accept new transactions to their block, it has to go through a procedure known as the proof-of-work. “The proof-of-work involves scanning for a special value that when hashed, such as with SHA-256, the hash begins with a number of zero bits” (Nakamoto, 2008). The cryptographic hash function involves an input that is a message or file, that will produce an output of a string of numbers known as the “hash”. The output is essentially a random number because it cannot be decrypted backward. However, for a given input it will always generate the same output. Therefore, there is no better method than to just guess and check special values, which takes up a gross amount of computational work. The special value is also intrinsically tied with the transaction, so if previous transactions needs to be changed, the proof-of-work will also need to be changed. Once a node finds the proof-of-work, it will broadcast the special function for the block to all the other nodes in the network, where they will now link the new block to their previous blocks, creating a “BlockChain”. Since all the blocks are linked together, if one tries to change a previous block, it would have to re-do the proof-of-work for all blocks. Nodes that support the network by identifying proof-of-work are rewarded with a new coin. The process of adding a new coin into the system is known as mining. Similar to gold miners expending resources to add gold to circulation, bitcoin miners are expending central processing unit (CPU) time and electricity to bring coins into circulation.  Their efforts are essential to the system, because there is no central authority to issue coins (Nakamoto, 2008). The longest blockchain has the most computational work put into it, and will be the basis for which blockchain to trust. As long as the majority of CPU power is controlled by honest nodes, the honest chain will grow the fastest and outpace any competing chains. To modify a past block, an attacker would have to redo the proof-of-work of the block and all blocks after it and then catch up with and surpass the work of the honest nodes (Nakamoto, 2008). This becomes much harder as more blocks are added. Since there is no central authority, each node maintains their own copy of the blockchain, and as long as everyone agrees to give preference to whichever block has the most computational work put into it, it arrives at a decentralized consensus. Since cryptocurrency is not a tangible asset, the electronic coin is a chain of digital signatures which means the history of transactions on the blockchain is the currency. Martin (2014)  argues that “currency is not itself money. Money is the system of credit accounts and their clearing that currency represents”. The concept behind bitcoin is actually not novel and has been seen before on the Micronesian island of Yap. Since the Yapese did not have the tools to mine their own stones, they used Rai stones, quarried from the neighboring island of Palau, and called it money. Not only was it a dangerous voyage to collect the stones but became a cumbersome task to transport the immense size of the coin to the other party after an exchange (Tharngan, 2000). Villagers began to leave the coins where they were, with a mutual understanding throughout society that the ownership had changed hands. Originally, the tribal leaders had appointed one person to take charge of the community ledger, but he began to use the system to his advantage. Therefore, each family would maintain their own ledger and would update their ledger whenever a transfer had been announced. The ledger that was recognized by the majority of homes would then be the legitimate ruling. At one point, a Rai stone had accidentally dropped to the bottom of the ocean, but the villagers still recognized it as an exchangeable unit of currency. In many ways, the money used by the Yapese was in an abstract form. Economists estimate that only 8 percent of the world’s currency exists in physical cash (Grabianowski, 2003). The need for physical cash has declined over the years as society has come to rely more on electronic money with the growing acceptance of plastic cards, the internet, and participating in commerce on a wider scale.  In 2016, consumers made $23.1 trillion worth of payments through cards, which overtook the number of payments made in cash for the first time. The number of debit cards in circulations increased by 8.1% and the number of credit cards in circulation increased by 5.3% (Blumenthal, 2016). The convenience of using a card comes at a fee though. Merchants are charged transaction fees, flat fees and incidental fees for this middleman service, and are willing to pay fees not just because it is becoming more of a norm to use plastic cards, but because for online purchases, it is almost impossible to digitally send money without a third party. In addition to these basic fees, there are also costs from fraudulent charges. If a customer disputes a charge on their card, the merchant will forfeit both the money and the merchandise sold. Merchants try to gather as much information about a consumer before making a sale to prevent fraudulent charges. Bitcoin increases the privacy of consumers, lowers the fees, and protects consumers from fraudulent charges. Although there has been a growing penchant for plastic in this day and age, statistics released by the World Bank (2015) show that around 2 billion people in the world are still cut off from financial services. The majority of the unbanked population people live in poverty and can not meet the demands of the current banking system. In many emerging markets, it is also not profitable for banks to set up physical branches and people may not have the means for online banking. Women make up 55 percent of the World’s unbanked adults (WSJ Custom Studio, n.d.). In some countries, women are not allowed to have bank accounts without permission from a male or their religious edict might limit them from getting to a branch and interacting with male bankers. Lacking access to the financial system makes it difficult to build up lasting wealth, participate in the global economy, and leaves many of the unbanked trapped in poverty. These problems do not exist in Bitcoin and could be the solution for the unbanked. Bitcoin does not care who you are and allows anyone to create a Bitcoin wallet, send and receive payments, with a cheap cell phone.  A great example of how mobile banking can transform developing countries is, M-Pesa. It is a mobile phone-based money transfer, financing and microfinancing service that was created by Kenya’s largest telecom company, Safaricom. It started out as a pilot program when experts realized that more Kenyans had phones than bank accounts. To use M-Pesa, people create e-wallet on their phone, and then deposit money to a Safaricom agent (169,698 agents in the country), in exchange for an equivalent amount of “e-float” (Eijkman, 2010).  The “e-float” money is not held in the form of Kenyan shillings but is a separate claim of electronic value that is backed by deposits in the bank with which Safaricom has accounts.  The system has gained immense popularity with more than two-thirds of Kenyans using it and about 45 percent of Kenya’s GDP flowing through it (Masinde, 2016). Vodafone, which owns 40 percent of Safaricom, has also released M-Pesa in Tanzania, South Africa, Mozambique, Egypt, Fiji, India, and even Romania in light of its success. Before M-Pesa was launched, only 27 percent of Kenyans had access to some type of formal financial service, and now 80 percent of Kenyans are banked through either a bank or mobile money account. The UN has even cited that this service is credited for lifting 2 percent of Kenyans out of poverty (Donkin, 2017). Some argue that mobile banking might be too complicated or risky for people in poverty but Bill Gates, who has resources dedicated to improving financial services for the poor, said that “M-Pesa, proves that when people are empowered, they will use digital technology to innovate on their own behalf” (Gates, 2012). Although wildly successful, the infrastructure behind the process is costly. Safaricom agents travel around the country with large sums of money, which can be dangerous. In rural areas, money is usually being withdrawn as opposed to deposited, which drains liquidity and their physical cash pile faster. Rural areas also happen to be farthest away from banks, so these agents have to make much time-consuming journeys. Bitcoin can offer a more frictionless process for these developing countries. Although Bitcoin does not offer microfinance services, a veteran of microfinance created a Bitcoin startup called BitPesa which does, and even offers the added benefit of sending money directly between two parties for international transfers. On the other hand, M-Pesa is partnered with payment networks like Western Union, who charge the normal banking fees for sending money internationally at an average cost of about 8.5 percent globally, but in many countries can be around 10 percent of more (Vigna and Casey, 2015). The option of borderless transfers at the lower mining costs compared to higher bank fees would be especially helpful for international remittance. The World Bank (2016) shows that international migrants sent around $601 billion back to their home countries last year, with developing countries receiving $441 billion. Many developing countries are not driven by public expenditures and business investment, and heavily rely on expats to send money home. Remittance can be as high as 30 percent of a developing countries GDP (World Bank, 2016).  However, fees associated with transfers from traditional banks can take a huge bite out of that. Besides in underdeveloped countries, borderless transfers can be beneficial for firms. Film Annex, an online film and blogging platform that financially pays their filmmakers, writers, and reviewers, was the first company to start paying all of their contributors in Bitcoin. The company pays frequent small denominations to their contributors around the world, and the CEO, Francesco Rulli, realized that Bitcoin was a more cost-efficient method. Additionally, for the seven thousand young Afghani women contributors, it was a to bypass the laws of their patriarchal society and to pay the women directly. Rulli would also buy prepaid gift cards, and sell them on the Film Annex website in exchange for Bitcoin, which these Afghani women could then purchase (Macheel, 2017). Bitcoin may not be the potential solution for all countries though. For example, the United States and China already have well established smart phone payments. In China, State-owned banks levy close to zero fees for mobile payments which means Bitcoin merchants and consumers do not need to consider switching over to Bitcoin. People can make mobile payments through the messaging service, WeChat, or Alipay, which is a service created by the Alibaba Group. This service allows them to instantly send money, whether it is to a friend or a taxi driver. In the United States, similar apps would include Paypal and Venmo. Since these countries already have a sound system in place, it would be hard to convince them to switch to a new form of currency that is also extremely volatile. In 2013, Bitcoin reached $1,015 per coin, but then fell back down to $240 in 2014, and has now reached a high of 19,300 (Coinbase, 2017). A currency that can lose two-thirds of its value within six months makes the currency hard to be used as a unit of account. If consumers never adopt and show support for Bitcoin, even if it was bound to be a better system, then Bitcoin will fail. It will only be successful if enough people are actively participating in the system. As of right now, there are only 14 million Bitcoin wallets, but the number of users is less than that if a user has multiple wallets. In 2014, around $50 million per day was being processed by the Bitcoin network compared to $30 billion per day being processed by Visa and Mastercard (Vigna and Casey, 2017). Although big corporations like Microsoft and Tesla have started accepting Bitcoin, many consumers have not adopted Bitcoin as a means of exchange. There is a finite supply of 21,000 million Bitcoins, and currently, only 80% of those Bitcoins have been mined and are in circulation. Once all of the coins are mined and popularity increases with more people owning bitcoins, the cryptocurrency will start to stabilize. On the other hand, because there is only a limited supply of Bitcoins, it means there is no way to free up credit. This makes bitcoin a deflationary currency because, in times of crisis, people would hoard their money instead of putting it back into the economy.