By Vin Armani
Author’s note: In this article, the term “Bitcoin” refers to any cryptocurrency network running a version of the consensus protocol described by Satoshi Nakamoto in the Bitcoin White Paper. This includes, but is not limited to: Bitcoin (BTC), Bitcoin Cash, Litecoin, Dash, ZCash, and Decred.
In my last article for Coinivore, I made the case for profit-seeking (in Bitcoin, not fiat) as the most effective engine for mass adoption of Bitcoin. I gave a vision for the structure the first businesses model that would embody Bitcoin-profit-seeking and bootstrap the new Bitcoin economy. I call this business model “Non-Custodial Financial Services Provider” (NFS). Bitcoin’s ecosystem – miners, developers, entrepreneurs, traders, merchants, and consumers – is able to maintain its decentralized nature, free from any central authority, through the use of a shared set of protocols, freely available for anyone to use in order to join the network.
It is this permissionless aspect that sets Bitcoin apart from the financial networks that came before it. In this article – the first in a two-part series – I will explore the ways that the Bitcoin community can leverage the adoption strategies of existing digital payment networks, through profit-seeking, to incentivize mass adoption. My next article, part two, will explore the communication standards, known as Payment Protocols, that I believe hold great promise for delivering profits to those companies most highly incentivized to increase global use of Bitcoin as peer-to-peer electronic cash.
Permissioned digital payment networks that move trillions of dollars of value every year have existed for decades. The largest exemplars of such payment networks are Visa and UnionPay. UnionPay is the largest digital payment network in the world by transaction volume, processing $8 trillion USD worth of value in 2015. The Visa network processed around $7 trillion USD worth of value during that same period. UnionPay is a network tightly controlled by the Chinese government and only available between Chinese banks. Visa is an international network servicing member banks all over the globe.
Visa’s visionary founding CEO, Dee Hock, has always seen Visa as a currency unto itself and has said as much in his writing and speeches. You will often hear Bitcoin advocates discussing how Bitcoin’s infrastructure might be enabled to “scale to Visa levels.” What you almost never hear Bitcoin advocates discussing is how Visa, a global permissioned digital payment network (and arguably a currency), ended up with the level of adoption it currently has. After all, before a Bitcoin network’s infrastructure needs to scale to Visa levels, the consumer and merchant adoption – the amount of economic value moving through the network – is going to have to be at Visa levels. I believe that Bitcoin can follow Visa’s path to adoption if members of the ecosystem capitalize on existing, but little used, standards while seeking profit.
Bitcoin is a system which elegantly leverages economic incentives. The economic incentives that drive adoption are easy to understand:
The party with the most economic incentive to increase the number of legitimate transactions (real economic exchanges between buyers and sellers) on a digital payment network is any party that earns a profit on every transaction they enable.
In other words: No one is more interested in you using a digital payment network than someone who makes a profit every time you use a digital payment network. Very simple economics.
So, who is most interested in you using the Visa digital payment network?
Well, Visa of course!
You might think that Visa is primarily a technology company. After all Visa’s raison d’etre is to provide a global digital payment network between member banks. In 2017, however, Visa spent $620 million of its $6.2 billion operating budget on “Network and Processing” but spent $922 million on “Marketing.” These expenses are separate from personnel expenses, which were over $2.6 billion during the same period. It would not surprise me to learn that the lion’s share of the personnel budget was spent not on engineers and technicians, but on staff supporting Visa’s marketing efforts. It would make sense to call Visa a “marketing company,” and yet the fact that Visa would spend nearly one billion dollars per year on marketing should strike you as counterintuitive. Visa Inc has never issued a single card to a consumer or answered a single customer service call (the phone number on the back of your Visa card belongs to the issuing bank). All consumer marketing of actual cards is done by member financial institutions. If you are like me, you receive credit card offers on a daily basis. All of that marketing, likely tens of billions of dollars worth every year, is paid for by individual member banks, not by Visa.
You probably know Visa’s signature slogan. C’mon, you know it…
“(It’s) Everywhere you want to be.”
If you were a child of the ’80s or ’90s you also know the set-up for that slogan as it appeared in the myriad Visa advertisements during that era. You would be shown some exciting destination or event and then told, “…they don’t take American Express,” before the Visa logo and slogan would appear. The message Visa has slammed into the skull of generations of consumers around the world is that no matter where you, if you have a Visa card, merchants will accept it as a form of payment. The message to merchants, who are (let’s not forget) consumers themselves, is that consumers from all over the world are carrying Visa cards, so you had better find a way to accept it if you don’t want to lose that business to your competitors (who are accepting Visa cards). This message is only powerful and effective if it is an actual reflection of reality. That means merchant adoption of the payment method, which is significantly more complex than the consumer experience of simply putting a card into a wallet, had to happen on a global scale. Point-of-sale systems and processing services had to be deployed in millions of shops before Visa could spend a single dime telling people that such systems were “everywhere you want to be.”
No one is more interested in you using a point-of-sale terminal than someone who makes a profit every time you use that point-of-sale terminal.
If you’ve ever registered a business, you know that within days of such registration, your business mailing address begins to receive marketing materials from payment processors providing online and point-of-sale systems which support major credit cards such as Visa. There is fierce competition between these processors. They compete on dimensions such as ease-of-use (Square has had great success in this realm) and the percentage charged on each transaction. Obviously, the less a merchant has to pay in processing fees, the more profit the merchant makes on any given sale. The fact that a payment processor which supports Visa makes more profit by increasing the total number of merchants that accept Visa as a form of payment is the fuel which continues to power the engine of Visa’s merchant adoption. Visa’s engine is based on a system of financial custodians (banks), who control and move funds between one another on behalf of consumer and merchant clients.
Bitcoin, designed specifically to be, as the title of the white paper says, “Peer-To-Peer Electronic Cash,” removes the need for a custodian of funds. This creates a fundamental challenge to payment processor profitability. If payment processors can’t make profits by increasing merchant (and, by extension, consumer) adoption, then there is no fuel. This is where we are today. This is why merchant adoption appears to have stalled. I also believe this is why the entire space is in a fierce bear market. Bitcoin’s adoption engine needs a new form of fuel.
When you use your Visa card to make a purchase, the point-of-sale terminal calls the merchant’s payment processor (bank). The payment processor is a member of the Visa network and uses Visa’s network infrastructure to query your (the purchaser’s) bank to get authorization for the charge. Basically, a check is made to be sure you have an adequate bank balance (or the bank is willing to cover the charge) to make the purchase. If the authorization is approved, your bank, the merchant bank adds a credit from your bank to its ledger, for later settlement. When the funds are settled, your bank removes a small percentage of the amount sent (known as the interchange fee) from the total. An even smaller amount is paid to Visa for use of its network. The merchant’s bank, before crediting the merchant’s account, subtracts an additional processing fee as payment for providing service to the merchant’s point of sale operations. In this scenario, you have three parties. Two of these parties, assuming the originating and merchant banks are different entities, are fierce competitors with one another.
However, despite the competition, it is profitable to all parties to increase the total number of Visa card holders and Visa accepting merchants. Because all three parties profit from each transaction, competition which results in increased adoption helps all members of the network. Dee Hock, Visa’s first CEO call this organizational model, a balance of competition (chaos) and cooperation (order), a “chaord.” From Visa’s standpoint, it doesn’t matter which bank has the largest market share, so long as the card being swiped is “everywhere you want to be.” The structure of the network makes it clear why Visa is incentivized to market itself as aggressively as it does. Visa is advertising its standards, its communication protocol.
Bitcoin, unlike Visa, is a financial system that has the express goal of eliminating the middleman. In the view of Satoshi Nakamoto, as expressed in the white paper, trusted third parties are “the problem.” The Visa network, originally called BankAmericard, was bootstrapped in its infancy when Bank Of America “airdropped” millions of fully activated credit cards to its clients. The bank fundamentally “gave away free money” to consumers. Merchants, in order to get a piece of the action, had to agree to accept the new cards as a form of payment. Although the original program was mismanaged and resulted in significant initial losses to the banks that did the drops in the early years, history shows that it was enough of a spark to light a new global financial paradigm. Because Bitcoin, unlike a credit card balance, actually has had a history of increasing in value if not spent, airdrops to spur merchant adoption stands little chance of being effective. The incentives of Bitcoin, however, are well laid out for a profit-seeking strategy that focuses almost exclusively on increasing the total number of transactions on the network, regardless of the particular wallet or point-of-sale device being used by the merchant and consumer.
The “Visas of Bitcoin,” in terms of incentives, are Non-Custodial Financial Services companies. These are companies which, for a small fee written into the transaction itself, enable advanced communication between buyer and seller, as well as transaction and reputation validation services using widely accepted standards. These standards are called Payment Protocols and they will be the focus of my next article here on Coinivore. An NFS is, fundamentally, a Bitcoin Payment processor. Companies like BitPay, Coinbase, and CoinPayments already offer cryptocurrency merchant services, allowing on and offline businesses to accept Bitcoin. All of those businesses, however, take custody of funds on behalf of their merchant clients. They extract their processing fees upon settlement with the client – moving the funds from the payment processor’s account into the merchant’s account.
Non-Custodial Financial Services companies, using Bitcoin’s innovative multi-output transaction format, instruct the consumer’s wallet how to structure the transaction so that not only do funds travel directly (peer-to-peer) from the consumer’s wallet to a wallet (or multiple wallets) controlled exclusively by the merchant, but also that one of the outputs represents the small fee paid to the NFS. This fee can be “paid by the merchant” in that the amount sent to the merchant can be reduced relative to the fee sent by the NFS. Such an arrangement would be part of the prearranged terms of an agreement between the merchant and payment processor and is a closer analog to the current model used by payment processors. As an example:
On a $5 in-person point of sale purchase
- A total of $5 in value is sent by the purchaser in single input
- $4.98 is output to an address owned by merchant
- $.01 is output to an address owned by NFS
- $.01 is miner fee
Not only does the Non-Custodial Financial Services provider communicate how the above transaction should be structured, in most Payment Protocols, the signed transaction itself is sent to the NFS and then, if valid, is broadcast to the Bitcoin network, at which time all parties can verify its status. There are some nuances to this approach and also some trade-offs which I will discuss in my next article.
Another role that an NFS ecosystem can (and will) play is blockchain-based reputation management. This is not a widely discussed application. There are a few experiments with the concept in the wild, such as Swarm City. In the highly decentralized economy engendered by Bitcoin, reputation (think Yelp reviews or Uber scores) will be crucial for NFS providers to track in order to determine which merchants should be allowed to use their infrastructure. However, this choice does not affect the permissionless nature of the system. Because the standards in use are open and available, there is no barrier for a new NFS, wallet or point-of-sale developer to enter the space. All wallets and point-of-sale terminals will be interoperable with all NFS platforms and with each other. As with the incentive structure of Visa, any party increasing adoption in one area allows it to both compete and cooperate at the same time. The system is a “chaord.”
In Part Two of this article, I will explain why Payment Protocols, an existing set of standards yet to gain wide adoption, stand the best chance of enabling a new financial paradigm built on top of Bitcoin.
Vin Armani is the founder and CTO of CoinText, co-founder of Counter Markets, instructor for CodeFromGo beginner’s coding course, and the author of Self Ownership. Follow Vin on Twitter.
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