Currency has existed in some form since ancient times but it's only within the last 30 years that humans started to move beyond traditional physical cash and embrace a digital payment system. Previously all digital cash was at least somewhat connected to physical paper money, however. Cryptocurrency, which is purely digital, represents the next step in that transition. What does it mean for the future of payments? We take a look at some of the biggest potential problems and solutions below.
By: CryptoVantage Staff | Mar 7, 2020 | Modified Jul 20, 2020
The original Bitcoin white paper refers to the technology as a peer-to-peer digital cash system. The basic idea outlined by Satoshi Nakamoto was to create a new digital financial system that would remove the need for third parties in online transactions.
“What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party,” wrote Nakamoto.
The white paper focuses on the inherent weaknesses of reversible payment systems, noting that the lack of non-reversible payment options opens the door for third parties to get between businesses and consumers, which creates a variety of issues, such as higher costs and potential censorship.
Cryptocurrency has brought in several notable differentiating factors into the world of digital payments. One being irreversibility, and the other being direct ownership over ones funds. Both revolutionary in their own right, in comparison to the way that banks are currently facilitating digital transactions. One massive effect of these differences is censorship resistance, the ability for your transactions to not be stopped or reversed.
When many people learn about Bitcoin for the first time, they generally think of it as nothing more than an alternative to PayPal, which has been the most well-known option for online payments since the early days of eBay. However, there are key differences between these two payment systems.
With PayPal, funds are held in a variety of fiat currencies (such as USD or EUR) by a centralized company on behalf of the users. In Bitcoin, each user is in full control of their funds by way of the keys associated with their Bitcoin wallet.
This is typically the same schema used for all cryptocurrencies. The key that represents ownership over your assets is called your private key. All of this means there is no central authority that can seize funds from the users or block transactions sent to specific individuals or businesses.
This key difference between Bitcoin and PayPal was put on display in the early days of the cryptocurrency’s existence through its use for things like illegal purchases on Silk Road and donations to Wikileaks.
It should be noted that the original vision of PayPal was for it to work more like Bitcoin than how the online payment giant operates today. However, due to complications when pursuing certain features, PayPal was forced to change its business model.
While many of the early companies built around Bitcoin were focused on payments, the digital currency has come to act more as a digital gold than a tool for cheap online payments over time. Many of the startups in Silicon Valley and elsewhere were focused on signing up merchants to accept Bitcoin back in 2013 and 2014 – with the main sales pitch being that businesses can avoid costly credit card fees and chargebacks.
However, the adoption of Bitcoin among consumers has remained mostly stagnant over the years. Eventually, fees started to rise quite substantially in 2016 and 2017 as more people wanted to speculate on Bitcoin and other cryptocurrencies via the exchanges. While there was a push to increase Bitcoin’s block size limit by way of a hard fork in order to keep fees low, the change could not gain consensus among the Bitcoin userbase. Eventually, some users who valued the payments use case over the digital gold use case branched off to the alternative Bitcoin Cash network.
Data from Chainalysis indicates that 90% of Bitcoin network activity is still related to exchanges, which shows that most people are still more interested in using Bitcoin as a store of value or speculative asset than a means of payment at this time. However, it’s possible that Bitcoin could increase in popularity as a medium of exchange as more and more people join the network and put some of their savings into the digital asset.
Of course, Bitcoin is not the only cryptocurrency that exists. There are thousands of other cryptocurrencies and tokens that have popped up over the past decade, and many of them are focused on being a better option for payments than Bitcoin. However, the proponents of these altcoins tend to leave out the downside of focusing on lowering on-chain transactions fees above almost every other feature.
While Bitcoin has a primary focus of security, and providing a permission-less network for all to use, this comes at the cost of having a slow transaction throughput. Other cryptocurrencies, known as altcoins take a variety of different approaches, each with their own set of pros and cons. These other cryptocurrency project often have cheaper fees, however, one must examine, and ask why the fees are cheaper, and how this has been achieved. Cheaper fees may sometimes comes at the cost of having a less secure network. It is important to examine how the network is governed, and where the fees that you’re paying actually go.
On top of the centralization issues, there is also the problem of bootstrapping a completely new money with each new altcoin. Bitcoin is much larger and more liquid than any of the other cryptocurrencies on the market, and many of the advantages of having low transaction costs are lost when users are forced to use a form of money that nobody wants to hold as a store of value.
There are a couple of easy ways you can spend your cryptocurrency to purchase products or services:
You must first ask the question, what I am using either for? Many people see cryptocurrency as a store of value, or as an investment. If you see cryptocurrency as an investment, then spending it to obtain a cup of coffee may be the wrong way of going about investing. However, if you believe that cryptocurrency is the future of money, and in the future, government currencies such as USD, or CAD won’t exist. The sooner you start spending cryptocurrencies, and teaching your local merchants about wallets, the sooner mass adoption is going to arrive.
For everyday purchases, in most places in the world, cash is still king, as banks and financial institutions have made using government currency (FIAT) a seamless experience. A better cash would be one that has the benefits of cryptocurrency (censorship resistance, cross border payments), and the stability of cash. This exists, and is known as stablecoins.
Stablecoins are meant to bring price stability to the volatile world of cryptocurrencies. Instead of operating as their own commodity or currency, stablecoins are tokens issued on top of platforms like Ethereum that are backed by real-world currency held in a bank account (there are other, more complex types of stablecoins based on algorithms but we’ll keep it simple for now).
Stablecoins like Tether and USD Coin have gained traction among those who want to move funds between exchanges or make international money transfers, and now these coins are also being implemented into payment platforms like BitPay. However, it’s unclear whether stablecoins will be sustainable over the long term.
Remember, the key selling point with cryptocurrency is censorship resistance and the irreversibility of transactions.
When you bring money held in a centralized bank account into the equation, it puts into question why a blockchain is needed for these projects. After all, the bank account behind the stablecoin is basically a form of the centralized third party that Satoshi Nakamoto intended to remove with Bitcoin in the first place.
If more people start using stablecoins for illegal activities, it’s unclear why these sorts of systems would not end up in a similar situation as Liberty Reserve or e-gold where the project is shut down. In a situation where the stablecoin projects embrace regulation, it’s not clear how they’ll be much different from PayPal down the road.
The ultimate stable cryptocurrency, is one that is properly decentralized. A stable coin that you receive from locking up some of your cryptocurrency as collateral for a loan of a stable asset. A stablecoin that uses collateralization is a powerful tool, as it inherits all of the benefits of blockchain, including censorship resistance and cross border transactions, without losing its stability. What we may see in the future, is one where Bitcoin and Ethereum are stores of value that can be locked up, and provided as collateral for stablecoin loans. The stable coins will be used as cash, and Bitcoin and Ethereum will be reserve currencies, much like gold was before 1972.