Making money: Bitcoin and virtual currencies (Pt. 1)

Just imagine that the guys running Wikipedia, Mozilla or WordPress would start producing money. Indeed, this is what is happening since 2009. Just as the encyclopaedia Wikipedia relies on an open network of editors and contributors, and Mozilla’s and WordPress’ free software products are being maintained by a large, but only loosely connected open source community, the electronic currency bitcoin runs on a radical “distributed” modus operandi. There is no central authority, no government, no company or any other organization which controls bitcoin. It’s all decentralized and collaborative.

Unfortunately, most press coverage on bitcoin almost exclusively focusses on either online fraud (most recently: the malware Cryptolocker which offers its victims to pay a ransom in bitcoin in order to get access to their computers again) or on excessive ups and downs in bitcoin exchange rates (today like in 2011, when it dropped from around $33 in June to $2,50 in October). By this, we are missing the best part of the story.

Here is why the new currency is worth our attention apart from sensational incidents which are reported by the news.

One fantastic thing about bitcoin is that it makes possible to sell and buy things over the internet almost without any fees. Bitcoin charges as less as 0,02 % per transaction! This is especially interesting for micropayments and small donations: Today, the largest single actors who benefits from platforms like or others are PayPal, Visa and other companies. PayPal, for instance, charges 35 cent for each transaction plus 1,9 percent of the total sum. Thus, donating a small amount like two Euro for a project doesn’t really make sense either for the person making the donation or for the one receiving it. Setting a minimum well above two euro, on the other hand, won’t solve the problem either, because in many cases people are just not willing to spend that much.

Bitcoin has a fix for this. If we think that micropayments are an attractive approach to create a digital economy which doesn’t rely on spying on customers by Google & Co., but instead refunds individual people for their work and products which they offer through digital channels (See Netopia’s column “Marketplace delayed”, then we should no longer regard bitcoin just as a nerd thing. Bringing payments into the game could help to create high-quality content and services which are not accompanied by tracking and privacy-violations.It might well turn out that bitcoin is the one piece in the big puzzle “internet” that has been missing all the time.

Another advantage is that in order to use bitcoin, one doesn’t have to have a bank account. This makes the currency especially attractive to countries in the developing world, where many people indeed do not have bank accounts. (There are estimates according to which 64 percent of people living in developing countries don’t have access to financial services. See this working paper by Ardic et al. issued 2011 by the World Bank.) On the other hand, mobile technologies are widely in use in these countries. Mobile payment (relying, for instance, on the closed-system service M-Pesa in countries such as Kenya, Tanzania, and Afghangistan) is already quite common. Bitcoin could help making these mobile payments not only cheaper. It could also enlarge the wider network within which mobile currencies can be used. In fact, all this is already starting to happen: the bitcoin wallet service Kipochi, for example, recently developed a product which allows M-Pesa user to exchange bitcoins (see report: How Bitcoin Could Help the World’s Poorest People).

Also, with Bitcoin it is easy and cheap for migrant workers to send money sent back home. Today, these cash flows are a major source of income for many of the poor. There are estimations according to which the total amount of money sent home by migrant workers in 2012 has reached the value of $372 billion. The costs for this are considerable, though: up to twenty percent of the money goes into the hands of financial service providers like MoneyGram or Skrill. Switching from money wiring services to bitcoin would therefore be equivalent to the release of a considerable amount of foreign aid. Estimating that the average costs for money wiring are around seven percent, replacing money wiring by bitcoin would amount to $26 billion. The U.S., world leader in foreign aid, spent $23 billion in foreign aid in 2012.

Furthermore and maybe even more important, bitcoins could be an escape for people who seek for an alternative to their country’s devaluated currency. Small entrepreneurs could participate in the global economy without being harmed by extremely low exchange rates for their national currency!

But there is also a drawback. Bitcoin is not really money in the strict sense. It’s a payment system outside the established monetary order. It’s peer-to-peer computer protocol, stuffed with encryption technology. And it’s exactly because of this that bitcoin can offer to work almost without any transaction fees. Other services like Dwolla (see the recent coverage in Technology Review), which try to achieve the same result without stepping out of the regular monetary economy, are much more complicated in terms of organisational overhead. Therefore, they are not widely available and also still much more expense than cash (25 US-cent per transaction).

That bitcoin is not really money is a problem because it takes a long way to explain to people what bitcoin is and how it works. Usually, we don’t care for the technical details of financial transactions. But in this case, we do: Because in order to use bitcoin, one has to get engaged with real money. In exchange one gets a currency which, in a way, is not much different from tokens we use in game. Once our peers quit playing, these tokens are useless. The same is the case with bitcoin. It’s truly not only a digital, but a virtual currency. It’s a fad, if you like to call it that way. Sure its founders have taken care that the currency cannot just be produced by anyone in any quantitative (for a 1:44 minute introduction see the animation by on Youtube. Or listen to bitcoin lead developer Gavin Andresen on Econtalk and on Surpringly Free for a comprehensive explanation of the technical details or read the Mercatus Center report “A Primer for Policymakers”. But still people could just withdraw from using bitcoin. As a result, the price for one bitcoin would rapidly drop from several hundred US-Dollars, as it is these days, to zero. We should, indeed, be interested to hear why this is not very likely to happen.

Continue reading – second part here.