When studying a new language, you can pick up just enough to visit another country and order a coffee. Or you can spend time and energy to be fluent. According to Patrick Sells, the Chief Innovation Officer at NYDIG, who presented at the NEACH 2021 Future of Payments Conference, understanding Bitcoin is a lot like that.
Whether your familiarity with cryptocurrency is fluid or rusty, it’s always helpful to learn more. During his session, Sells provided a detailed description of how Bitcoin arose and evolved and shared its use cases in banking and payments.
What is currency, anyway?
Sells began his presentation with a fundamental question: What is money?
Although anything can be used as money, from paper to paintings, not everything is a good form of money. There are three key attributes to evaluate a type of money: its store value, mode of accounting, and means of exchange.
Take gold, for example. Because it is largely finite, it has store value; the supply of gold increases only about 2% a year. As a mode of accounting, it’s ok: bars, ounces, and coins. But as a means of exchange, it scores poorly. As globalization has evolved, it’s difficult to store and transfer gold.
That’s how paper currency evolved: a piece of paper to represent the gold you have.
But paper money’s store value isn’t terrific; the supply can be instantly increased at whatever velocity someone decides. Think about how much money has been printed in recent years.
And then there’s Bitcoin, which has been around since 2008. Bitcoin is an open-source monetary system. It’s not controlled by anyone in that there’s no central bank to modify what the supply is. It’s decentralized and rule-based.
As a store value, Bitcoin is excellent, because the amount of Bitcoin can’t be changed: There can only be 21 million Bitcoin. Each Bitcoin is divisible by a million increments: far thinner than paper money. As a means of exchange, it also scores very well: Two people with phones on the other side of the world from each other can send it to each other instantly.
How does Bitcoin work?
Sells provided details about the way Bitcoin functions: Bitcoin operates on a blockchain, a decentralized ledger of transactions that can be viewed by anyone, anywhere, 24/7. Transactions are added to the blockchain approximately every 10 minutes, through a process called mining.
Bitcoin miners solve complex mathematical problems to create blocks and confirm transactions.
Miners are paid by those transacting in exchange for securing the transaction on the blockchain.
Bitcoin relies on pre-existing technologies, public-key cryptography, and digital signatures to provide strong proof of control, ensure user privacy, and verify payments. It uses both a private and a public key. The private key is a unique password that allows one to send Bitcoin from one Bitcoin address to another. The public key is derived from a private key and is used to create a Bitcoin address and create unique digital signatures for transactions by matching with its corresponding private key.
Unlike a password, however, this private key can never be reset. If it’s lost or hacked, it’s forever gone. So how do you keep private keys safe? That’s what a digital asset custodian does, Sells explained.
There are two ways digital custodians handle private keys. First, a hot wallet, which is a piece of software connected to the Internet. Many Bitcoin holders rely on hot wallets because they’re faster to use for needs such as immediate access or trading with cryptocurrency. But if that software is hacked, the private key goes along with it. The other option: cold storage, which is a hardware security module not connected to the Internet—similar to how a thumb drive works for storing files.
Although it’s safe to say Bitcoin’s usage is on the rise, Sells was quick to explain Bitcoin is highly unlikely to replace the dollar. “While there are weaknesses to the central bank system, it’s still a very strong central bank. It’s the combination of dollars and Bitcoin from which we can create the most financially secure future,” he said.
He added, “However, in countries with less secure central banks, such as El Salvador, Bitcoin represents security and is more widely used.”
Bitcoin’s market potential
There’s a strong, untapped market for Bitcoin, said Sells. According to his presentation, only about 22% of American adults own Bitcoin, and more than half of them have bought it just in the past year. Of those Bitcoin holders, 80% would choose to store it with their financial institution if offered, and more than 71% would switch their FI for one that offered Bitcoin products.
Customers and members want to take advantage of the trust and strength of their existing relationship and use their bank or credit union as their gateway to financial assets. People will choose their FI of tomorrow based on access to Bitcoin today, Sells added.
That said, friction still exists in terms of accessing Bitcoin. The reasons are largely three-fold:
- Lack of familiarity. When it comes to the vernacular around Bitcoin; terms sound confusing to potential Bitcoin holders.
- Lack of trust. People don’t want to go to an unregulated exchange, share personal information, or download an app they’re not familiar with.
- Lack of flexibility. It can seem complicated to open up a new relationship somewhere else, transfer money, take additional time, and potentially pay fees.
But FIs realize the potential and are already planning, Sells said. “In 2021 we saw the industry start to really pay attention to Bitcoin. Many put teams together, and in 2022 I expect an explosion of incumbents bringing in Bitcoin or providing some type of access to it.”
Bitcoin for payments
As it stands now, at least in the U.S., people don’t use Bitcoin for payments, Sells said. Not only do they not want to give up potential future appreciation of their cryptocurrency, but they also don’t want to sell it and incur capital gains taxes to make payments. Again, Sells mentioned El Salvador as a country in which Bitcoin represents stable legal tender currency; you can sell it without a taxable event.
As countries around the world develop their tax framework for crypto, that will drive what’s happening from a payments standpoint.
“People may want to borrow dollars against Bitcoin to unlock liquidity, comparable to a homeowner using a home equity line of credit,” Sells said.
Because Bitcoin can be used like data, it can move freely and instantly between systems, clear and settle instantly, not depend on any intermediaries, and require no minimum transaction accounts or fees. It can be used in a whole host of potential payments use cases, such as real-time remittances, cross-border payments, and peer-to-peer payments.
Bitcoin is just one of many types of cryptocurrency, and it seems like the field is constantly expanding. Changes like these will pave the way for a huge jump in cryptocurrency acceptance, especially for Bitcoin, which has been around the longest and was designed to be an open-source monetary system, unlike other cryptocurrencies such as Dogecoin—which was actually established as a joke.
But Bitcoin holders shouldn’t jump in without strategically considering why a digital asset exists and the role a trusted FI should play in that. Banks and casinos do very different things, Sells said, and we can think similarly when it comes to cryptocurrency.
The promise is there, and the planning is happening. As Sells said, “Bitcoin and crypto will revolutionize payments—and soon.”
AUTHOR: Joe Casali, AAP, NCP
Executive Vice President
As the EVP of Payments Innovation for NEACH, Joe focuses on exploring innovative solutions and technologies that will help position members for success, both now and in the future. Connect with Joe to read more of his blogs, articles, and posts.