BitCoin – Hey guys, Barry Joyce here and I’m delighted to talk to you about the economics of virtual currency and bitcoin and this topic has been just an incredibly fun and exciting topic to research and learn about. It’s emerged in the public imagination over the last two or three years, as a key piece of technology that might really change the way finance works for consumers, for people in developing countries and for the way that financial institutions actually conduct their business.
So one of the things that is challenging about this technology is that, there’s so many details about how it works.
Just like in the early days of the internet, if you went to a conference about the internet, you would hear people talking about protocols and SMTP and FTP and how we get packets around. And really, none of the things that you would talk about in that kind of a technical environment would really be important in knowing, whether you should start Amazon.com or eBay or whether you should invent PayPal or whether pets.com would succeed or fail. And so similarly for bitcoin, a lot of the details of how the technology works can really be separated from what the technology is and what it does.
And so what I wanna talk about today is really what this technology is and what kinds of things it can empower and then we can all sort of use our collective imaginations to think about where it’s going to go. And just like having this conversation in 1993 or 1994, we could have very informed guesses based on economics and needs and shipping costs and warehouse costs and logistics and communication needs. We could make some very interesting predictions. Probably, none of us would’ve realized how exciting YouTube or Twitter or all these other things that people figured out to do later would be.
And so in a similar way, we’re not going to be able to fully forecast the best uses of this new technology. So at its really fundamental level, bitcoin is something quite simple, it’s a spreadsheet. It’s a big spreadsheet. Now you might think, wait, Lotus 1-2-3 was invented in the 1980s, so what’s new here? And in fact, really to think about the history of spreadsheets, we need to go back before they were called spreadsheets on they were actually called ledgers.
And so in the beginning of commerce in primitive economies, you might have learned in some class that people bartered an apple for an orange or a dead deer for a hunting knife. But in fact, that is really not how commerce emerged for the most part, even in fairly primitive societies use ledgers going way, way back in time. So it’s kind of complicated to actually have two things, one in each hand and trade them for each other.
And so it’s been very natural for human societies to use ledgers to keep track of things, so that I can contribute today and get something back tomorrow. So really, the origin of money itself is a ledger. Before there was money, there were ledgers that kept track of who had what and who had contributed. So, bitcoin is in its essence, a big spreadsheet or a big public ledger and what it does is it keeps track of who has sent what to whom.
So, it’s gonna say that person 123 sent one bitcoin to person 456. That’s what it does and hat’s pretty much all that it does. How can this be so innovative and so exciting, if that’s all it does? Well, if you imagine for a second that we just put up a big spreadsheet that kept track of trillions of dollars and we just posted it on the internet from a server, what do you think would happen? Someone might hack that server and try to change the ledger in some way. So if you’re going to have a ledger that keeps track of things that are very, very valuable, it’s very important that it’s secure.
That’s one thing and so I won’t tell you how that works today, but I’ll say that one of the big innovations in the invention of bitcoin was a method to keep that ledger secure. And the way that’s done is that there is not one computer that’s holding that ledger, cuz pretty much any one computer is hackable, but rather copies of that ledger are kept all over the world and they all have to agree.
Not all, a majority have to agree on what the correct ledger is. And so if any one or if even 20% or 30% of those were hacked or changed or altered in some way, that still wouldn’t change the full public record. So this distributed technology, of course, only really enabled by the internet to be able to distribute something so widely and easily is part of the security about of how this works. A second thing is that if we wanted to have a big ledger to keep track of things, it would be natural to think about sort of having somebody in charge of keeping track of it and so you could have PayPal.
PayPal creates a big ledger. If you have an account on PayPal and you send it to someone else on PayPal and you both carrying balances, no money actually moves, just PayPal makes a debit on one side and a credit on another side and nothing else has to happen.
But now you have PayPal, a company, that’s keeping track of that ledger. The thing about bitcoin is that it’s an open source software protocol that allows people to make their own entries on the ledger in a decentralized fashion. So if you own a bitcoin, that means sort of two things. One is that you have the address for the bitcoin and someone has sent it to you.
So there has to be an entry on a ledger saying, you have it, but that’s not enough, because you also need a security key or a password to authorize a movement of that bitcoin to someone else.
If you don’t have the pass code, you can look out at that ledger and admire your beautiful bitcoins sitting there, but you can’t do anything with it. So you could say that you own it, but it’s not really meaningful that you own it, because you can’t move it. If you have the password and you have an entry on the ledger that says it’s yours, then you have something of value that you can actually do something with and what can you do with it? Well, exactly one thing. You can authorize a movement to someone else. But hopefully, that person is gonna give you something back and that’s what makes it useful, so that’s it. Big public spreadsheet with some passwords and some really cool ways to keep it from getting hacked. So why is that important and sort of useful? Well, first of all, it’s the first time that we have a purely digital asset, where the whole definition of owning that asset is just the digital thing.
There is no corresponding physical asset and that’s going to allow many thing, probably the easiest thing is just that I can send something of value to you digitally with the same kind of time frame and user experience as sending an email, that’s something that I can do globally.
I can do it without asking anybody’s permission without requiring some other institution to do something for me, I can just do it. I could meet somebody on a chatroom and have them email me a digital good or provide me a service and I could extend them back something of value and we could be done in ten minutes and never have to see each other again. That’s pretty powerful. So what’s gonna happen is that this person wants to send a bitcoin to someone else, they’re gonna have a certain address.
They’re gonna enter their password and they’re gonna authorize the movement of one bitcoin say, it doesn’t have to be one to someone else. And then ten minutes later, that shows up as a new entry on the ledger.
And that’s an instantaneous, not quite instantaneous, but very fast movement of an asset that in a way that’s really not possible using other technologies. So if you want to see how this looks from a user’s perspective. A user can use something called a Wallet. And a wallet is a piece of software that looks out at that whole big ledger, which is very long by now. And looks at just the transactions that are important to you that are associated with your address and displays to you your balances.
And it’s just a very simple piece of software. It’ll help you keep track of your passwords and things like that. Now as an economist, I look at this. It’s very cool. It’s very neat. But an important early question to ask is well why a Bitcoin? Did you just make up this idea of a Bitcoin either to be a Ponzi Scheme, or something cool like gimmick, that make’s people excited about your new product? Like, most people don’t wanna think about holding an asset whose value fluctuates.
If you wanna hold an asset, if you wanna hold cash, you wanna hold cash in the currency that you’re gonna spend It in. You don’t wanna walk around holding Euros if you’re gonna spend Dollars. It’s not convenient, you have to keep track of the US to Euro exchange rate. And similarly, it’s very inconvenient for you hold say something called a Bitcoin when you’re gonna go ultimately pay things that are priced in dollars. So can we just get rid of this whole Bitcoin thing, and use this really cool spreadsheet that actually keep track of dollars? Okay.
So let’s just put dollars on a spreadsheet.
Well, let’s talk a minute about what that means. So the guys who invented this security technology were really, really smart. But unfortunately, they did not figure out how I could beam a dollar bill onto your keyboard. I can’t go zoom and a dollar bill appears. Not possible. So if I had a password and authorize an entry on that spreadsheet that said I gave you a dollar, of course that would be an incomplete description of what happened, because I didn’t just give you a dollar. I just made an entry on a spreadsheet. I didn’t actually physically give you a dollar. Maybe I promised to give you a dollar. Maybe somebody else promised to take a dollar out of my account and put it in your account. All sorts of things might be true, but the one thing that’s not true is that I just sent you a dollar.
Okay? So this would not be a complete description of any system What could be a complete description of the system? Well if I, instead of saying I am gonna send you a dollar, that’s just a message that I would have to honor, instead I could actually send something like an IOU.
So if there’s a dollar on the spreadsheet that belongs to me, of course it’s not really a dollar on the spreadsheet cuz I can’t pinpoint dollars to a virtual spreadsheet.
But I could have an IOU. Say an IOU from Bank of America. So for that it’s useful to sort of think about what happens when you have a Bank of America account. You log into your online account, you look at the website, and you actually see it tells you, you have money. Now where is that money? It’s not actually on your computer. It’s not even at Bank of America because they’ve leant out 95% to someone else. What is it that you’re seeing when you see that you have $100 in the Bank of America, you’re actually seeing just a promise.
Bank of America promises to give you $100 if you ask for it. That’s your relationship with Bank of America. And so, Bank of America, could, in principle, agree, that it’s gonna let you keep some of those dollars. Like, you might have two or three different checking and savings accounts. You could have another account which is exposed to a some sort of virtual currency system.
And when a message is sent on that ledger, Bank of America could promise to honor a contract, to send that money to someone else. Okay? So if I wanted to send money to someone in Chase, I could make an entry on the spreadsheet using my password. And if Bank of America and Chase had already agreed to plug into this system they could then respond to that by actually sending the money. Okay? Now this actually is very close to a system that we have today called SWIFT.
BitCoin – So if you want to send money say to Europe.
Then you’re gonna send a message through something called SWIFT. And that message is gonna say that I’m sending someone else money and who’s account it’s supposed to go to? But on the back end, that’s not at all what happens. On the back end, say Bank of America goes to a correspondent bank. That correspondent bank goes to another correspondent bank in Europe. That correspondent bank might go to another correspondent bank in another country and then eventually it’s gonna show up at the destination. There is a whole sort of back end system behind that and everybody has agreed though that if you send a SWIFT message then everybody is gonna honor that message. Okay. So that’s a way you could think about this sort of more advance ledger technology as something that can be used as a replacement for SWIFT. Cuz SWIFT only works in certain countries and not everybody has agreed to follow it.
However, if you were sending a digital asset like a Bitcoin, you wouldn’t need the whole correspondent banking system. You could just immediately send the money and that helps understand what the kind of benefit is of having these digital currencies rather than physical currencies.
The fiat currencies from national countries require this back end movement of money in a way that is not necessary if you’re just moving a digital currency. So I was very excited about this idea and then I was going around giving these talks with these very slides about a year and a half ago. And then I learned that Stanford GSB alumni named Chris Lawrenson had co-founded a company called Ripple, that implemented a ledger just like this. That ledger allowed you to keep not just its own native currency, which it has called the XRP, but also, any other currency you wanted on the ledger.
And so, today, a number of financial institutions have done just what I described. They’ve plugged into the ripple ledger. And they’ve allowed people to put US dollar bank balances onto the ripple ledger. And then you can use them to send money to anybody else in the world in any other currency. And so then I joined as an adviser for Ripple Labs and now I’m on the board of directors. So it’s a technology that I’m really quite excited about. As an economist, the reason this was appealing to me is that I don’t want to have a bunch of consumers in a whole bunch of stable developing countries holding something other than their local currency. I would like them to think about the financial technology innovation here as one of being able to move money quickly but not of one where you’re just holding some other currency.
On the other hand, if you’re sitting in Argentina or Venezuela or one of these very high inflation countries, it’s a completely different kettle of fish. If you’re a consumer in one of those countries, you have very limited ability to save.
How do you save if you’re a poor consumer in a developing country, with high inflation? You could buy a gold necklace. That’s a popular way. Guys go to Miami and get a suitcase full of hundred dollar bills and come around and sell them to people. And then you buy them and stuff them under your mattress. That presents some security risks for you and your family.
If you’re wealthy enough, maybe you buy a physical asset like a car, or a tractor, or a horse, but if you don’t have enough money to do that, then any cash you have just gets inflated away very quickly.
Because you have very little incentive to save, and very little ability to get out of poverty. A technology innovation like this can allow people all over the world, even who don’t have bank accounts, immediate access to international financial markets. Because all they need is sort of a mobile phone, and instead of someone walking around with a suitcase full of $100 bills, they can walk around with a phone and a little bit of cash, and exchange the cash for this digital asset. Which could then be converted into dollars or euros, or whatever else, rather than stuffing $100 bills under your mattress.
And, so this is one of the areas that’s actually happening now, and it’s becoming very popular in these countries where the existing financial systems are quite poor.
This type of technology enables a connectivity of international financial markets in a way that’s just really never been possible. It’s also gonna make it very difficult for those countries to maintain capital controls. So right now, of course, recognizing this, they don’t let people leave.
That’s why you have to smuggle the suit case full of $100 bills and pay a bribe at the airport. So this is going to really change the economics, the macroeconomics of those types of countries, as it becomes impossible to really enforce capital controls in the area of digital assets that can be moved without needing to access the banking system. So, let me give an example of this type of international movement of money.
I mean, how it would work today, and I’ll give it from the perspective of a U.S. consumer, even though in some sense we have less need for it than many other countries in the world.
So suppose I want to send some money to Japan. If it’s a small dollar amount, I could actually be pretty much priced out of that transaction. Western Union, or something like that is gonna charge me 20 to 30 bucks, if I do a bank to bank account transfer, that’s gonna cost me 50 to 100 bucks, and take a couple of days. So, there aren’t actually great options for making small person to person international payments, and this is one used case that people have started doing. So if I wanted to send money to Japan, what I could do is initiate a dollar transfer through a linked account to a Bitcoin service provider. In the US, two of the very consumer friendly ones are Circle and Coinbase and so say for example, if you want to establish an account in Coinbase, I would link up my bank account.
So I’ve done this myself my with Bank of America account with Coinbase, and they sent me 73 cents in an ACH transaction and I confirm the dollar amount so we know that we are linked up and our ACH is working.
And I send them my passport and they check out who I am and I give them my credit card number if I want them to actually make funds available immediately. So if I have an immediate need I’ve got to get some money to Japan, what I can do is I can just log onto that. Quickly get on my account and say oh, Coinbase. I want a certain sum of money, so I want a hundred bucks, give it to me. And because they’ve already verified me, they’ll immediately make that available in my little online web account. Then I can look for a quote for what is the exchange price between dollars and Bitcoins right now? So there’s a few exchanges.
Well there’s actually a large number of exchanges, but there’s a few very big ones. And one of them is called Bitstamp. On say the bit stamp exchange you can look out and see the order book. Some people want to buy bitcoins, other people want to sell bitcoins.
And so you can see how many bitcoins would I get for my dollar. And I can place an order and then within a few minutes I can exchange my dollars for bitcoins. And in the case of Coinbase they’ll help me do that transaction. So a few minutes later then the bitcoins show up in my Coinbase account. Now, all I need is the bitcoin address of my friend in Japan.
I tell Coinbase, send my bitcoins there, and boom, those bitcoins are gone, my friend in Japan has the thing of value. At that point, we can walk away, we’re done. They have the thing of value. Now my friend in Japan, if they want to get out of BitCoin quickly, then immediately take those BitCoins onto an exchange that operates in the BitCoin to Yen currency pair.
On that exchange, that would make another currency exchange and get their yen out and go home, okay. So in a very short period of time, we would have moved the thing of value.
There could be delays getting in and getting out. Like if I didn’t have my coin based account set up or if there wasn’t something like that in Japan, they might have to wait a little bit to turn the bitcoin to dollars, but the point is, very, very quickly they have an asset. There’s a few things you have to worry about along the way. Like you don’t want the exchange to go bust while you’re in the middle of a transaction. That would be bad, you would lose your money. But you’re not gonna be on that exchange very long at least unless you want to be. So you really have to trust these exchanges for a relatively short period of time. You might also worry about fluctuations in the currency. People say, well bitcoin used to be a thousand dollars a bitcoin and now it’s 300 dollars a bitcoin, doesn’t that make it really bad for sending money to Japan? I can say well no, actually, because it really doesn’t change very much in the course of ten minutes
BitCoin – And that’s really all we needed to know.
We needed to know is it gonna be stable while we process this transaction? While we get in and out of BitCoin? And so this is my, from an economics perspective, I think of this as a payment rail. This is a movement, a way to move money, and I got it from here to Japan instantly, and that was very powerful. But I didn’t have to hold it. It’s not something that I need to hold or use as money in my daily life for it to be useful. It can be used for that, too, but it doesn’t have to be. So this is one really crucial use case. Another use case is of course just that you and I could use it with each other to split a check, split a taxi, to move money between each other. Now that all of us are starting to ditch our wallets and only carry our phones, that would be very convenient.
Like Venmo allows you to do that. In Australia and in Europe, actually, just bank to bank transfers are instant and free. Why don’t we have that? Good question. That’s a question about competition and market power but we’ll get back to that. So in principle you have other ways to do that but it’s one nice way to do it. So I’ll mention right now I’m in the process of running an experiment with MIT undergraduates where we’ve given 100 dollars worth of bitcoins to a majority of MIT undergraduates.
And so we’re gonna watch over time and see if when all of their friends have them if they find this a very useful thing to do. But it turns out a lot of them, a majority of them, were already using Venmo which is this peer to peer cash app and so they already had some pretty good cashless ways to split checks as well.
So, it’ll be interesting to see whether BitCoin they find superior or inferior to the mechanisms that they already have. So let me say a few more words about uses cases of this. So as I mentioned this international transaction is a really big use case. So this table just shows sort of the bank fees.
There’s outgoing and incoming wire transfer fees if you wanna move money internationally. So it’s not just the un-banked that have to pay Western Union a lot of money. In fact, Western Union is cheaper than what your bank will offer you. Remittances, of course, is a huge market. So the formal remittance market is roughly six or seven hundred billion dollars. The informal remittance market is north of a trillion. And again, these fees are being paid by some of the world’s most vulnerable people, people who are going off to work 70 or 80 hours a week and remit money home. They might have emergencies. Maybe the folks on both ends are not that organized with budgeting. And they may have unforeseen needs where they don’t have any kind of buffer, so it’s fairly frequent that people are having to send these remittances and pay fees maybe more often than you would like.
And they’ve become a relatively onerous burden. Why are they expensive? Well on the back end, it actually does take a fair bit of time to move money from one country to another.
So Western Union and other types of remittance companies will generally make the money available to the consumer on the other end but it actually takes them a couple of days to get their money. That means they have to hold capital and they have to hedge their exchange rate risk during that time period, which adds to the cost of the transaction. If you were able to eliminate those time delays, you would reduce the cost of operating these businesses. So some of the businesses that are being proposed and built right now are crypto-currency based solutions Where you might build a network of on ramps that change local currency to Bitcoin, move it internationally using Bitcoin and then cash out again.
So you can imagine a set of say newsstands in one country and a set of florists in another country that say hey let’s start a remittance network.
Maybe my brother moved to some other country and he’s got the florists and I’ve got the newsstands. And so, we’re gonna get together and we’re gonna send the money. We don’t have any capital though, we’re just kinda scraping by in our little businesses, but we do have a lot of retail outlets. So, without any capital I can actually operate a remittance business because I can move the money instantly and I don’t bear any risk from doing that.
So, I don’t actually have to have a lot of capital nor do I have to have, my agents hold a lot of capital. And so we are seeing kinda informal entrepreneurial activity happening, which can make a lot of countries better connected than they are today. People are also using Ripple for this. And so, there’s a couple of remittance companies now that are looking into and prototyping, using Ripple as a back-end. Where they don’t even have to actually touch any virtual currency, but they can just use Ripple as a payment network to move money instantly overseas.
So, how does this affect society? Well, there’s lots of applications.
So, we’ve talked about back-end money movements like remittances, also multinational firms. So, even very large firms end up paying tens or even hundreds of millions of dollars in fees as they move money back and forth around the world. Every time they move a little money, they have to pay to pay a fee. If you have a trillion dollars of transactions moving back and forth across your balance sheet over the year, even a small percentage of that adds up to a lot. And so, corporate treasurers of major companies are very unhappy with the fees that they have to pay. Cuz they say, what service are you providing me with anyways? You’re just moving my money from me to me, but why am I getting taxed these large sums of money for this very minimal service.
And so they also use these very complex IT systems to keep track of their money internally. Recently Citibank lost $300 million dollars in Mexico. You lose things with these complex IT systems. And if everything was on sorta a ledger, say, an internal ledger for the company that was public within the company. And everybody could see where the assets were moving.
You wouldn’t lose the money. And you also wouldn’t have to pay the fees or pay the IT support costs. So there’s lots of ideas being explored in this direction, from keeping track of development funds and government funds. To collections of firms that are all trying to keep their books in a novel way. Finally, there’s this idea of sorta programmable money. So getting back to the very beginning of the talk, we said what was really novel and different about Bitcoin or any other kinda purely digital asset that was kept on a ledger.
And there are many besides Bitcoin and Ripples Currency XRP.
What was special about those things is that you can actually operate on them as an individual without middlemen. And you might think, well, I don’t mind the middleman. I kinda trust my banks. I’m not that worried about it. But actually the middlemen slow things down, as well. And it’s impossible to write a computer program that’s going to execute a complicated financial transaction between lots of different financial institutions.
They each have their own systems and their own delays. But once the money is all digital, you can actually write computer programs on top of it. To automatically execute transactions, and that’s gonna allow very new things to happen. Just a very simple example is multi-sig, so I want two people to sign a check.
So I can write a computer program that says here’s this money in this Bitcoin account, but it can only be moved out if two people both put in their passwords.
That could help protect you from being mugged or anything else for your digital assets. Because somebody else would have to put in their password too in order to get the money out, it could also protect firms. One of the things that’s getting built right now are actual platforms for programmable money so Ripple Labs has a platform called Codius. There’s another one called Ethereum out there. Both of them are trying to help people write what they call smart contracts, or computer programs that distribute money. The Codius platform would allow you to write a program, and it will make it easy for people to verify the program works. They would say, if these five things happen, then this person gets paid. If these other three things happen, this other person gets paid.
So we could just, for example, you could think about some sorta complex financial derivative. We could take as an input the Bloomberg feed of stock prices.
And we could make very complex bets about well, if this stock goes up and this stock goes down, and this other thing happens, and the national weather service says its sunny today, then this person gets paid. And if these other things happen some one else gets paid. So that’s going to really reduce the barriers for entry for creating financial derivative products. And it’s going to allow more people to hedge more complicated situations where theres not enough people right now to make the market worth while to create the asset and have it verified.
And that’s really where we all have to use our imaginations for, what could I do? If hundreds of people who didn’t know each other all over the world could participate in a state contingent financial transaction.
That paid different people in different circumstances. It just wasn’t possible before. So we’re really not sure what people are going to do with it. So what is that going to do? Well we’re going to see various types of changes in industry.
We might see diverticalization of international transfers, so again the flower stand and the news stand can get together. We don’t need to have big financial institutions do this. Banks also may lose some of their business, because we can use, we can hold money in Bitcoin. And we don’t need to hold it in our checking account. And if we don’t need to, if we trust the computer algorithms, and we don’t need to trust an institution. Then I may be willing to hold my money lots of other places, besides the zero interest checking account, that I have at my bank.
And as banks start, their services start to get unbundled that’s been a frequent phenomenon with the internet is something that used to all go together now gets broken apart.
Their business models may change. And finally we are going to see just lots of new services so you know things like public recording of messages. I can pick an entry on the blockchain that verifies some fact or some piece of information in the secured public ledger forever, for everyone to see. And we can write contracts based on that. We can provide low-friction escrow services. When you buy a house, there’s a title agent, you pay them a bunch of money, and they hold on to your money and they only give the money to the seller when the title changes over to the buyer.
We only do that for expensive stuff, but we could do it for much cheaper stuff. So air B & B expanded partly because they, unlike previous sites that did the same service, they kept the money in escrow.
And the person only get paid once you actually had your stay in the house. They escrowed the funds. So you can imagine lots of other transactions, smaller value transactions where I’m not sure I trust you enough. And I’m not gonna just wire money to somebody in China to give Mandarin lessons before I go on my business trip, because I might wire it and never see the person again. But we can put it in escrow and make that transaction possible in a way that wouldn’t have been possible before or would have required a platform to mediate and then take a cut.
Tracking flows of funds and generally I think the theme is that we’ve seen from Uber to Airbnb to TaskRabbit and all the other great new internet platforms out there. Information and contractility, making things easier and more frictionless. And allowing people to transact with each other without such a level of trust. Has enabled huge markets to grow where no market existed before.
And digital money is going to allow that to happen in new services and applications as well as making existing one more efficient. So this is basically why I am so excited about this technology. Not because I think you should speculate in Bitcoin and buy it at 300 and hope it goes to a thousand.
But because, fundamentally, it’s like the internet. A new technology that allows things to happen that couldn’t happen before. And we have a whole range of some of the world’s brightest entrepreneurs, trying to figure out what to build on it. The first wave of them may go bust. But eventually, I have a lot of faith, that. The way that we move money is going to catch up with the way that we move information today. Thanks very much.
Yours to Success