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Part 1: What Credit Unions Should Know About Bitcoin and Blockchain

Part 1: What Credit Unions Should Know About Bitcoin and Blockchain
Posted: May 24, 2016
Comments: 0
Author: Tom Davis

Not a day goes by where you don’t read or hear news about bitcoin and/or blockchain.  One expert in the payments world likens bitcoin to the Kardashians, the reality show stars who manage to keep themselves in the headlines even if there is nothing new to report.  Without question, bitcoin and blockchain are the darlings of the financial and business media. What follows in this article is background and insight on bitcoin, the cryptocurrency, its relationship to the blockchain, and reasons why credit unions won't need to spend too much time (if any) worrying about bitcoin.

In our second article, to be published on The Payments Review at a later date, we will take a much deeper look into the intriguing and complex world of the blockchain distributed ledger technology and why credit unions will want to keep an eye on it.

Bitcoin and the Blockchain 101

Bitcoin and its related blockchain network was started in 2009 by an unknown person who goes by the alias Satoshi Nakamoto (although many are now coming forward to take credit). It is one of more than 669 known cryptocurrencies in the world.  First, we should define bitcoin and blockchain separately.

Bitcoin

From a high level, bitcoin is a decentralized digital currency that is used to store and transfer value within the bitcoin network.  Although digital, bitcoin is a lot like any other fiat currencies (a currency declared to be legal tender but is not backed by a physical commodity) that we are used to today.  You can store, exchange and transact in bitcoin just like you can with or any other fiat currency.  However, unlike fiat currencies, bitcoin’s value is derived by faith in the bitcoin network, not a central government or backer of the currency. 

There are some advantages to this structure when we look around the globe and see what can happen to the value of a currency when the backer of that currency is not prudent with their monetary policy.  However there are drawbacks as well since in most instances bitcoin is an unregulated currency and therefore does not provide protections that may be afforded to other fiat currencies such as the protection that the US government can provide to the dollar.  There will only be 21 million bitcoins available and they will be released throughout the network over time.

Blockchain

Blockchain is the distributed database that stores the bitcoin transactions and ultimately the network participant’s balances.  All participants on the bitcoin network have a copy of the database and therefore are aware of all the transactions made on the network.  Although anyone can view the transaction history, the participants remain anonymous through use of a public / private key structure.  Transactions are “broadcast” to the network and verified by “miners”.  Miners bundle transactions into blocks that are added to the chain and placed into the distrusted databases. 

The process by which transactions are validated, bundled, and added to the network is fairly complex.  The short version is that miners solve increasingly complex mathematical formulas that “chain” transactions together in a sequence that is computationally verifiable.  This structure deters fraudsters from being able to place fraudulent transactions into the chain since nonconforming transactions would not adhere to the sequencing and therefore be rejected by the network.  For their work, miners are paid with new bitcoins and additional bitcoins are released into the network.  At some point in the future there will be no new bitcoins to reward miners for their work.  When this happens, miners will be rewarded only by fees that can optionally be added to transactions to expedite a transaction being added to the network.  According to CNN/Money 25 bitcoins are mined every 10 minutes.

What is the allure?

Because bitcoin transactions are anonymous and not regulated, it has earned a somewhat notorious reputation as a favorite payment form for illicit activities (drug dealers, etc.) on the so-called dark web. Many believe that bitcoin payments have been used to fund terrorist activities.  With bitcoin, it’s easy to move money across international borders without being detected.  There are no middle men, no banks or no transaction fees.  Bitcoin can also provide utility when there is volatility in the local fiat currencies due to poor monetary policy or civil unrest.

Some merchants are drawn to the low to no transaction fee structure.  Merchants wanting to accept bitcoin payments can work with a companies like Coinbase and BitPay who are now among the largest bitcoin processors providing payment processing services for merchants.  BitPay merchant processing mitigates bitcoin price volatility which allows merchants the ability to accept bitcoin and convert immediately to US Dollars and/or Euros.  Although, the lengthy processing times of a bitcoin transaction, which can take more than 10 minutes, has limited its POS acceptance at this time.

Speculators have also contributed to the allure of the bitcoin network.  Although viewed by some to be peripheral players in the bitcoin network who have lived and died through bitcoin’s sometimes volatile exchange rate fluctuations, speculators provide an import role in the bitcoin ecosystem.  Speculators draw interest and provide a means to exchange fiat currencies for bitcoins.  This allows transactors to utilize the network for its transaction capabilities without requiring them to maintain their positions in bitcoins. With a healthy pool of speculators, participants have the means to quickly exchange their currency of choice for bitcoins and vice versa.

Venture capitalists have been very active in the network.  Their investments have been the driving force of innovation in developing technologies like bitcoin wallets, currency exchanges, network messaging, and countless other enhancements.  Recently, venture capitalists have become really interested in blockchain technology.  There are some that feel it is the blockchain, and not bitcoin, that is the real value of the network.

Coming Soon to TPR: Part 2 on Blockchain

Thanks for reviewing this article about bitcoin.  I hope it helped to shed some helpful light on the topic.  Don’t forget to be on the lookout in The Payments Review for our second part to the series on blockchain distributed ledger technology.


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Tom Davis

Tom DavisTom Davis

Tom is President & COO of CSCU. He joined CSCU in 2004 and today wears many hats as highly respected executive and tireless evangelist on new payment technologies and innovations and how they will positively impact the success and growth of credit unions.

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