I’ve tried explaining Bitcoin to people a few times, and more often than not I find myself in a place where I’m unable to go any further. I’m then disappointed in myself that I’d managed to get over the first hurdle of talking Bitcoin to someone who knows nothing about it, only to then leave them more confused than when they knew nothing.
There are so many technicalities when talking crypto: blockchain; hash rates, layer 1’s, smart contracts… the fact of the matter is, unless you have quite an advanced knowledge of computer systems, you’re not going to understand a lot of this stuff – in exactly the same way you don’t know how your credit card operates, or your mobile phone, or your Wi-Fi. You just know it does.
I have a slight advantage over some people in understanding how transactions work having worked in the IT department of a financial institution. This means that I’m aware of issuers, acquirers, and third-party processors, as well as transaction fees and the hardware and software required to operate the banking system – which is why I’m so optimistic about Bitcoin/cryptocurrency and why I understand what problem it solves.
Every single digital transaction requires 3 entities: an issuing bank (your bank who “issue” your credit card, debit card or bank account), an acquiring bank – who “acquire” your transaction (such as a physical store or an ATM that doesn’t belong to your bank), and a third-party payment processor such as Visa or MasterCard.
The main reason for the third-party payment processor (aside from providing the physical network) is dispute resolution. Here’s the example:
You go to an ATM that doesn’t belong to your bank, and request $20.
The ATM dispenses $10.
There are two possibilities:
- You incorrectly requested $10.
- The ATM incorrectly dispensed $10.
If you contact your bank and they confirm $20 was authorized, and the bank or machine operator that the ATM belongs to says $20 was dispensed, how do we resolve this dispute?
3rd party payment processor to the rescue.
This is the same for your internet transactions, store cards, subscriptions…when you pay for groceries with your card – all involve the three entities and all require the third-party.
These Visa/MasterCard type institutions verify all transactions (charging a fee for every transaction) as they pass across their network and report on them to each institution. They confirm how much was requested (by you), how much was authorized (by the issuer) and how much was dispensed or sold (by the acquirer). Funnily enough, each of the other entities (the issuing and acquiring banks), also charge fees for transactions, meaning every time you spend money, there are 2-3 other institutions that make money from the transaction. And who pays for that? Well, you do.
Whilst we still have to pay for Bitcoin transactions right now, these transactions are verified without the need for either the banks or third-party payment processors who have the power to switch off the routing of yours, or your bank’s, transactions (like when they stopped payments to WikiLeaks for example).
This is good for many reasons, such as:
- With more adoption we will obtain lower transaction fees.
- The less we use banks to store and transact with our money, the less money and power they have for their fraudulent activities (watch ‘The Big Short’).
- The less money they have for their fraudulent activities, the less likely we are for events such as “interest rate hikes”, “inflation” and “GFC’s” (watch ‘The Big Short’ again).
The result of this is more spending power for your money because it’s worth more, and less susceptibility for your money to be used irresponsibly and illegally by those holding it.
By decentralizing the payments infrastructure we take back our freedom and liberty to transact as we choose, which, like freedom of speech, is a good thing.