Bitcoin is an expensive way to pay for some stuff

I'm not really that into Bitcoin but I do like me some financial innovation. A cruel generalization you could make about financial innovation is that it consists in large part of disguising transaction costs. Because the product provided by the financial services industry basically is transaction costs, sheer efficiency-based cost reduction can't really be the goal of the people in that industry. But you've got to compete somehow. So if you can find a way to charge for something but call it "free" then that's pretty much the ideal.1

Anyway a claim that is sometimes made about Bitcoin is that it is a way to send money without incurring transaction fees. This strikes me as mostly false, but in an interesting way, and I had a fun conversation about it on Twitter today; let me share it with you.

Like so many financial innovations, part of what makes Bitcoin clever is its method of, let's say, naming transaction costs. Transaction costs are basically the money that is paid to someone for doing the bookkeeping work of transferring your dollars or Bitcoins or whatever to someone else, subtracting them from your account and adding them to the recipient's account and making sure everyone's records are up to date. In any sort of electronic payment system -- for dollars or Bitcoins or whatever -- someone needs to do that work, since if they didn't I could just go around being like "oh yeah I have a million Bitcoins [dollars], give me all your heroin" and no one would know if I was lying. And if you want someone to do that work I guess someone else needs to pay them.

If you want to send $1,000 via Western Union, Western Union (and some banks) does that work, and charges you a fee. You type in what you want to send and Western Union tells you that you'll pay a fee of $5 or $20 or $95, and you keenly feel Western Union sticking its hand in your pocket.

If you want to buy something online with your Visa card for $1,000, Visa (and some banks) does that work, but it doesn't explicitly charge you a fee. You just pay $1,000: Visa's fees (call them 2% or 3%) are paid by the merchant so you don't see them directly. The merchant does, and complains, but mostly out of your earshot. This counts as financial innovation: Visa, founded in 1958, is stealthier than Western Union, founded in 1851.

Bitcoin is quite a bit better yet: If you buy something using Bitcoins, neither the buyer nor the seller normally pays any transaction fees.2 Instead, the transaction is processed by the network of Bitcoin miners, who do the work of confirming transactions -- plus some extra cryptographic makework! -- in exchange for some Bitcoins. Basically every 10 minutes someone gets paid 25 Bitcoins for doing that work. Those Bitcoins come from ... the ground? I guess? the lingo is that they are "mined" ... so nobody "pays" them.

The thing is though that they're kind of a lot. Here's a chart of how much they are:

As of today miners took home about 3.5% of the value of transactions that they processed.3 Which is more than credit card companies! Though maybe less than Western Union, I don't know.

Page 1 of 2 >>

Copyright 2014 Bloomberg. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.

comments powered by Disqus
Check out Futures Magazine - Polls on LockerDome on LockerDome