Sidestepping Banks

Geeks. They have knack for upsetting the set ways of a market with the introduction of new technologies that often undermine traditional distribution channels.

The music and entertainment industries are the classic example of how decentralised peer to peer networks (p2p) permit the distribution of media amongst each other.

Wikileaks, for example, seems to be entering the ‘breaking news’ space, historically the domain of the traditional media outlets.

The same technology is now being touted as a means of creating a “virtual” currency – the implications of which, if it gains traction, could enormously impact financial institutions, central banks and law makers.

Virtual currencies are not new. They have been mooted as the next big thing in the past and failed.

During the dot com boom, or bubble, companies such as Beenz and Flooz touted their virtual currencies as the next big thing.

But as with most enterprises of that era, at the chagrin of venture capitalists, Flooz folded, while Beenz was sold to a US-based marketing group for an undisclosed sum.  However, perhaps due to the excesses that led to the GFC, a grassroots movement has taken hold that seeks to remove the need for a central entity (be it a bank, company or government) to issue currency in a decentralised manner and create a payments system around it.

Welcome to the world of Bitcoin, a digital currency based on p2p technology.

Like something out of the ’80s Wargames or Hackers, the concept is the brainchild of Satoshi Nakamoto, an identity believed to be a hacker pseudonym. Bitcoin digital currency around which a decentralised payments system exists that dispenses with the need for an intermediary and the need for a central authority to issue currency.

By utilising a highly decentralised peer to peer network, Bitcoins negate the need for a financial institution – you don’t even need a safe to keep your coins.

In his original paper, Nakamoto argues that Internet commerce is too reliant upon financial institutions serving as trusted third parties to process electronic payments where they may also be called upon to mediate disputes due to non-delivery of goods, or even fraud.

The associated costs and payment uncertainties can be avoided, he argues, by 1) creating transactions that are computationally nigh impossible to reverse, to protect sellers 2) further, escrow mechanisms can be implemented to protect buyers (with the need for a bank).

As a fledgling, grassroots currency, Bitcoin has enjoyed both success and notoriety. As of early June, Bitcoin has been capitalised at approximately $100 million and managed to achieve exchange rate highs of almost USD20. It has also enjoyed much mainstream coverage in Wired, FT and Business Insider over the past few weeks.

So should financial institutions be afraid that this new upstart of currency will come to dominate Internet commerce?

Not for the moment, but lawmakers in the US have expressed concern about the use of such a currency to buy illegal goods online for the murkier depths of the Internet, since you can’t trace something without a centralised system.

And as Wikileaks has proved, new Internet technologies can still surprise us.