Strategy for Information Markets/Micropayments

Bitcoin

Bitcoin (BTC) is a recent decentralized electronic currency that is used in online transactions between two parties. It continues to be a substitute for online transaction with the goal of one day being the primary online currency. The main benefit that BTC continues to make known is the removable of a central bank to process transactions and the use of cryptography to verify each transaction. It was released in 2009, by Satoshi Nakamoto (possibly a pseudonym) and since then it has had a slow start at gaining popularity. The design of BTC is considered to be sophisticated and bullet-proof to hackers and abuse. Bitcoins are primarily used for online transactions with the exception of a few establishments able to do BTC-to-Dollars exchanges (and other national currencies). There has been negative criticisms that BTC has had dealt with, including abuse from attackers of the network in efforts to try to find weaknesses and other possible faults described below. There has also been good response from the increase in users, merchants, traders using the electronic currency to sell their products and increase their BTC profits.

Breakdown

Getting Started

'The first step to enter the market of bitcoins is to download the free software available to anyone on various websites. Bitcoin is currently available to MAC and Windows user and as of mid-2012 it has released its 0.6.2 version. Once the software is installed a user must obtain a bitcoin wallet to be able to store their wealth. There are a variety of wallets not including the one provided by the software, which can give the user a more sense of security over their currency and that offer additional benefits. Some of these bitcoin wallets are InstaWallet, and flexcoin. As an example, flexcoin serves as an online bank where you are able to store your money and have access from various online devices such as mobile applications and multiple computers. Once the software is installed users can begin to obtain BTC using a variety of methods.

Mining

New BTC are generated and enter the network's eco-system through a process called "mining." The term "mining" is used because it assimilates the real-life work that miners perform to extract minerals. Users competing in Bitcoin mining run computerized programs that solve puzzles in return for new BTC. The creation of BTC is much more complex when analyzed in depth. The process of mining generates "blocks," at a predetermined rate based on the number of miners in the network. An amount of data tracking the time consumed by the computer running cycles to solve difficult problems, or a new block, is known as “proof-of-work”. This proof-of-work helps regulate the number of blocks released (as of May 2012 at one block every ten minutes for the whole network)., as well as the validity of the block. This proof-of-work tracks and secures the validity of each BTC preventing double spending. When a miner creates blocks, they are able to charge transaction fees for that blocks information and receive bitcoin transaction fees from vetting. The idea that for currency to have value there must be a finite amount, Bitcoin minting is set so that the number of BTC released approximates but never reaches 21 million. The number of bitcoins entering the economy is reducing as more blocks are created(as more miners enter the network), and will continue to do so until its max is reached. It is estimated the maximum number of bitcoins circulating the economy will be reached in 2029. Mining has the potential to be very lucrative, if the user is able to supply a high power computer to solve the problems, since there is double payout in doing so: one with the minting of BTC and second with the transaction fees charged for using blocks. Users can also increase their BTC wealth by establishing themselves as merchants, selling products in the BTC market, or purchasing directly from a seller. There is no set exchange rate of bitcoins-to-US dollars( or other national currency), so the value of bitcoins fluctuates based on the exchange rate of the market. At one point a single bitcoin was worth 30 USD before crashing and setting at approximately 2 USD in October 2011. Other common ways to earn bitcoins is by participating in surveys, or rating products, finding free bitcoins online, joining mining groups, and other ways that payout out small quantities of BTC.

Transactions

When a users signs up to the BTC network they are issued a sets of crypto-keys. Also known as public-key cryptography these keys allow for users to safely transfer BTC among one another without the risk of being duplicated or misused. The public key is embedded with the information of the owner of the bitcoin, and also serves as a tool to track and verify the genuineness of that single coin. When a transaction takes place, the owner attaches the key information (bitcoin address) of the receiver and waits for a miner to validate the coin(s). Validating the authenticity of the bitcoins being transferred requires the information embedded in the second key. The process to transfer BTC using public-key cryptography has assured BTC users and merchants of the piece of mind they can have when transferring and receiving currency. Once this piece of mind can be established in the users of bitcoin, the user can feel comfortable making multiple transactions that lead to an increase in the network.

Merchants

As of October 2011 there was an estimated 20 million BTC users, with a about $20 million USD worth in BTC. Today you can buy software, alpaca socks, servers and many other products using BTC. The number of transactions have also begin to increase as more BTC enter the economy. Bitcoins also offers merchants the ability to capitalize using the electronic currency. Merchants must pay transaction fees for the use of running a credit card at the point of sale. Transaction fees can vary, but in 2008 financial institutions pocketed around 48 billion USD charging merchants these transaction fees. Bitcoin has pushed for the use of their currency by promoting the low transaction cost that merchants pay for the use of BTC. These low transaction fees can result in merchants increasing their profits. Merchants have the option of managing each and every transaction or can also use third parties that can manage their accounts. The increases in small transactions, also known as Micropayments, have the potential to benefit merchants if the customer finds it beneficial to make multiple transactions.

A micropayment is a term to describe a financial payment system in which a low per-unit price is offered to consumers. The low price is offered in order to entice consumers to purchase multiple amounts or items. As such the system must have a large network of users for the concept to be affective. Examples exist in different types of networks:

• Real: Subway/Public transportation systems, Gift-card, University meal plans
• Virtual: ITunes, ESPN, Online multiplayer games
• Sponsored: One party in the transaction will have control over the network

Network Externalities

Bitcoin can be considered an open network by definition, because as long as you have a computer and Internet access, you may download Bitcoin and begin to make use of it. There is no reason to conclude that there is a set administrator that prevents anyone from downloading and installing it and the software is free. BTC is considered a peer-to-peer network because the information generated from the mining of any block becomes public, and through the publication of such information the network prevents fraudulent activity by keeping everyone accountable. The latter is possible with the use of very sophisticated encryption for the transactions being performed between both parties. This also leads to conclude that the network is sponsored since there is a creator of BTC, which continue to release updated versions. To renforce the latter the network is maintained by a community of open source developers. The use of BTC is a one-sided network just like the US dollar and any other national currency. There is user ‘A’ using BTC to purchase a good/service from user ‘B’. The increase use of BTC, has also allowed other user to enter this network platform such as flexcoin. The managing of BTC from flexcoin allows users to use this third party source to facilitate process of the transaction. Bitcoin has served as network with various multiple parties using BTC for different purpose, creating positive network externalities. It can be argued that it is a multi-sided network, but since its primary purpose is, and continues to be, a medium of exchange (money) it has the nature of a one-sided network. As more online users begin to use BTC as a mean of exchange of goods and services, the more useful the BTC become to each user, leading to demand-side economies of scale. The increase in users, whether its merchants, consumers, traders, etc., will attract more non-users to join the network for a variety of reasons that each see beneficial. As of this writing in May 2012, Bitcoin is still in the beginning stages, but it is one of the most popular online virtual currencies. The benefit from using BTC can come in the way of more merchants entering the market and offering BTC as a form of payment. Currently the amount of merchants offering BTC as a payment option is very small, since its exchange rate for actual money is not stable. This also leads to a collective lock-in, because it is hard for an aggregate amount of people to do the switch do to the lack of popularity, trust and other barriers. Today using a credit card or PayPal to purchase goods is still more beneficial to everyone, then making a switch to a small network such as BTC.

Cons

The downside to BTC has been its lack of popularity among other concerns that have arise since its establishment in 2009. There has been a few attacks and glitches in the code that have lead to contamination of BTC. Such was the case of recent problems such as an overflow of transactions in a block in August 2010, and invalid transactions in micropayments in September of the same year. Since the start of BTC there has been a handful of updated version to correct problems that may erupt in the software. Another level of concern is the possibility of cyber-criminals using BTC and abusing it like regular currency. Since there are no specific ways to track who and where is using BTC in transaction, and with the absence of a central bank system that BTC lacks, the FBI has demonstrated concern that cyber-criminals will use it for illicit activities. This creates a problem for investors since there is no "state enforcer" looking out for the criminals and their BTC wealth. Unlike the United States dollar which is to some degree backed up by the government, BTC only has the confidence of the users to rely on. If confidence is lost in the currency, perhaps by the entrence of a new virtual currency, then BTC has the potential to fail. It is argued that the hoarding of BTC can also be a barrier for BTC to succeed. The possibility to create bitcoins is diminishing with time and as more users enter the network. Making them more valuable in the future and incentivizing owner of BTC to reframe from using them today to have greater wealth in the future. The latter in a large scale can cause BTC to downfall with less bitcoins in circulation driving users away. Many national currencies have the backing of their government that can instill confidence, a peace of mind, and seance of security for personal wealth. Bitcoin unfortunately still lacks all three. Other issues such as inflation, deflation, money supply, etc., that currencies are affected both positive and negativelly and that BTC still lacks can play a role in the future of BTC and its success.

References

• Nakamoto, Satoshi. “Bitcoin: A Peer-to-Peer Electronic Cash System” http://bitcoin.org/bitcoin.pdf
• http://www.zdnet.com/blog/feeds/why-the-fbi-should-be-worried-about-bitcoin/4795
• Zetter, Kim (May 9, 2012). “FBI fears Bitcoin Popularity with Criminals,” http://www.wired.com/threatlevel/2012/05/fbi-fears-bitcoin/