September 30, 2020

Bitcoin as a disruptive technology in finance

A disruptive technology is a new innovation in an industry that radically improves the current way of doing things and makes it obsolete. On investopedia it is described as:

“A disruptive technology sweeps away the systems or habits it replaces because it has attributes that are recognizably superior.”

Tim Smith

Today, in finance, we rely on banks when making our purchases. Quick transactions can be made with a credit card, but they are expensive. Mastercard averages around 1.55% – 2.6% per transaction and for American Express it is 2.5% – 3.5% (Credit Card Processing Fees and Costs). On the other hand, bank transfers are typically slow and can anything from a few days to weeks to complete. They too can be expensive. Apart from that, the central banks control the monetary system and thus we rely on them to make the correct decisions.

At the time of writing, with Bitcoin, the transaction is usually visible for the receiver in less than a minute and confirmed a few times in less than an hour. The cost can be as small as $0.01, regardless of the amount sent. There are currently some drawbacks with Bitcoin as well which developers are working hard on to solve (second layer solutions etc.). If everything goes well, it could make the traditional finance systems obsolete in the future.

I read a great book about the topic of disruptive technologies a while back. The title of the book is The innovator’s dilemma and is written by Clayton Christensen and is about why sometimes big major companies can fail. While reading the book, there were quite a few similarities to Bitcoin and cryptocurrencies. I am going to go through them here.

1 – Predicting the final use-case is extremely hard

“… disruptive technologies often enable something to be done that previously had been deemed impossible. Because of this, when they initially emerge, neither manufacturers nor customers know how or why the products will be used, and hence do not know what specific features of the product will and will not ultimately be valued.”

Clayton Christensen

Bitcoin was initially created to be digital cash as stated in the Bitcoin whitepaper Bitcoin: A Peer-to-Peer Electronic Cash System

A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.

Satoshi Nakamoto

Over the decade, more use cases have emerged. From purchasing illegal goods on the dark web to making cross-border payments and lately to use as a store of value because of its limited supply. In other cryptocurrencies there are smart contract functionality that someday also could be implemented in Bitcoin.

Emerging markets are always initially unknown, they are only obvious in retrospect. That could be the reason it is so hard for many people to see the value in Bitcoin today.

2 – Current people in the industry are dismissing it

Every new disruptive technology has initially been dismissed by their predecessors. From electric cars to smaller hard drives, a majority of the people in the industry have claimed that there is no use case for the new technology.

In The Innovators dilemma, Clayton explains that this is typically because emerging markets are small and cannot fulfil the need of the big enterprises. Therefore it is usually hard for those people involved to see the market value. Only when the disruptive technology surpasses the older technology in performance is it obvious. But by then it is usually too late for the big players to catch up.

With Bitcoin, there has been a large amount of big players dismissing it simply because the market is small and the vast majority of transactions are with fiat. One reason for the uncertainty is also that it is too volatile. However, we have already started to see some portfolio managers and institutions shift opinion on the matter.

3 – Old industry trying to come up with their own hybrid solutions

In The innovator’s dilemma there were many examples of how the older industry tried to come up with a hybrid product to compete with new disruptive technology. An example of this is the Hydrohoe, which used both hydraulics and cable mechanisms to operate.

In the crypto currency community there has been Libra, which is project started by Facebook. The project aims to improve financial services by making it safer and cheaper. To accomplish that they have created a coin that is going to be backed by a number of large companies and institutions on a blockchain. The catch is that it will not be decentralised or permission-less, but rather centralised and permissioned by those trusted parties. Initially, this would most likely be faster and cheaper than Bitcoin today but once the scalability issue is solved projects like Libra will most likely become obsolete.

Another recent example is Mastercard expanding their program for crypto card issuers. Using a card like this enables the customer to spend crypto currency when using a Mastercard to purchase everyday goods. It makes it possible to use Bitcoin and other cryptocurrencies to buy things, but the medium of making purchases is still the same. In the long run though, it will most likely benefit the industry as a whole.

4 – The lifecycle of a product

The “Buying hierarchy” model divides a products evolution into four phases: functionality, reliability, convenience and price.

Functionality can have many dimensions for a product. In Bitcoin’s case, it’s mainly to be able to send a transaction, peer-to-peer in a trust-less network. An early proof-of-concept for this was the Silk Road where anyone could purchase illegal goods on the internet with Bitcoin. Since then there have been several other use cases where people can buy different products online with Bitcoin. For example, in Sweden where I live, there is a retailer called Webhallen that accept Bitcoin as payment online and in their physical stores.

The bitcoin network is reliable. It is actually the worlds most secure network with (at the time of writing) 135 million TH/s. The current rate can be seen on Blockchain.com. One thing that might not be as reliable is the price stability. Right now, there are lots of big price swings. These price swings are becoming smaller and smaller thought, and the general trend is that the volatility in bitcoin is going down.

The price of sending Bitcoin has varied greatly, but generally it is a lot cheaper than traditional banking transfers. Especially for large transfers. For everyday purchases though, the cost has been significantly higher than using a credit card.

As a conclusion, it is a bit hard to place bitcoin into one of these phases. I think the major improvement bitcoin needs is in convenience. It needs to be easier to pay with bitcoin than current fiat currency for it to be really attractive. Although, one could probably argue that it already is more convenient in cross broder payments, but not more convenient in every-day purchases.

Why aren’t major companies starting to accept Bitcoin or cryptocurrency tech yet

Another point that Clayton talks a lot about in The innovator’s dilemma is that company resource allocations are highly dictated by the customers. Even if there is a growing trend, it is still difficult for a large company to motivate resource allocations into a small market. As Clayton puts it: “Small markets never solve the growth needs of large companies, and emerging markets are small.

But as seen in other markets, customer demand for new tech can change rapidly, and it can sometimes be very hard for large companies to then keep up. Once the new technology starts to take market shares in the smaller markets it can lead to it gaining attraction in the bigger markets.

Furthermore, the attributes that make the disruptive product worthless in mainstream markets are typically its strongest selling points in emerging markets. For example, Bitcoin is censorship-resistant. No single entity can control it, which means that no payment can be frozen and funds cannot be seized. This means that the users are in full control over their funds and if a mistake is made, it’s irreversible.

As a last note, the research made in Claytons “The innovator’s dilemma” was from the perspective of companies developing disruptive technology. Bitcoin, however, is not a company but the technology itself. Unlike a company, nobody controls it. With that said, there are many similarities to previous disruptive technologies and Bitcoin.

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