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Bitcoin - Micropayment system for the Internet?

I have been dabbling with crypto-currencies, specifically Bitcoin and Litecoin, over the past 12 months. Everything from mining to e-commerce to currency exchange. I think I "get" the magic of the whole idea now.

For better or for worse, crypto-currencies drastically reduces the friction of money flow. You probably won't be able to find another means of moving money at a lower transaction cost, especially when small amounts are involved.

In addition, the speed of transfer is excellent for a distributed system. With Bitcoin, it takes a few minutes. With Litecoin, it takes a couple of seconds. The low transaction fee and fast transfer speed respect no geographical boundaries. It applies whether you are moving money within the same country, or between two countries on opposite ends of the Earth. Which probably freaked more than a few legislators out.

Plus this is a distributed system with no central authority to slow things down or screw things up. PayPal is fast, but try talking to the people who have had their PayPal accounts frozen at a whim and had to jump through hoops to unfreeze their account, sometimes without success. Also, PayPal's transaction fees are notoriously high (Visa/Mastercard's fees are even higher) and they have to impose random rules required by the powers-that-be of the countries they operate it. For example, in certain countries, PayPal now charges a fee for transferring money between two individuals regardless of amount, even though PayPal started out as an easy way for people to email small sums of money to one another!

It is therefore clear that crypto-currencies like Bitcoin have unique features to offer over existing systems, so it is not entirely frivolous. It has the potential to solve problems such as micropayment on the Internet, which until now has not taken off due to the high transaction cost and lack of standard, so we pay for content with our privacy via online ads. If one of the crypto-currency becomes de-facto standard, it should be quite straightforward to have a browser that will automatically tip the author when content is accessed, made worthwhile due to the low transaction fee.

Which is not to say there aren't teething issues to be resolved. The idea of keeping all the transactions that ever existed in a monolithic blockchain makes it huge, and it is unclear whether such a system can accommodate micro-transactions of this scale without also raising the transaction fee. But there are ideas such as making the blockchain itself distribtued, which should eventually make its way into the mainstream.

There is also currently a heated debate between inflationary versus deflationary crypto-currency. Quite a few crypto-currency are intentionally deflationary, and standard economic theory tells us that people will tend to hoard deflationary currencies, which is probably what is driving the massive speculative activity behind Bitcoin right now. For a crypto-currency to be used instead of hoarded, it probably needs to be mildly inflationary. And some kind of clever algorithm to dynamically adjust the rate of inflation based on economic activity would be nice!

Still, like other P2P technologies, I think the cat is out of the bag and there is no turning back the clock. The concept of distributed crypto-currency is here to stay and it will only evolve at the speed of software. Eventually, I think most, if not all, of the kinks will be ironed out, one or more standards will emerge, and there will be widespread adoption by netizens. The next few years will be interesting to watch in this space...

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