Attestation Update – A&A for CPAs

Technical stuff for CPAs providing attestation services

Digital currencies are radical change on the horizon for banking and credit cards. (Radical change #2)

with 3 comments

There is radical change all around us and more on the way. I know that. My blind spot is figuring out how that will affect my audit firm.

(Cross-posted from my other blog, Outrun Change.)

Here’s one part of radical change I can see on the horizon:

1-24 – Wall Street Journal – Bitcoin and the Digital-Currency Revolution / For all bitcoin’s growing pains, it represents the future of money and global finance.For a brain stretcher on digital currency, check out the article. Focus is on Bitcoin, which is merely the starting point in a revolution of disintermediation.

Just like money funds disintermediated (that means cut out of the picture) bank deposits in the distant ‘80s, bitcoin and other yet-to-be-invented digital currencies will disintermediate a huge portion of the financial system.

Picture the long series of transactions when you buy a cup of coffee at the corner shop with your credit card (this is a long quote cited under fair use, oh, also to promote the book it is extracted from):

If you pay with a credit card, the transaction seems simple enough: You swipe your card, you grab your cup, you leave.

In fact, the financial system is just getting started with you and the coffee shop. Before the store actually gets paid and your bank balance falls, more than a half-dozen institutions—such as a billing processor, the card association (  Visa ,  MasterCard , etc.), your bank, the coffee shop’s bank, a payment processor, the clearinghouse network managed by the regional Federal Reserve Banks—will have shared part of your account information or otherwise intervened in the flow of money.

If all goes well, your bank will confirm your identity and good credit and send payment to the coffee shop’s bank two or three days later. For this privilege, the coffee shop pays a fee of between 2% and 3%.

Watch how far fewer players are involved and the increased speed when paying with bitcoin.

If you don’t already have bitcoins, you will need to buy some from one of a host of online exchanges and brokerages, using a simple transfer from your regular bank account. You will then assign the bitcoins to a wallet, which functions like an online account.

Once inside the coffee shop, you will open your wallet’s smartphone app and hold its QR code reader up to the coffee shop’s device. This allows your embedded secret password to unlock a bitcoin address and publicly informs the bitcoin computer network that you are transferring $1.75 worth of bitcoin (currently about 0.0076 bitcoin) to the coffee shop’s address. This takes just seconds, and then you walk off with your coffee.

What happens next is crucial. In contrast to the existing system, your transaction is immediately broadcast to the world (in alphanumeric data that can’t be traced to you personally). Your information is then gathered up by bitcoin “miners,” the computers that maintain the system and are compensated, roughly every 10 minutes, for their work confirming transactions.

The computer that competes successfully to package the data from your coffee purchase adds that information to the blockchain ledger, which prompts all the other miners to investigate the underlying transaction. Once your bona fides are verified, the updated blockchain is considered legitimate, and the miners update their records accordingly.

So what is the difference in timing?

It takes from 10 minutes to an hour for this software-driven network of computers to formally confirm a transfer from your blockchain address to that of the coffee shop—compared with a two- to three-day wait for the settlement of a credit-card transaction. Some new digital currencies are able to finalize transactions within seconds.

Faster by an order of magnitude or more (1 hr vs. 48-72 hr) and radically less expensive.

The revolution might have an even bigger impact in places where the banking system is limited. The developing world could leap stages of development if a usable digital currency system becomes available.

Downsides all around but improvements underway in one system

Downside of bitcoin is that it is in its infancy with a long list of growing pains.

Downside of the current financial system is the huge cost of all the intermediaries and time lag for payment. Oh, and there is a permanent record of every transaction you make creating an electronic trail of where you were and what you did.

There are severe vulnerabilities to digital currencies and our current banking system.

In our current financial system, there is systemic risk (2008 financial crisis), enforcement issues (money laundering, Libor & forex rigging), large costs (2% or more fee to the merchant, which makes it way into the price paid by consumers), and huge opportunities for exploitation (crony capitalists making money from their connections and politicians getting rich from the cronies and extorting banks. Oops, I mean, levying fines).

There is minimal effort underway to improve the current systems. There is massive effort underway to improve digital currencies.

I can see out on the horizon a tidal wave that will hit the financial industry. I can even make a rough guess where it will hit the shore.

Part 3.

Written by Jim Ulvog

January 28, 2015, 8:49 am at 8:49 am

Posted in Uncategorized

3 Responses

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  1. […] Part 2 – digital currencies are the massive change in the future of banking and credit cards. […]

  2. I’ve been following the maturation of the digital currency space for a few years now and it has given me a lot of fodder for pondering.

    A link to an article I wrote for Seeking Alpha in 2013 on Bitcoin and how it was becoming quite a disruption to Western Union (and other money transmitter) business models: http://seekingalpha.com/instablog/13581462-alicia-cruz/2363162-what-western-unions-3q-earnings-means-for-the-future-of-bitcoin

    Something that I’ve thought about is: what the future holds for digital currencies (or perhaps just the technology that supports it) considering our complete dependence on credit. Unlike fiat currencies, the bit of code you hold on a “digital” wallet cannot be copied, and the total quantity of currency cannot be inflated. So bringing it back to that morning coffee, you’d actually have to have those bits – there’d be no more spending what you don’t already have.

    Thinking about all this brings me back to econ class and discussion about how money is created. Once I get there my head starts to spin.

    Alicia C.

    January 28, 2015, 9:25 am at 9:25 am

    • Hi Alicia:

      Thanks for pointing to your article. That discussion illustrates one company (Western Union) that is in severe risk from digital currency. Great illustration for the discussion.

      Thanks for taking the time to comment.

      Jim

      Jim Ulvog

      January 28, 2015, 15:52 pm at 3:52 pm


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