Who Will Benefit From Digital Currency? Bitcoin Experiment Gives A Glimpse

This is the final installment in a three-part interview with Stanford Business School professor and economist Susan Athey on digital currencies. In part 1, we discussed what Bitcoin is and what potential applications are, and in part 2, we looked at the security pros and cons of cryptocurrencies, plus hurdles to adoption.

Today, we talk about who will benefit from digital currencies and a new Bitcoin experiment Athey is helping to conduct in which each MIT undergrad will receive $100 in Bitcoin.

Tell me about the experiment you are conducting with Bitcoin at MIT. What do you hope to find?

One of the questions that’s still an open question is whether, if all your friends had Bitcoin, if you would find it useful to use Bitcoin too. Right now, people don’t use Bitcoin to split checks, because for every person who has Bitcoin, most of their friends don’t. But if you had a whole community of people who all had Bitcoin, would they find this to be more convenient than using cash or other options?

Stanford Business School professor Susan Athey (Peter Tenzer)

By seeding an entire community with Bitcoin, we can test the hypothesis that it’s lack of community adoption that’s keeping people from using Bitcoin. Another hypothesis is that maybe it just doesn’t provide that much value above cash or other alternatives. One of the challenges the experiment will face is that, though this isn’t as broadly used in the general population, there’s a service called Venmo that’s been bought by Paypal that allows people to send money through mobile phones quickly and cheaply. So, for a lot of MIT students already using Venmo, the benefits of Bitcoin might be lower.

You asked earlier, why don’t banks make your money available immediately [when making person-to-person transfers], but if you use Venmo, you can send money between your friends free and instantly. Venmo has made the business decision to make the money available to you even though it takes time for the money to actually move, because it’s verified both of you and authenticated your bank accounts, and it can see you have the money in you bank account. Venmo isn’t taking much of a risk in doing that.

One hypothesis is that MIT undergrads might think that Venmo and cash are perfectly fine for their money transfer needs, and they don’t really need a digital currency. The other hypothesis is that digital currency does provide a lot of value and if a lot of your friends have it, you’ll find it even more convenient to use. One of the issues with Venmo is that you still have to get the cash in and out of Venmo [into or out of your bank account]. Now, with Bitcoin that’s also a problem, but if a lot of your friends have bitcoins, they can buy and sell them from each other. Imagine just sitting in your dorm room, looking on the internet and seeing what the exchange rate is and saying, ‘I could use some bitcoin.’ I might respond, ‘Oh, I have some bitcoin to sell,’ so I could just sell you some bitcoins and get cash right away. You could hand me a $100 bill and I can use my phone to scan the QR code of your bitcoin wallet and I push a button and send you some bitcoin. So if all my friends have it, it becomes easy and costless for me to move in and out of it and I don’t need to use these middlemen.

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What if they want to use bitcoin to buy a coffee?

The other aspect of the experiment is that since the Kendall Square businesses knew the MIT students were getting bitcoin and would want something to spend them on, a lot of the Kendall Square businesses are now accepting bitcoins. A merchant can accept bitcoin very easily, because there are these services that allow you to accept bitcoin as a merchant but then will just pay you in cash. So a coffee shop links its bank account to a service like Bitpay, and the student pays with bitcoin, and Bitpay will immediately transfer dollars to the coffee shop’s bank account, so it doesn’t actually need to touch bitcoin. It doesn’t have to worry about losing its relationship with its bank or exchange rates or anything like that. Bitpay takes care of all of that. The merchant likes this better than credit cards, because Bitpay would take a lower fee than credit cards, and there would be no fraud and no chargebacks. After the person sends the bitcoin, the transaction’s done. So it’s a very merchant-friendly solution, whereas credit cards are a consumer-friendly solution, because the credit cards allow you to call up later and say, no, that wasn’t me, and the merchant’s out the money.

The students can also buy things online like Overstock.com or Expedia, buy things in local cafes or split checks with their friends when they go out to dinner. So the question is, what do the students do in an environment where local merchants accept it, all their friends have it, where they can buy and sell it with their friends, where they can can exchange cash for bitcoins and bitcoins for cash at will? All that reduces the transaction costs of bitcoin, and makes it very convenient because it’s digital and they don’t want to carry wallets. They can just walk around with their phone and be able to split checks and do other things.

When you were saying that bitcoin is similar to Venmo where you have to get the money out to transfer it to dollars, does Bitpay also work with the average person to take someone’s bitcoin and turn it into dollars?

Coinbase and Circle are working with us on the experiment. Those businesses allow you to link up your bank account just like Venmo. So, when you want to change dollars to bitcoin, you just log into the site, put in your password, tell it to take $100 out of your bank account and put it in your Coinbase account, and then let you use that to buy bitcoins. Coinbase and Circle are solutions that allow you to use the ACH system, to make a withdrawal out of your bank account into Coinbase or Circle to buy bitcoins with them. The students have that choice, or they can buy or sell bitcoin from their friends.

In our interview, we’ve discussed potential applications of digital currency, and where it will have the biggest impact. Which populations will benefit the most from wider adoption of digital currencies?

In the U.S., we pay high fees for financial transactions and face delays but most people have bank accounts and the system works well enough to get most things done, so the need here is not as great. In countries where there’s already free person-to-payments, the need is even less.

Where I see the greatest need are international payments and developing countries where people don’t have bank accounts or the ability to create banks accounts, and so are completely cut out of international financial markets and participating in the global economy. There are countries where you have difficulty selling or buying through ecommerce. You can’t buy because you don’t have a credit card, or a lot of businesses refuse to accept credit card transactions internationally because the fraud rate is too high. If there are too many fraudulent transactions, they have to pay for them and might even lose their ability to accept credit cards at all. A lot of ecommerce businesses won’t accept international transactions, so someone internationally can’t buy the things we can buy. Nor do they have a good way to sell things since they can’t receive payments. So a large part of the world is cut off from global ecommerce.

Access to financial markets is very unequal around the world. Rich people buy apartments in London or houses in Palo Alto. They can purchase physical assets to protect their wealth. Poor people who don’t have access to banking and financial markets have very little ability to save, especially if they’re in a high-inflation country, so they can purchase buy a gold necklace or stash cash under their mattress. These are not great ways to save. They have a lot of frictions associated with them, and risks. So getting the world’s unbanked to be able to more efficiently access financial markets is a very important public policy goal. It’s very expensive to be poor. If you’re poor, you can lose all your assets to inflation because you can’t afford to buy a tractor or car that would actually hold its value. If you’re poor and working as a housekeeper in New York, and you’re trying to send money home to Costa Rica, you’re going to go to Western Union and pay $25 to get that money home, and you worked pretty hard for those $25. It’s a tax on being poor. So if we can find ways to get those costs down and promote financial inclusion, that will help inequality and growth and help people get themselves out of poverty.

Just as we’ve seen people [in developing countries] leapfrog landline telephones and landline internet and start to use their mobile devices to connect to the global economy, digital currencies provide a way to immediately participate in the global economy without any of the impediments of the traditional financial system. This is something regulators are concerned about because, while there are billions of poor people who don’t have bank accounts, and it would be great to get them access to the financial system, there are also terrorists and criminals who have other reasons for not being able to get bank accounts.

But in the early days of the internet, most of the traffic was pornography, and The internet makes it easier for criminals to communicate and move money, and it makes certain types of crime possible, like certain types of pornography, but it’s also useful for a lot of good things. Digital currency has the possibility to connect the world’s unbanked poor much more quickly to international financial markets, and that promise is worth a lot.

To give some examples, especially in the developing world, moving money between countries can require multiple hops of correspondent banks from one country to another, and it can be quite expensive, but using digital currencies, you could set up a remittance corridor between two countries, very quickly and at low cost. If you had a network of newsstands in one country and a network of flower shops in another country, the two business owners of those chains could get together and agree to make it possible for people to put cash into the newsstand and have people receive it at a flower shop in another country, and they could use digital currency to make that go quickly. If you’re a small entrepreneur, the fact that the money moves immediately is very important to you.

Right now, if you are a large financial institution, you can make the money available immediately even though it takes time to travel. You can take that risk and hedge the exchange risk you have. You have to hold cash at each end, to make money available instantly, even before it arrives at your bank. But if you’re a small entrepreneur without a lot of capital, it’s hard to make money available immediately and have enough capital to hold in reserve so allow to cash out immediately before the money arrives.

So this technological innovation of moving the money instantly lowers the cost of entry to remittance markets and allows you to basically connect any retail chain that has the ability to accept cash and give out cash can so it can become part of a low-cost, low barrier-to-entry remittance corridor. Some of this might end up evading regulations intended to protect against money laundering or terrorist financing, so the fact that it becomes easier for anyone to set up a remittance corridor is a risk and makes law enforcement harder in some ways, but it also enables people to get their financial needs met much more quickly.

Before we go, can you tell me about Ripple Labs, where you are a board member?

Ripple Labs is an alternative to Bitcoin but it’s actually quite different, so you could think of them as an application of using this ledger block chain technology to do different things, so it’s providing services to connect financial institutions directly. They have a ledger that keeps not just virtual currency but also promises to pay regular currency so banks can use it as a ledger or spreadsheet to help them keep track of transfer of funds without even holding or touching digital currencies themselves. Right now, they’re setting up a system where a bank in Europe and a correspondent bank in the U.S. are connected to create instant transfers to Europe.

Some people describe Ripple as just an alternative to Bitcoin and it is that, but it’s also taking the technology in another direction. It has a currency that is an alternative to Bitcoin but it also has technological capabilities different from Bitcoin’s capabilities — you can decide only to accept transactions with people you trust. That allows banks to feel secure about the fact that they can plug into this ledger safely and that no terrorist or person from a sanctioned country will send money into their account. That would be a problem, even if they didn’t authorize it. Someone with bitcoin could just send you money and you can’t say no to it, it just gets added to your account, but Ripple has a trust system built up to help protect people and allow them to plug in more safely from a regulatory standpoint.

Ripple is another example of how in some sense, the digital currency revolution is about the creation of a technology at its core, and it can be used for payments and for remittances and for transferring money, but it can also be used to help two correspondent banks keep track of transfers back and forth to each other and to move funds without even touching digital currency. Again, it’s like the internet. This is a technology that has many, many uses, and there are already a lot of people creating a lot of uses.

Be sure to catch Part 1 of the Q&A with Susan Athey, on how digital currency could transform our lives, and Part 2, about the security advantages and disadvantages of cryptocurrencies and obstacles to adoption.

Laura Shin is the author of the Forbes eBook, The Millennial Game Plan: Career And Money Secrets For Today’s World. Available for Apple iBooks, Amazon Kindle, Nook and Vook.