- Banks form the traditional financial system we all know today which although reliable and trusted, has its drawbacks.
- The Bitcoin network was launched to eliminate third parties and build a trustless system.
The 2008 financial crisis submerged 30 banks including some of the biggest names in the industry like Washington Mutual Bank, Silver State Bank, and IndyMac among others. In the next three years, another 400 were to drown in this flood. This proved the high interdependency of banks upon each other and how the failure of a single bank could start the domino effect that could engulf billions of dollars.
Bitcoin was launched as an alternative to the payment system and eliminated the dependence on such third parties and other financial institutions. The term Bitcoin, however, is collectively used for various things. First, the currency or digital token is a medium of exchange and holds some value. Second, is the protocol, which is the set of rules and mechanisms on which the system runs. Third, the network is the ecosystem of all the various users.
Everything does not qualify as becoming a store of value. The object should have purchasing power and be readily exchangeable. These two factors put some constraints on the definition of the store of value. They should not have a short lifespan (like food, and flowers), should be highly liquid (real estate holds value but is not readily liquid), and scarce (although air is vital, it is abundant).
Traditionally, people have used precious metals like gold and silver as a store of value because of their rarity and high liquidity. Fiat currencies (USD, GBP, YEN) are printed and backed by the government and encourage people to use them for commerce and taxes. Similarly, for centuries real estate, paintings, and books have been a storehouse of value. However, all these have their flaws regarding hyperinflation, outperformance by others, and illiquidity, which makes them conservative.
Ting, Ting, Ting, The Fight Begins
At the heart of each transaction process lies the issue of trust. The buyer and seller trust each other, that they will receive money once they deliver the goods. Often third parties like banks are present to offer this trust.
The easiest and most trusted form of transaction is cash payments. The buyer instantly handles the relevant amount of cash once they receive the goods. Herein, no third party is needed to confirm the transaction, however, both parties should check regarding counterfeit notes before confirming and moving on.
Many people use card transactions daily to cover their daily purchases and expenses. While you just swipe your card, enter details, collect the bill, and walk out of the shop, several steps take place in the background. It involves communication between the card network and banking network and trust is gained by using a well-reputed network. The three major steps involved are authorization, clearing, and settlement.
In the authorization step, the user’s identity and the availability of funds are verified. It involves the user entering pin details and the transaction confirmation message. However, the funds are still in your account and have not been transferred. The next two steps involve the actual transfer of funds i.e. debiting your account and crediting the merchant’s account and takes nearly 24-48 hours to complete.
As we can see, there are so many steps involved making the process cumbersome and informationally heavy. The many counterparties need to trust each other and the whole system will collapse because of a single point of failure. The Bitcoin transactions take place using Distributed Ledger Technology (DLT). Any transaction is first broadcasted on the network and several nodes independently verify the transactions. Then, miners set out to solve a cryptographic problem and the first one to solve notifies the network, and other miners check its validity. Once gaining a consensus, the new block is added to the blockchain and finally, the actual transfer of Bitcoins takes place.
Advantages of Bitcoin over Banks
Bitcoin removes trust by making a trust-less system, where it is replaced by a set of defined algorithms. The multiple back-and-forth communication channels make the process tiresome and give rise to a single point of failure. Whereas in the Bitcoin network, the nodes and miners are just sub-parts, and removing or compromising a few of them still ensures network security.
Final Thoughts
Banks are closed on weekends and public holidays, whereas Bitcoin runs 24*7 all days. Other factors such as influential people getting soft loans with lower interest while common people have to wait months and produce several documents before a loan is a transaction. All such minor discriminations are also overlooked in that decentralized network.
