According to the “Bticoin: A Peer-to-Peer Electronic Cash System” by Satoshi Nakamoto, one of the founding purposes of Bitcoin was to overcome inherent weaknesses of a trust based model. Consider the following:
“Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments. While the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust based model.” Page 1
I have experienced this first hand. In general, third party financial institutions are the long pole in the tent and lengthen transaction time. It’s a dichotomy of sorts. On one hand the financial institutions allow for transactions that would not be possible otherwise if dealing with strictly local currency, at least in a pre-digital currency sense. On the other hand, the same financial institutions place lengthy holds on funds and take significant transaction fees.
Probably the worst aspect of interacting with traditional financial institutions is the reversible nature of any electronic transaction. The beauty of peer-to-peer cash transactions is that, in general, once cash is exchanged for a good or service, the transaction is assumed complete. Not so with electronic transactions, electronic transactions tend to linger with increased probability of return or cancellation. I assume this is why manufacturers of Bitcoin miners who offer pre-orders require a wire transfer instead of a credit card payment. Nakamoto accurately describes the challenge with the reversible nature of traditional financial transactions below:
“Completely non-reversible transactions are not really possible, since financial institutions cannot avoid mediating disputes. The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions, and there is a broader cost in the loss of ability to make non-reversible payments for non- reversible services. With the possibility of reversal, the need for trust spreads. Merchants must be wary of their customers, hassling them for more information than they would otherwise need. A certain percentage of fraud is accepted as unavoidable. These costs and payment uncertainties can be avoided in person by using physical currency, but no mechanism exists to make payments over a communications channel without a trusted party.” Page 1
I have experienced the challenge of reversible transactions from the perspective of a product manufacturer. Early in the life of a manufacturing company we had accepted a sizable international order (one of our first international orders) for a consumable product. We had accepted payment via credit card and purchased the raw materials and ramped up staffing to accommodate the order. As the international shipping company was picking up the order our customer had cancelled the order upon receiving the shipping confirmation. We disputed with the customer and they simply disputed the claim with their financial institution and the payment was revoked. It didn’t matter that the order was placed with the consent of the customer, the raw materials used and expended, and labor costs incurred. Shortly thereafter we had implemented policies instituting a restocking fee and wire transfer requirement for orders above a certain threshold to reduce our risk. In hindsight, the restocking fee was ineffective as financial institutions refunded customer funds regardless.
Another aspect linked to trust is the holding of funds by financial institutions. As a company becomes larger and more established this becomes less of an issue over time. However, when bootstrapping a startup it can really cause some serious problems. There is a high degree of frustration when a startup is experiencing cashflow challenges and a large order is received, only the funds will not hit your operating account for three days. This sort of delay causes other delays down the operating chain as it increases the duration of the feedback loop between customer and provider. Increasing the feedback loop in turn slows down growth of the business. Conversely, if the receipt of payment is near instantaneous, order fulfillment can occur shortly thereafter, funds can be reinvested in the business and in turn the business will grow faster.
It appears that Bitcoin, at least in its pure form, would reduce the probability of these sorts of things occurring. By making the transaction non-reversible, it would require an equal amount of due diligence on both sides – the manufacturer and customer. Of course there are easy ways of managing that process and the benefits are significant. The possibility of removing the financial institution from the transaction allows for the suppliers and customers to act as they were intended – as two self-interested traders.
1. J.R. Sedivy. Bitcoin: A Peer-to-Peer Electronic Cash System Abstract:
2. Satoshi Nakamoto. Bitcoin: A Peer-to-Peer Electronic Cash System: