This article is the first installment in a three-part series on digital currencies, such as Bitcoin, Litecoin, Ripple and others. Part 2 covers the security advantages and disadvantages of cryptocurrencies, as well as the obstacles to their adoption, and Part 3 explains how MIT students, the poor and criminals will all benefit from Bitcoin.
Insofar as this is possible, Susan Athey is a rockstar economist.
At age 36, the Stanford Graduate School of Business professor became the first woman to receive the prestigious John Bates Clark Medal, awarded to an American economist under age 40 who has made the most significant contribution to economic thought and knowledge. The former MIT and Harvard professor has a whole host of other accolades to her name: member of the National Academy of Sciences, member of the American Academy of Arts and Sciences, plus many more. She also was the first chief economist hired at Microsoft MSFT +0.59%, as a consultant, and she now serves on the board of Ripple Labs, the creator of the Ripple protocol, a more bank-friendly alternative to Bitcoin.
Her work has focused on the cutting edge of technology. One theme in particular has been how complex platforms and marketplaces, such as internet search advertising and online advertising auctions, can be designed to make them work more efficiently — for instance, using big data to predict how advertisers would react if online ad prices were changed and how that would change the users’ experience of and interaction with ads.
She also has concentrated on how technology enables the creation of new platforms, and how that affects the industries involved — for instance, how the internet has affected news media. “This is a new frontier of statistics and econometrics — the statistics of economics: to try to combine tools that are geared toward large data sets with lots and lots of covariates and not a lot of structure with the ability to answer very structured questions,” she says.
Stanford business school professor Susan Athey (Peter Tenzer)
Because of her interest in the effect technology has on our lives, cryptocurrency immediately piqued her interest for its potential to disrupt financial services. I recently met with her at her office at Stanford GSB to talk about what digital currency is, its potential, the hurdles it faces and other related issues, including an exciting new project involving Bitcoin. Because of the length of our interview, I’ve separated them into individual stories in a series. In this first installment, we discuss what Bitcoin is and applications for digital currencies.
What is digital currency?
At its core, the new technology that’s been invented in the last few years is a way to maintain a ledger or spreadsheet that keeps track of who has what. So if there’s an entry in that spreadsheet that says a certain address has 10 bitcoins and you know that address and the password, you can authorize a new entry on the spreadsheet that moves that digital currency to someone else. So Bitcoin is just a big spreadsheet that keeps track of who owns what, and what’s really innovative about it is that, first, it is secure. It uses decentralized maintenance of that spreadsheet, so there are copies all over the world. There’s not just one computer that can be hacked.
Second, the fact that it’s purely electronic means that if the spreadsheet says I have some bitcoins, and I have the key for those bitcoins, I can authorize a movement to someone else simply by entering my security code, which then immediately makes another entry on the spreadsheet and allows someone else to control this thing of value without any banks or companies or other types of middlemen. With just a password, I can almost instantly transfer something of value to someone else, purely digitally and without any promises from companies to honor it. It’s a piece of open-source software.
So digital currencies are a technological innovation for moving value digitally and securely and quickly, just like the internet was a fundamental technology for moving information somewhat securely and quickly.
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How might digital currencies change our everyday lives?
Like the internet, digital currency is a technology that enables lots of applications to sit on top of it. One thing that’s hard to do today is to move money internationally, especially quickly. If you useWestern Union WU -0.05%, there’s a large fee, and if you want to move money between two banks internationally, it costs you $60 or $70. For regular consumers doing small transactions, it’s often too expensive. So digital money makes it easy to move money at the speed of information rather than a week or longer.
Digital currency also makes it easy for anybody to move money between one person to another. There are applications today that allow you to do that, like Venmo, but there are fees to getting money in and out of applications, and these apps are not that broadly adopted. So I expect that either people will directly use applications built on top of digital currency to move money, or that competition from digital currency might induce banks and other financial institutions to lower their fees. There are actually a lot of countries in the world, where, if two consumers want to send money to one another, that money becomes immediately available to the receiver, and there’s no fee. But that’s not the case in the United States.
Where is this available?
Europe, Australia. Person-to-person bank transfers are free and instant in a lot of the world. So when you talk about the benefits of digital currencies to people in other parts of the world, they are surprised that they are not available to us already in the U.S.
The backend system that banks use to send money to one another, ACH, is an old system coordinated by the federal government. It takes time for the banks to actually receive the money. There’s a delay built in. The cost the banks are charged is very low but the banks charge the fees to the consumers and they don’t always make the money available to consumers as soon as they receive it.
The banks still have a delay in Europe but they just go ahead and make the money available to consumers even before the money moves between the banks once they know that it’s coming. You might wonder, can’t Chase and Bank of America work something out between them? Can’t Bank of America check you have the money in Chase and Chase says they’re sending it and then make the money available to you? They could but they don’t.
Digital currency, by its very nature, makes that very easy, so if the banks don’t provide those services to us, we expect that services built on top of digital currency will provide those services, and that would hasten the arrival of those services. It’s just basic nuts and bolts competition.
Do you see it already happening?
What brings down prices is competition. Currently, all the banks charge these fees and impose these delays, so competition doesn’t seem to be working to bring the price down to cost. Competition from outside services might have that effect, but so far it’s been too small. Digital currencies haven’t been large enough to put price pressure on the banks, and the banks are making a lot of money from those fees. Fees are charged to consumers and businesses — even large companies. These fees are problematic for the efficiency of society because they make certain kinds of transactions cost-prohibitive or less productive.
It might be easier to just move money electronically but since you can’t do it instantly, instead you use cash. There might be small transactions, like in-app purchases or charges in an app store, where the credit card fee might be very large in proportion to the value of the transaction, so those just get priced out. If a newspaper wanted to do micropayment for content, then the credit card charges might be cost-prohibitive because there’s a fixed fee for every credit card transaction, so we see lots of types of transactions not possible in a system when you have to pay credit card fees or bank fees to process the transaction. What digital currencies do is remove a lot of these minimum fees and make it easier and cheaper to move small amounts of money.
What are some other ways digital currency will change our lives?
We’ve talked about sending money internationally, which could include person-to-person payments and remittances. Formal and informal remittances are maybe $1 trillion, so that’s a big application. We’ve talked about digital currency putting pressure on person-to-person transfers within a country, which today could happen quickly but don’t. And we’ve talked about a payment system, so a merchant could accept bitcoins for payment, bypassing applications. So that’s four applications we’ve talked about.
People can also use the digital currency technology to create more complex contracts or instruments. For example, today people use escrow accounts when buying a house: You put money into escrow, but it only goes to the seller when the seller hands the title to the property to you. We use escrow accounts when we have trust issues around a big important transaction and we want the money to move at the exact same time the property moves.
But we only use that for big transactions because escrow is expensive. With digital money, you can write costless computer programs that create escrow services, so I can put digital currency in an escrow account and have a computer program only release that money to a seller when certain conditions are met. You can call it programmable money: It’s money that we can write computer programs on, and these computer programs check when certain conditions are met. In situation one, the money gets sent to one person. In situation two, the money gets sent back to the original holder of the money. In situation three, it might go to someone else. We can write contracts that are enforced by a computer, instead of a relying on an escrow agent and paper signing and these horribly old-fashioned things. We can use escrow for goods of much smaller value and without interacting physically across borders.
People are also investigating using programmable money for financial contracts, like for instance, financial contracts in derivatives which involve multiple parties. You might put some money in a financial contract which will pay out according to what happens to certain stock prices. So you could have a computer program that took in as an input stock prices from the Bloomberg terminal feed and then, depending on what happens to certain stocks or certain combinations of stocks, certain individuals get paid back.
Like a buy or sell order?
Yes, but you could set up more complex derivatives that might pay out to certain people, as a complicated function of what happens to multiple stock prices. Derivatives are financial instruments that pay investors according to complicated functions of what happens to stock prices. For example, it might be a lot if the stock falls by more than a certain percentage, or not at all if it goes up.
People have proposed to create more complicated derivatives where any individual could make up a contract, and people all over the world could invest in them and the people would know a computer program would follow the rules of who gets paid when. So they could be complex multi-person derivatives, financial instruments, and instead of trusting an individual or an institution to make the payments according to the rules, the computer program would spit out the money to the right people.
A little more abstractly, smart contracts with digital money allow you to write a set of rules that tell you in what circumstances different people get paid. These could be very complicated contracts that could depend on lots and lots of prices and lots and lots of information and could involve people who don’t know each other or trust each other and live in different countries all over the world. All these people could read the rules of the transaction, participate and trust that the computer program would carry out the rules. So as long as everybody put their money in, it could be held in escrow by this computer program and they would know that it would get spit out according to the rules.
So it’s a substitute for people you paid like escrow agents and title companies or services that would be provided by a financial institution, where the financial institution would create an instrument, but you’d have to trust them to follow the rules and so only certain trusted institutions could convince people to give them money and trust they would give it out according to the instructions. Now this can all be done in a computerized way.
People are very excited about this possibility, but part of the reason this sounds abstract is that we haven’t seen a really productive use case. It’s just a possibility now. This is just like beginning of the internet. When I was in college, I’d say, wow, you could send information all over the world. I can write a message to my boyfriend. People would say, you’re sending email to your boyfriend? Why don’t you just call him? People couldn’t understand why it would be so much more useful to email information than use traditional methods. In the early days of the Internet, people would say, yes, I can send messages through text and files, but they couldn’t envision YouTube or Twitter or Google. The applications that were going to come later weren’t completely clear.
Digital money is similar. The first thing you do with technology is do what you were already doing better and faster, like sending money internationally, sending money to our friends, paying for things on the Internet. Many people believe that the best is yet to come, and new things are possible, but we’re not sure which of those possibilities have the most value. We have this new technology that allows money to be allocated with computer programs according to specified rules. We haven’t quite figured out what to do with it, but it seems like a powerful technology.