Bitcoin Isn't the Future of Money, But It Could Be the Future of Moving Money Around

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Big financial institutions could use bitcoin to move money across borders.

It's been a hell of a week for Bitcoin, the digital crypto-currency turned Internet punch line. First, the price of a single Bitcoin jumped up past $600, after spending months hovering in the $100 to 200 range. Then, it got an impressive imprimatur in Washington, with Fed chairman Ben Bernanke saying that the currency may hold "long-term promise." That comment, along with a letter from the Federal Reserve Bank of Chicago that called Bitcoin "a remarkable conceptual and technical achievement," sent prices even higher. At one point, Bitcoins were trading for $900 apiece (meaning that if I'd held on to my one Bitcoin instead of selling it earlier this year, I'd have made enough to buy the iPad Air I've been coveting).

I agree with Timothy Lavin that the price swings of the last few weeks are a bad sign for Bitcoin's long-term viability, since no currency with such crazy volatility will ever be trusted as legitimate money. But I think there's a solution to all of this: Bitcoin needs to give up on its dream of replacing fiat currency, and focus on becoming something both much bigger and much more mundane: an invisible middle-man for the global payments system, which is currently way too expensive and outmoded.

Right now, the process of moving money around the world is a nightmare. Most cross-border payments are made with the help of one or more of two systems: SWIFT and CHIPS (Society for Worldwide Interbank Financial Telecommunication and Clearing House Interbank Payment System, respectively). In very basic terms, SWIFT is the alert system for payments — it tells banks when money has been sent and received — and CHIPS is the bookkeeper that actually does the tallying and transferring.

For example: If I want to wire $1,000 to a friend in Japan, my bank, which has a unique eight-digit SWIFT number, looks up the eight-digit SWIFT number of my friend's bank in Japan, and sends that bank a message containing the amount of the transfer, the type of asset being transferred, the names and account numbers associated with the transfer, and the date and time of the transfer. After my friend's bank gets the SWIFT message, it processes the transaction using CHIPS, a different system that simultaneously debits my account in U.S. dollars and credits my friend's account in Japanese yen, using the exchange rate at the moment of the transfer. (A more complete explanation of the process, which is extremely complicated and involves lots of conceptual overlap, can be read about in this FinCen report.)

The reason it often takes a day or more to complete an international money transfer is because there are lots of intermediaries, each of which can drag its feet in settling payments. It's also annoying for banks, which is one reason they charge exorbitant fees. (At Chase, for example, you'll pay $40 for an international wire payment, and $45 if it's denominated in a foreign currency.) The system for sending money between banks inside the U.S., using a service called ACH, is almost as complicated, which explains why start-ups like Dwolla are trying to build better, cheaper clearing systems.

This is where Bitcoin could be incredibly useful. Imagine using Bitcoin as the invisible middle layer in a cross-border transaction. You'd ask your bank to send $1,000 to your friend in Japan, and immediately, your bank would convert your U.S. dollars into Bitcoin, place the Bitcoin into a secure virtual wallet, and send it to a Bitcoin wallet held by the Japanese bank, which would then convert it into local currency and credit it to your friend's account. In a system like this, it wouldn't matter if Bitcoins were trading at $600 or $6 million, since the money would only stay in Bitcoin for a millisecond or two before being converted into another country's currency. In fact, you wouldn't necessarily need to know that Bitcoin had been involved at all — all you'd see is U.S. dollars leaving your account, and Japanese yen appearing in your friend's account.

This would be massively cheaper than the current system. Banks might still charge a per-transaction fee for a Bitcoin-based wire system, since there would be costs associated with setting up the technology needed to make it happen securely. But once a solid platform had been developed, there'd be no reason for them to charge anywhere near $40 per transfer. (Of course, you could cut out the banks entirely by creating a peer-to-peer Bitcoin conversion platform, but that would carry its own risks.)

The downsides of this plan, as with most Bitcoin-related schemes, would be in the realms of security and regulation. Bitcoin theft is still a massive problem, and with so much money flying around the world every day (CHIPS processes an average of $1.4 trillion daily), the risk that hackers would pick off a portion of that money is non-negligible. A friction-free payment wire system would also be catnip for money laundering and other illegal transactions, so you'd have to build in enough tracking and compliance features to make it kosher with regulators. And banks, who like their wire-transfer fees, would have to be convinced to participate.

But if a Bitcoin-based instant global money transfer system, with fiat-denominated bank accounts at either end, could be worked out, it would save companies and individuals billions of dollars a year in fees and processing costs. It would make sending cash around the world as easy as sending e-mails. And it would give Bitcoin a reputation as something truly useful, not just a crypto-libertarian plaything.

First, though, Bitcoin enthusiasts would have to give up on the dream of a universal currency that is treated as money and accepted at stores all over the world. Bitcoin is too inherently volatile to be trusted, and normal people will never be convinced to give up their government-backed money for a math-based currency. Instead, everyone currently building venture-backed Bitcoin gizmos should refocus their efforts into developing a secure, stable platform for cross-border payments, using Bitcoin as the new and improved middle layer. Bitcoin may not be the future of money, but it could very well be the future of moving money around.