November 5, 2016

Understanding the Obstacles Blocking Bitcoin Adoption

Although the Bitcoin concept is unique in a technical sense, its adoption seems to follow a familiar path, namely that of an
unsponsored technical standard within a two-sided market suffering from strong network externalities.

Photo by Mike Kelley

Two-sided markets are well-studied. Thus, we can inform our expectations by the wide inventory of similar phenomena. What follows is a forecast concerning the bitcoin adoption process as well as seven suggestions for how to hasten the process or at least to make it more pleasant and fruitful for businesses and consumers.

Problems of the Current Stage

Bitcoin is often referred to as either a currency, payment system, distributed communication network, and/or monetary concept. Technically and potentially it is all of these. However, at the current stage of adoption it is only just entering the realm of what could be considered a “payment system” and has a ways to go before it is considered “money” in any strict sense. Bitcoin in its present stage is a speculative asset the value of which depends on free market factors — e.g. supply/demand, anticipation of the technology’s success — but also on several factors related to the consolidation of Bitcoin’s executive power in Greater China.

Adoption is still the most pressing issue

By overrating the stage of Bitcoin, community members continuously overlook actual problems and ignore the fact that bitcoin is still misunderstood by 99% of the world. Bitcoin might still become what many bitcoiners dream of — a libertarian economic base — but at the moment it is not much more than an new-age casino with a novel chip system and terrible user experience.

Bitcoin: The Next Betamax?

With its ongoing — and intensifying — scaling debate, Bitcoin has fallen into the common “standards trap” that plagues unsponsored technologies. This results from lack of coordination and misaligned interests. To be fair, Bitcoin is “decentralized” by default and so these issues, while troubling, are natural and to be expected.

The Importance of Initial Adopters

Despite the increasing global connectedness of things, there are still certain interactions that benefit from being “local” — for instance, payments. As cool as it is to send magical internet money through the air, the experience of receiving cash-in-hand is still difficult to improve for everyday transactions — especially, for the average non-technical person. So the question of how merchant-level adoption for bitcoin will occur is important for many reasons.

Let us recall that no payment system has ever emerged without direct interest and support from retail businesses — specifically those of the brick-and-mortar variety. In order for these providers to join Bitcoin they should be incentivized to do so. But, even if the scaling discrepancy — seen by many insiders as “the most pressing issue in bitcoin” — was resolved tomorrow the result would only indirectly influence bitcoin-for-merchants adoption. Bitcoin benefits to retail businesses are manifold: from potentially ultra-low transaction costs to various tax optimization opportunities; but, regardless of how the scaling debacle shakes down there are specific tactics and development efforts required in key areas to breach the adoption-threshold.

It is hard to predict but a large number of experts suggest that poorer, developing countries are likely to spark the flames of widespread bitcoin adoption. As the argument goes, these markets lack of incumbent infrastructure including: banks, financial services, and credit cards could easily lead to the demand for bitcoin under the right circumstances. We disagree. In the 1990s, Africa and Asia didn’t have Internet either, but the resulting online revolution largely passed-over these developing nations. Bitcoin payments, like the internet at large, is relatively high on Maslow’s Pyramid of Needs it turns out.

Massive bitcoin adoption is more likely to begin in developed nations as opposed to those of the third-world. The main idea is that the proliferation of new payment methods is largely dependent on the existence of retail merchant substrate where the payment method can be used. At the same time, we know that the US has the least favorable regulatory climate and none of the 50 states offer an easy road to Bitcoin.

The basic conclusion here is that Bitcoin ecosystem will deepen its oligopolic segmentation even further because rare business horse can make it across the vast premiere of the USA.

When is it Going to Happen?

At what point in time should we expect the network effect to kick-in and when is that hockey-stick curve going to appear? We suppose it is at least a decade away. It is well recognized that network externalities will define the process velocity. It is important not to confuse Bitcoin’s two-sided market adoption pattern with an ordinary one-sided network phenomena such as the rise of fax machines or Facebook. There are fundamental differences between bitcoin-as-a-product and the two just mentioned. Bitcoin’s case does not fit into a model where the value of joining a network is directly related to the number of other users who join the technology as well.

Two-sided markets are economic platforms having two distinct user groups that provide each other with network benefits. Example markets are: HMOs (patients and doctors); operating systems (end-users and developers); yellow pages (advertisers and consumers); video game consoles (gamers and game developers); recruitment sites (job seekers and recruiters); search engines (advertisers and users). The payments industry is a classic two-sided market case where the payment-tools-provider is only a catalyst, not the main economic actor.

We suppose the adoption is inevitable but it won’t take place any time soon because of the classic two-sided nature of the underlying market. Basing our estimation on how long did it take other unsponsored payment systems to rise, we are talking at least about a decade.

Which Scaling Approach will Win?

Bitcoin is a classical case of an unsponsored technology: it is available to all; any firm can join and propose changes changes to a standard. Unsponsored standards often lead to multiple equilibria and lock-ins. Heterogeneous users and development groups join the market and adopt one of several standards, depending on their own preference and the number of other users of each standard. The arrival order of the earliest adopters could potentially lock the system into either standard/approach — even if that standard is inferior. This phenomenon is known as path dependence: the system has multiple equilibria and which one becomes standardized often depends more on historical events, preferences, branding and less on underlying soundness of the technologies in question.

Satirical small-block criticism taken from big-block blogger @John_Blocke

We do not know what the playing field will look like in the battle between for small and large blockers by the time Bitcoin begins turning from a speculative asset into a usable payment system. In either case, the technologically worse solution can win even if its drawbacks are obvious to everyone.

Small-block solutions from The Bitcoin Core Roadmap

Examples of the suboptimal outcomes are numerous: inferior typewriter keyboard layout (QWERTY) was adopted but the technical considerations behind it are no longer relevant (frequently used characters were placed apart to prevent jamming). Another obvious example is inferior VHS vs Betamax. There are less understood but very interesting cases about AC/DC (Mr. Tesla vs Mr. Edison), helicopters/gyroplanes (the latter is many times safer and more fuel efficient but it lacked engineer attention), rotor/cylinder engines (the former have times better characteristics but also lacked investments on early stages).

So, knowing this, it is easy to understand why some people may want to aggressively push their preferred standard even knowing that it may less favorable of the two choices. Let’s face it, objectivity is a rare commodity these days. The backfire effect states that individuals are likely to double-down support for their deeply held convictions in the face of incontrovertible evidence counter to said position. We like to think of technology and science as objective domains where the best arguments teamed with evidence can defeat inferior positions. Neither history, nor the present bitcoin climate shows this to be the case though.

Thus, we can expect the worst: we may very well have to have to live with an inferior standard with few opportunities to improve at a later date.

Which Scaling Approach will Win?

Examples of the suboptimal outcomes are numerous: inferior typewriter keyboard layout (QWERTY) was adopted but the technical considerations behind it are no longer relevant (frequently used characters were placed apart to prevent jamming). Another obvious example is inferior VHS vs Betamax. There are less understood but very interesting cases about AC/DC (Mr. Tesla vs Mr. Edison), helicopters/gyroplanes (the latter is many times safer and more fuel efficient but it lacked engineer attention), rotor/cylinder engines (the former have times better characteristics but also lacked investments on early stages).

  1. Reach-out to brick-and-mortar merchants. Enter the POS market space.
  2. Build hybrids. Let you product carry BTC, fiat and fiat-over-blockchain. On-board both consumers as well as merchants to blockchain wallet use but don’t insist on BTC or nothing. Offer built-in hedging.
  3. Cooperate with banks — especially with smaller, local ones. Build co-branded and co-functional products. Decentralize at this level, not at the level of a particular individual. Banks aren’t disappearing any time soon. VISA and PayPal may go extinct, maybe even the USD. But, not banks.
  4. Wrap up the product in a familiar form such as digital cheques. Don’t push “money” or “digital cash”. Bitcoin is yet neither of those, anyway.
  5. This is the last time you have a chance to influence the standard war. Now or never. The point of no return is approaching.
  6. Focus on the US. Pick a state, not a country.
  7. Come correct. Merchant-level adoption is not going to happen overnight. Spend time preparing well, you won’t be late for the show.

It is hard to overestimate the importance of bitcoin businesses approaching brick-and-mortar merchants. The basic idea is that merchants won’t adopt in a “voluntary” way, bitcoin offers will need to be bundled with something they already need. Larger retail and hospitality is already under unprecedented pressure from all sorts of startups. So, we suppose that the only segment left for creativity is small and very small businesses. Something can be done about making it happen sooner, though.

Let’s consider few historical examples. The credit card was invented in 1949. Unlike cheques for example, the adoption of cards involved substantial network externalities: it needed a certain large number of accepting merchants and card holders to ignite the functionality and usability of the system.

First concepts — such as Diners Club and AmEx — had a very niche/club-type focus. It took twenty years before the concept was able to emerge beyond the travel & restaurant niche into ubiquity. Furthermore, it was not until the 1970s when open networks of Visa and MasterCard laid the ground for wider usage. Thus it took 25 years (1974) for the number of US credit card transactions to reach a usage frequency of 1 per capita/month!

A completely different story can be told for ATMs. Although ATMs are subject to network externalities, even a single ATM provides significant value to both consumers and banks. This allowed banks to introduce ATMs in 1969 as stand-alones or in small closed networks. About ten years later the regional and national ATM networks were established, giving the product its network value.

Now compare cheques and cards. The personal cheque is the oldest major non-cash instrument and was invented centuries ago; it also used to be the most widely-used. Cheques can be offered as a single-bank service, similar to ATMs. Banks step in with their existing customer base and marketing infrastructure to ease the critical mass requirements. In our previous posts, we argued that it is too early to bury the cheque business model and that it can be revitalized for blockchain-based assets. As the ATM example shows, this approach might halve the adoption time while providing a number of other benefits. The cheque model would allow users to conduct a quicker transfer from the speculative stage to the payment system stage. There, bitcoin-as-currency may have to neighbour with fiat assets to win its position as a double-sided market entity. Form there it may move further on towards being a monetary instrument and an independent single-layer network.

Thus, by applying an older (tested) business model (such as digital cheques), we can lower dependence on network externalities effects and find cases where two-side nature of the market can be minimized.