Bitcoin vs Traditional Finance
We’ve now covered a few topics related to Bitcoin:
In this two-part blog, we’re going to focus on how Bitcoin differs from legacy financial systems. Starting with how money moves around in traditional finance and Bitcoin. In the next blog, we’ll touch on how the money supply is managed, ending with a comparison of how Bitcoin’s money supply differs.
Moving Money in Traditional Finance
In the legacy financial system, money moves around in a few different manners which can be roughly divided into four categories: Cash, ACH (“automated clearinghouse,” which includes checks), Wires, and Third-Party Platforms, such as Venmo. Each category offers different benefits and functionality.
Cash
Cash is king, they say. When considering transaction simplicity and finality, “they” are right. Cash in your wallet is yours, and can instantly be traded for any good or service at any time. These transactions offer “instant cash settlement,” which means that the transaction is considered fully settled and final at the time of the sale (merchants can choose to allow returns/refunds when dealing with cash, but that is considered a separate transaction).
Of all four methods of traditional finance, cash is the only one that doesn’t require a third party to process (and potentially block) the transaction. Cash is the only method that allows completely anonymous transactions as well.
There are two risks that come with cash. First off, if you lose it, it’s gone. Lost or stolen cash offers near-zero odds of ever being recovered. Additionally, cash simply doesn’t work in an online economy: you can’t buy goods or services from any online merchant without first converting your cash into a form of payment accepted online. The process to do that involves one of the following two methods for moving money.
ACH (Automated Clearing House)
ACH transactions are batches of transactions that are sent via the legacy payment systems, winding their way through your bank’s software provider, the Federal Reserve, the destination bank’s software provider, and eventually into the account you’re sending to. ACH transactions are cheap (often free) but they can take a couple of days to settle. Online bill-pay, direct deposits, and paper checks almost always utilize the ACH system.
Wires
Wires are direct payments from you to the destination, with only the Federal Reserve as the intermediary. Wire transactions are fast–offering same-day settlement–but often come with a fee. Many institutions use the wiring system to move large sums of money around quickly.
One caveat of wiring money is that once the money is sent, it’s gone. There’s no way to get it back without cooperation from the recipient. Often when money is wired to an incorrect destination, the receiving bank is happy to send the money back, but such a situation is not guaranteed.
Third-Party Platforms (TPPs)
There are many TTPs. Some of the more well-known ones include Venmo, Cash App, PayPal, etc. These differ in functionality from all the other methods of moving money around because, technically speaking, the money doesn’t actually move once it’s in the ecosystem.
To begin, a user sets up and funds an account, sending the money via ACH or a wire. After the TPP receives the money, they put it into their own bank account and credit the user. The user can send the credit in their name to other users, but the TPP doesn’t actually move the money–they only update their internal ledger of who owns what. Because money is not actually moving inside the ecosystem, payments are incredibly fast and cheap. If a user wants to withdraw their money from the system, they do so via an ACH or a wire once again.
Drawbacks to TPPs are the time it takes to fund and withdraw from accounts, as well as the fact that money can only be sent to users of the same TPP (Venmo users can’t send to PayPal users, etc.).
Moving Money with Bitcoin
Moving money around in the Bitcoin network can best be understood as digital cash. All of the benefits of cash–privacy, quick settlement, irrevocability–apply to Bitcoin transactions.
For me to send some Bitcoin to you, all I need is your receiving address generated by the Bitcoin software on your computer, phone, or dedicated Bitcoin device. I can then use that address to send Bitcoin directly to you, exactly as if I were handing you cash in person. There is no bank or other trusted third party to monitor, stop, or reverse the transaction.
Bitcoin’s functionality enables significant control over a person’s finances but comes with risks. Just like cash, if Bitcoin is lost, it is mathematically irretrievable. Bitcoin sent to an incorrect address will not be returned without the cooperation of the receiving party (who may be unknown).
Bitcoin transactions are settled on the network via a process known as mining, covered here (Link to How Bitcoin Works blog post). Every 10 minutes, Bitcoin transactions are settled onto the public ledger known as the blockchain, and after about 60 minutes, Bitcoin transactions are considered immutable, meaning that no entity in the world has enough computational power to reverse them.
We started this post discussing traditional ways of moving money around and ended with a glimpse into how the Bitcoin network transfers value. The next post in this two-part series will cover the management of the money itself–how much money there should be, how it is issued, and what happens once it is created.
