Disclaimer: This is not financial advice. Anything stated in this article is for informational purposes only and should not be relied upon as a basis for investment decisions. Triton may maintain positions in any of the assets or projects discussed on this website.
TL;DR
Part II
Genesis: What problem are we even trying to solve?
In order to understand where all of this is going, we first need to establish a shared appreciation of what this technology was trying to solve in the first place, almost 20 years ago. The growth in the technology has definitively broken open the design space of what blockchains can ultimately be used for, but despite all of the attention, grandeur, craziness or skepticism that is associated with the technology, its original roots are actually quite practical, so let’s start there.
Most readers would likely agree with the ‘Introduction’ snippet above. It is hard to argue with the fact that as our lives are increasingly lived online, we are ever-more reliant on institutions to act as intermediaries, facilitate transactions and move money on our behalf. Very rarely do we consider what actually has to happen for a simple online purchase to go through, or more importantly, the costs associated with that. As consumers, this is especially true – we swipe our card and move on, settling up the bill at the end of the month. In many developed countries, issues with our payment systems are not top of mind on a day-to-day basis.
But retailers and small businesses, on the other hand, are acutely aware of the added costs and headaches that utilizing 3rd party payment providers adds on. All of the local bodegas, tradesmen, hairdressers or gas stations with “$10 minimum credit purchase” signs or lower prices for cash purchases than for cards, are testament to this fact. In many cases, swipe fees are one of the largest expenses small businesses pay, after rent and payroll. Even a 3% difference in net sales can be the difference between a small mom-and-pop restaurant staying in business or having to shut down. In 2023, payment processing fees in the US were nearly $200 billion, up 48% from 2019.
For larger retailers, chargebacks and card fraud are massive cost burdens, to the tune of $125 billion annually. Chargebacks are when a customer disputes a charge after the fact, either intentionally claiming a product/service was not delivered and seeking a refund, or quite frequently, through ‘friendly fraud’ claims where users may report a package missing, only to have it delivered several days later and not re-reporting that to the card company or merchant. Friendly fraud accounts for an estimated 44% of chargebacks. This is what that introduction is referring to when it refers to the costs associated with making ‘reversible payments for non-reversible services’. Every time a business makes an online sale, they take a leap of faith that the buyer is not going to simply reverse their payment after receiving the item. Until that payment is settled and finalized, there is no guarantee.
For every $100 chargeback a retailer faces, they incur roughly $240 in associated expenses due to merchandise loss, loss of revenue, chargeback fees and administration fees. From a consumer’s point of view, this may be seen as a ‘victimless’ crime or minor issue, but for retailers, this is a real and growing problem. For small businesses, solving this critical issue can be the difference between staying in business or shutting down.
Whether done intentionally or unintentionally, credit card fraud is massively costly to the economy. And it is growing rapidly as ever more of our payments happen online. Whether it is a result of removing the personal connection that used to be involved in purchases (e.g. in cash at a store), or just a nature of how complex our e-commerce and logistics systems have become, there is a real $125 billion issue that needs to be addressed.
That is just chargebacks alone.
How many times have you been worried as a consumer about paying for an item from a somewhat-questionable website, or perhaps from one in a different country? Everybody has experience taking that online leap of faith, submitting their credit card details or using PayPal, and then crossing their fingers and hoping that their oversized burrito blanket actually arrives 2 weeks later.
That distrust and uneasiness is natural, and we as humans feel that even more acutely when we transact online without the human-to-human interaction that, up until just 20 years ago, was how we conducted business. That is also the opportunity that current payment providers take advantage of. PayPal rose to prominence primarily because it enabled people to make online payments without having to directly trust the counterparty. Instead, they both had to trust that PayPal will ensure a) the payment is good and sent, and that b) in return, the product or service is provided in return. What does PayPal offer? Trust in an online transaction. Its value? $80 billion.
These examples are intentionally narrow, as most readers are likely most familiar with the experience of day-to-day payments online. But this issue of trust, frictions and middlemen in transactions is deeply engrained across our entire financial system. Banks, asset managers, stock exchanges, remittance providers, commodities and derivatives marketplaces, in aggregate representing hundreds of trillions of dollars of financial activity, all equally suffer from similar problems, and billions, if not trillions, of dollars are spent annually trying to overcome them. As a result, our financial system today is a byzantine web of opaque markets and siloed servers with minimal interoperability between companies, platforms and payment rails. Clearinghouses, T+2 and 2/10 settlement, correspondent banks, escrow agents, payment processors and gateways. All of these are examples of the patchwork solutions we have in place to make our payment systems function as they do today. We led with the consumer use case because the sheer scale of the inefficiencies in the financial system is almost too large to fully appreciate, and any solutions therefore seem to border on fantastical.
But the reality is that the costs incurred to solve these issues grow exponentially as you move up the ladder from consumer payments to global business. Credit and counterparty risk is inherent in every business transaction. One of the major ways companies protect themselves is through credit default swaps (CDS) – a $30-trillion per year market in the US alone. Buyers purchase these in order to protect themselves from the credit risk of an investment or deal. These are the instruments that were front and center of the 2008 financial crisis that ultimately led to widespread bank failures and the enormous tax-payer funded government bailouts that followed. The contagion that spread was largely driven by the complete inability of any entity to trust any other entity or the securities and collateral they offered.
As another tangible example – when an oil trader strikes a deal for 1 million barrels with a buyer in a different country, they take on enormous credit risk. At current prices, that deal would be roughly $70-$100M. After an agreement is reached, the seller has to ship the 1M barrel cargo around the world (~3 weeks), and even after receipt, the buyer typically has 3-4 weeks to settle the contract. Needless to say, a lot can happen over a 6-week time period that may lead to the buyer not being able (or willing) to pay, despite the seller already having shipped that oil around the world. Any disputes that arise regarding non-payment are incredibly difficult and costly to settle on top of being out that entire payment, oil shipment and opportunity costs. $100M is a lot to float another company across the world with the hope of getting it back a few weeks later. Every single deal an oil trader makes has to involve their credit underwriting department.
Trust and credit are completely central to enabling global commerce but come at an enormous cost and present incredible risk to the system if fractured in any way, as we saw in 2008.
That ‘Introduction’ text snippet we showcased at the top was from a paper written in 2008, when computers had just 2GB of ram, e-commerce was just taking off, and when Amazon’s revenue was just 0.06% of what it is today. But it was also at a time when the world was suffering through the most severe financial collapse since the Great Depression, and trust in financial markets, governments and ‘the system’ around the world was low. Though the specific focus of the paper was on simple online payments, the broader context of that paper was in the midst of the global financial system grinding to a halt due to the lack of transparency, obfuscated risk taking, and need of an extensive web of middlemen to facilitate payments between parties.
That publication is The Bitcoin Whitepaper, describing a “Peer-to-Peer Electronic Cash System”.
We encourage all readers to read the whitepaper in its entirety. It is short – just a few light pages – but lays out the pseudonymous creators’ vision for what problem Bitcoin was trying to solve and provides high level details about how the protocol functions in practice. Do not worry about understanding it all but try to at least appreciate the what and the why behind its development and the reason its creator Satoshi Nakamoto (pseudonym) felt it was a necessary creation in the first place.
The first block mined of Bitcoin, the ‘genesis’ block, viewable here, includes a not-so-subtle hint:
There are two key issues that Bitcoin was designed to address. The first is the far more practical need for a peer-to-peer payment system that does not require intermediaries and the fees they charge to enable online transactions (Visa and Mastercard collectively charge $60B per year to use their networks, for example). This is the problem that Bitcoin addresses as “a peer-to-peer electronic cash system”. That is, how can we replicate all of the positive aspects of cash, but in an internet native way? Most readers are likely fine with that proposition – Fintech and Paytech are pretty standard areas of technology development.
It is the second issue where many likely start to feel a little more consternation. And that is fair, as it is admittedly a more existential issue and quite the leap from ‘internet cash’: a growing, metaphysical lack of trust in governments, institutions and currencies, and the requisite need for a truly neutral, permissionless way to protect wealth that exists outside the control of any one entity. This latter framing has gained far more prominence since Bitcoin was released, and for many around the world, it is what makes Bitcoin most valuable. It is also a natural pushback against the ever-growing encroachment by technology and governments on our privacy. The argument that Bitcoin is ‘digital gold’ primarily arises from this viewpoint. And once you blend both of those pieces - digital gold and a way to transfer it in a frictionless and global way - the value proposition starts to become clear.
In the following segments, we will go deeper into each of these objectives to provide better context around why Bitcoin was such a unique innovation when it was created and how it retains much of that uniqueness, even today. We are putting a heavy emphasis on Bitcoin to begin this series because a) it was the first, b) it is the largest by far, and c) it is relatively simple in its approach. We do this so we can use Bitcoin as a foundation from which we can better contextualize all of the other developments happening, which is where the majority of our focus will be over the coming weeks. But for now, we will keep this introduction short and instead ask the reader to do your homework and take the first step towards understanding this technology: reading the Bitcoin whitepaper.
Also available here: https://bitcoin.org/bitcoin.pdf
We promise that it is a quick and fairly accessible read, but for those just looking for the TL;DR:
Discover how Bitcoin is revolutionizing transactions and cutting costs
Understanding digital assets: addressing real problems beyond the hype and scams.
