There is an argument recklessly thrown around that Bitcoin could never work as a currency because its transaction speed is very slow. It takes up to 10 minutes to confirm a Bitcoin payment. On the other hand, fiat transactions take place instantly.
This argument appears to be true, but it is disingenuous because it compares two different layers of monetary systems. Any monetary system has to have layers as a mechanism of striking a balance between security and transaction speed. A super-fast monetary system could compromise on security. A slow system that maximizes security has to give on the transaction speed side of things.
Slow transaction speeds mean some of these cryptocurrencies are not scalable. No one wants to wait 5 minutes at the point of sale waiting for the bitcoin transaction to be confirmed. This is a valid point.
In order to have both speed and security, a monetary system is developed in stacks, one imposed above the other. These stacks are called layers. The first layer has maximum security. The second layer, superimposed above the first layer, has faster transaction speeds.
There can be third and fourth layers as well built upon each other. All sorts of firms have cropped out on the third and fourth layers of the Fiat system. The FinTech revolution, building on top of the fourth layer of fiat money is also revolutionizing banking and finance.
Consider the Gold Standard Monetary System under which the first layer comprised of gold. Gold was considered to be the real money. Gold was physically exchanged between bankers as a means of settlement.
The second layer wasn’t far from the first layer. It comprised of gold coins minted from gold bullion. These were primarily used as currency in exchange for goods and services. As trade and commerce blossomed the monetary system got more advanced with paper certificates being issued by bankers as a confirmation that a person deposited his gold with the banker who was holding it in custody.
Paper certificates were then used in the exchange for goods and services. Paper certificates metamorphosized into cash money. Cheques were imposed into this structure as another layer.
From this you can observe that:
- Gold Bullion — was the First layer — reserve money — for settlements
- Gold Coins — was the Second Layer-trade money- settling trades and currency
- Cash Money -was the Third Layer-transactional money-currency
- Cheques — was the Fourth Layer-transactional money-currency
When the Gold Standard was phased out, the monetary system became what is known as the fiat system. Currency is declared to be so by law from the government. The system is debt-based with a fractional reserve system at its core. New money is largely created via debt with a tiny portion coming into existence directly as notes and coins.
The system is more complicated than the Gold Standard monetary system. It’s internationalized and electronic. It is a double-entry ledger-based system with nation-state central banks at the core, which issue currency in their jurisdictions as well as maintain their side of the ledger.
Central banks have their own children known as commercial banks in their jurisdictions. These banks serve the public primarily in and lately out of their jurisdictions. To mutually agree on which entries to pass in the books (actually databases), banks communicate using a secret method called the SWIFT system.
This system is essentially a communication protocol that allows them to transfer value by mutually confirming the entries to pass, for example, debit John Doe’s account in Nebraska, USA, and credit May Blow’s account in Windhoek, Namibia. These messages are queued and cleared in batches. They call this process batch settlement.
To the end-users, John Doe and Mary Blow, this process is fast and instant, but what actually happens in the background is not that fast. There are layers that need to be cleared in the back offices. When Joe Doe in the USA instantly pays Mary Blow who is in Namibia, a little bit of credit is involved.
All these transactions do not involve the physical movement of money. It’s just ledger entries. The ledger entries need to be confirmed and mutually agreed on by bankers. This confirmation process takes time because it has to be secure. And that is the crux of the whole matter.
Mary’s bank trusts the system such that upon receiving the message, actions it by extending credit to Mary (crediting Mary’s account), and to Mary, it’s done. Once the confirmation process is over, Mary has already been sorted and the bank has passed the necessary entries.
But the bank can only extend this temporary credit for small transactions. For big transactions, they have to wait for the message to be mutually confirmed by all the banks involved (sometimes there can two or three or more banks involved in between John’s bank in Nebraska and Mary’s bank in Windhoek).
At times, the confirmation process can take up to 3 days. Bankers call this T+3. Sometimes it can take two days.
From this, you can notice that:
- Central Bank Databases and the SWIFT System — are the First layer — database money — for settlements
- Credit Money — are the Second Layer-trade money- settling trades and currency
- Electronic and Cash Money -are the Third Layer-transactional money-currency
- Tech-enabled platforms- are the Fourth Layer-transactional money-currency
For lack of a better term, what I am calling credit money on the second layer are essentially clearing facilities that banks have between each other, within nation-states (for example ZIMSWITCH in Zimbabwe) as well as across countries (intermediary banks, correspondent banks). These allow transaction batches to be cleared faster.
With Straight Through Processing (STP) within local banking systems, a transaction can go through faster. It can be processed to the recipient before the actual settlement of the batch takes place. Always keep in mind that Settlement is just coming to an agreement on a list of debit and credit transactions and concluding that in the end, one owes the other.
Electronic money and cash are the most fascinating layer of fiat money. They are super-fast. If both sender and recipient use the same bank, electronic transfers take place immediately. Why? Because the relevant entries are within the same database. Not much confirmation is needed. A long time ago much confirmation was needed as each branch of a bank had its own database and the branches had to do inter-branch clearings.
The same efficiency goes for cash. Cash is very efficient, it’s only inefficient when large sums are involved. Cash needs only one confirmation; that it is not a fake note. Well for coins, and a stack of cash, you need to count. Other than that, the database entries are simple. Your physical wallet is a database. When you pay cash, you are debiting your database and the vendor is crediting his database. When you withdraw money from an ATM, there two databases involved, the bank’s database debits your bank account, and you credit your physical wallet database (by inserting notes in your wallet or pocket).
The fiat monetary system is so humungous, complicated, and efficient. It could be accused of being bloated but it cannot be accused of being inefficient. It’s that rare case where a thief is not a liar. Usually, every thief is a liar, and every liar is a thief.
You have all these moving parts (databases, banking systems, settlements systems, clearing systems, messaging protocols, networks, card systems, banking android apps, internet banking portals) working together harmoniously behind the scenes to empower the world of commerce with the ability to execute transactions and transfer value. It’s a wonderful world.
Bitcoin is an excellent monetary engineering product. When you build a monetary system from scratch, it makes sense to build a very strong first layer. Bitcoin has a first layer system that is decentralized, yet it maximizes security.
Bitcoin has a standardized unit of measurement. One bitcoin is one bitcoin the world over. The Gold Standard Monetary system ran into challenges because the way to measure the weight of the bullion bar was different in each jurisdiction. England measured gold in pounds whilst the Americans measured gold in dollars.
Sometimes the weight in each bar would be different so to agree on the value you would have to come up with exchange ratios. The differences would grow notably after a debasement, where a country changes the weight of gold in their bullion and changes the composition of gold in each minted coin. The SI system of measuring in kilograms got rid of the disparities.
The Fiat Monetary system has at its core central bank databases and the SWIFT system. Yes, our money is just numbers entered in databases. Each central bank has its own set of numbers, kept in its own database, where it has the sole right to type in more numbers. We call these currencies. The more numbers a central bank creates in its database, the weaker its currency becomes.
The Federal Reserve is at the center of global central banking. Its own set of numbers called the United States Dollar is the most popular set to calculate exchange ratios with. All the other central banks have a tab at the Federal Reserve, where the Federal Reserve keeps an account of who owes them how much, and how much change they have to be given back. Global clearance and settlements are done via the Federal Reserve in United States Dollars.
On the Bitcoin network, the verification and confirmation of first layer transactions are fast. It can take a maximum of 10 minutes for a transaction to be verified and stamped on the immutable decentralized database.
For the gold standard, it used to take up to a month for a bar of gold to be literally shipped across the Atlantic for settlements. It can be done faster these days with airplanes.
Within the SWIFT system, it takes up to 3 days for a transaction to be verified and confirmed. Most people who are not involved in international trade or who are not involved in moving big monies are not aware of this. They are not aware of the existence of layers. They are also not aware of the existence of credit in the form of clearing and settlement accounts that play a very crucial role in ensuring that most of the smaller value transactions do not have to wait for 3 days.
Bitcoin is an evolving system whose First layer is unmatched by Fiat’s first layer. Apple-to-Apple, we are comparing 10 minutes vs 3 days. There are 4,320 minutes in three days. Thus, on an apple-to-apple basis, the Bitcoin system is 432X faster than the Fiat system.
Comparing Bitcoin’s First Layer with Fiat’s second, third and fourth layers is spurious. It is disingenuous and mischievous.
The confusion is partly a result of the democratic way in which the bitcoin monetary system operates. Bitcoin’s monetary system allows anyone (big or small) to participate in the system at the first layer.
The small player does not know that he is participating at the first layer, but big treasury departments that are accustomed to participating at the first layer of fiat will admire the speed at which first layer bitcoin transactions are approved. You can literally send a billion dollars across the world in less than 10 minutes without filling-in a single document.
Does the Bitcoin system have a second layer? Not yet. It is still in development. The Lightning Network is developing “lightning-fast” second layer Bitcoin blockchain payments that are capable of processing millions of transactions per second. To put this into perspective VISA processes 1,700 transactions per second.
When completed, the lighting network will simply be incomparable to the VISA network.
Bitcoin’s first layer system handles 4.6 transactions per second.
The landscape for building second-layer Bitcoin transactions is evolving fast with many players eying the market as Bitcoin’s adoption curve steepens and its value rises.
Once Bitcoin manages to get to the level of gold by market capitalization, we should start to see second layer technologies infiltrating. The gold market is valued at 10 trillion, bitcoin is still under a trillion. It will take time for bitcoin to surpass gold. It will take even more time for Bitcoin to gradually replace fiat’s first layer.
Central banks are not going to wake up one day and start to use bitcoin for certain settlements because bitcoin is anti-central banking. Maybe, some banks might do that, in order to avoid the weaponized SWIFT system but it’s a long shot.
There are certain use cases that could trigger avoidance of the Federal Reserve and SWIFT system. For example, if Zimbabwe wants to sell uranium to Iran, it could require payment in Bitcoins instead of US Dollars. The central bank of Iran sends the required bitcoins to the central bank of Zimbabwe. This transaction will not appear on the fiat monetary system and the OFAC cannot block the funds.
Basically, the same argument thrown around that bitcoin can be used by criminals also applies to the use of bitcoins by “rogue states”. However, once proven to be a fast, secure, and democratic way of first layer settlements, there is nothing that could stop the “rogue states” from migrating more of their transactions onto the blockchains.
On a strictly layer-by-layer comparison, the Bitcoin monetary system is way better than the fiat system.
That being said, the transaction speed issue is secondary. As long as fiat exists, there won’t be any real need for a Bitcoin second layer. Fiat systems can act as the second layer, as long as there is convertibility from Bitcoin to Fiat. You can always instantly convert your satoshis to fiat at the point of sale.
A person can save in Bitcoin, keep his money in Bitcoins but transact in fiat. Only a total apocalypse scenario for fiat (e.g., hyperinflation) will necessitate fast second-layer bitcoin transactions.
That being said, transactions speeds are important but are a secondary factor, the primary factor is the soundness of money. Bitcoin outmuscles all fiats in this area. It also outmuscles all the other cryptocurrencies (i.e., new monetary systems).