Thursday, June 5, 2014

DISH, Overstock, and Bootstrapping a New Currency

By Jon Matonis
Saturday, May 31, 2014

On the heels of the recent Dish Network announcement to begin accepting bitcoin payments, we saw the same clueless chorus of naysayers and payment newbies come out claiming that Dish doesn't really accept bitcoin because they actually end up with US dollars.

It would be just as ridiculous to say that a hotel in Barbados doesn't accept US dollars because, after the VISA credit card transaction, the hotel ends up with Barbados dollars.

Dish Network selected bitcoin payment processor Coinbase to manage the foreign exchange conversion risk in the same way that other international merchants select credit card processors. It matters not what the merchant's native currency is, but what they permit consumers to use when purchasing.

As with Overstock's decision to begin accepting bitcoin payments, the Dish announcement is significant because it adds yet another payment outlet for holders of bitcoin and it brings another large merchant into the ecosystem of processing bitcoin transactions.

Dish's executive vice president and chief operating officer Bernie Han said that Dish sees its new payment option as a way to boost customer service:
“We always want to deliver choice and convenience for our customers and that includes the method they use to pay their bills.”
One cannot overlook the fact that something as mundane as a payment option is also being strategically deployed as a competitive wedge in a branding and messaging campaign. However, this residual bonus has a diminishing impact as more companies announce their intention to embrace bitcoin and we move past its early adopter phase.

The monetary transition process

While some analysts observe that new merchant acceptance has the effect of creating downward price pressure for bitcoin, since processors immediately convert into national currency for their clients, I maintain that the entire process is simply part of bootstrapping a new currency.

And yes, selling pressure from new merchants converting out of bitcoin may not always be replaced by new buying. Bitcoin is barely in the early stages of this monetary transition process.

That process includes price discovery on liquid exchanges, creation of closed-loop systems to both receive and spend bitcoin, and finally, pricing of goods and services in the new numéraire.

The trend towards global participation

In an important but somewhat pessimistic paper, "Cryptocurrencies, Network Effects, and Switching Costs," William Luther observes that there is a systemic bias against monetary transition. His research concludes that despite the inferiority of the prevailing currency and due to both network effects and switching costs, "cryptocurrencies like bitcoin are unlikely to generate widespread acceptance in the absence of either significant monetary instability or government support".

As an economist, I disagree with this thesis because it fails to consider global usage and the potential for bypassing capital controls. Luther's cited monetary instability or government support are both conditions relevant only within the restricted political borders of a monetary regime. They may serve as great litmus tests in a confined jurisdiction, but they are utterly useless in considering cross-border transactions.

The trend towards global merchants participating in a global economy will only serve to strengthen this dynamic. We are witnessing it today with at least 60 countries blocked out of the current prevailing payment systems, and hence unaware of the switching costs and network effects of Luther's incumbent monies.

Quoting bitcoin prices

Beyond the network effect of incumbents, I do agree that the holy grail for bitcoin is having prices quoted and displayed in bitcoin rather than mentally going through a conversion process. This step completes the process for monetary transition and it is difficult to predict how that specific step occurs.

In "The Origin, Classification and Utility of Bitcoin," Peter Šurda correctly states:
“Even though not money, bitcoin is a medium of exchange ... While it is true that economic calculation is beneficial, this is merely one of the relevant aspects of media of exchange. Economic calculation depends on the unit of account, and while bitcoin is not used as a unit of account to any apparent degree, it may happen in the future, and its utility would increase even more in such a case.”
Redditor ISkiAtAlta makes an interesting observation on why it's not easier or more beneficial to (re)obtain bitcoin than it is to obtain or use fiat, claiming that we're not there yet because the barrier to obtaining bitcoin is too high and the perceived benefits have not yet been internalized – particularly for new users.

That above rationale addresses the issue of monetary switching costs, but I think it applies equally to the establishment of a numéraire, or favored unit of account.

Framing it as an issue of timing, ISkiAtAlta offers three items that must be present for motivating consumers to go through the trouble of transacting in bitcoin: (1) it has to become easier to obtain bitcoin, (2) people must see the value of holding their savings in bitcoin, and (3) merchants must offer discounts for bitcoin transactions.

I would add that consumers must have more user-friendly applications and that merchants must also see the value of holding balances in bitcoin which becomes reinforced by expenses and liabilities – expressed in bitcoin through supply chain vendor demand or employee demand. It becomes infinitely easier to maintain bitcoin balances if a merchant or company knows that risk can be reasonably hedged and that others will also accept settlement in bitcoin.

Bootstrapping a new currency is always a chicken-and-egg dilemma, but when it comes to volatility, original perspective can be helpful too. Perhaps it's not bitcoin that is volatile against the US dollar, but it's the US dollar that is volatile against the future store-of-value bitcoin.

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