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Using a credit card to pay for purchases has negative implications for businesses and consumers. Bitcoin provides a better, alternative payment method.
Contrary to some predictions, Bitcoin is quickly becoming an accepted means of conducting transactions. Major companies like online retailer Overstock.com and mobile provider AT&T already allow customers to pay in bitcoin. And the list of businesses accepting bitcoin keeps growing every day.
On a basic level, this trend proves that bitcoin isn’t a useless virtual currency as critics love to claim, but it also represents something more fundamental: Bitcoin’s potential to replace legacy payment processing systems like Visa and MasterCard.
Perhaps this may sound far-fetched, but there are plenty of advantages that Bitcoin offers both consumers and merchants. And if you know anything about the creative destruction inherent in capitalist societies, Bitcoin replacing credit cards is only a matter of time.
Let’s look at the anatomy of credit cards and Bitcoin payments before highlighting the differences between both of them.
How Do Credit Card Payments Work?
When you pay for a product with your credit card at a point of sale, the money doesn’t go directly to the merchant as you may think. The actual process is a dance of sorts, involving you (the cardholder), your bank, the credit card network, the merchant’s bank and the merchant.
Here is an example to illustrate:
Imagine you (the cardholder) pay for a pair of sneakers with your Visa card at Bob’s shop downtown. Essentially, you’re authorizing Bob (the merchant) to “pull” the payment from your account. But this payment must pass through several intermediaries before Bob gets it.
First, the credit card network (Visa) relays the payment request to your bank. Then your bank authorizes Visa’s request to transfer money from your account to Bob’s bank. The last step involves Bob’s bank accepting the payment and depositing money into Bob’s account.
From this illustration, you can see that Visa is just a player in the payments network. It merely facilitates interaction between different parties in the ecosystem. This is a crucial fact that many tend to miss, especially when comparing Bitcoin to credit cards.
How Do Bitcoin Payments Work?
To pay in bitcoin, you transfer coins from your wallet to the recipient’s address by signing the transaction with your private key. The payment is recorded on the Bitcoin blockchain, which is akin to a ledger used to record transactions. The difference is that this ledger is public and entries cannot be modified or deleted.
Compared to your credit card, Bitcoin “pushes” the payment directly to the merchant. There are no third parties involved in processing the transaction, which is why Bitcoin is described in the white paper as a “peer-to-peer electronic cash system.”
If we apply this concept to the previous example, then you might see how Bitcoin payments differ.
If you want to pay Bob with bitcoin, all you need is a wallet containing bitcoin and Bob’s public address on the blockchain. Then you’d transfer a specific amount of bitcoin to Bob’s address, authorizing the transaction with a digital signature generated from your private key.
Bob will immediately receive the money in his wallet once the payment is confirmed by miners, without enduring the authorization, exchange and settlement processes used in credit cards. Thus, Bitcoin payments are like wire transfers — the money passes directly from the customer to the buyer.
Now, let’s dig in and understand how Bitcoin’s features make it better for processing transactions.
Why Should Bitcoin Replace Credit Cards?
When comparing Bitcoin to credit cards, critics often highlight disparities in the processing speeds of both systems. For example, Visa handles 24,000 transactions per second (TPS), compared to Bitcoin’s five to seven TPS.
However, such comparisons leave out many crucial details. Swiping your credit card doesn’t automatically deposit the money in the merchant’s account. Instead, credit card companies take several days to authorize and clear the payment.
Bitcoin is designed as a self-contained bank and payments network. You only have to move coins from one address on the blockchain to another if you’re paying with bitcoin. This process completes in 10 minutes or less and provides transaction finality, unlike your credit card payment.
Also, Layer 2 solutions like the Lightning Network can scale Bitcoin to speeds to rival the fastest payments systems. Lightning Network offloads transactions from the main chain, reducing transaction confirmation times and boosting network throughput. Although Lightning Network adoption is still growing, it could potentially disrupt the Visas and MasterCards of this world in the future.
The downside of relying on multiple parties, as credit card payments do, is that it increases the risks of a malicious attack. When you enter your credit card details on an e-commerce site, you’re authorizing it to deduct money from your account. This isn’t a problem if the business is trustworthy, but what happens when an unscrupulous hacker steals that information?
Large businesses, including Equifax, Neiman Marcus, Target, and Marriott Hotels, have been victims of targeted attacks designed to steal customers’ credit card information. These thefts often expose customers to risk since hackers can use stolen card details to complete unauthorized purchases.
The security risks of credit card details also extend to physical purchases. Card skimmers are notorious for stealing credit card information from point-of-sale devices, like self-serve gas pumps or checkouts at retail stores. They can drain your accounts in minutes with that information.
Save for the amount and the recipient’s address, Bitcoin doesn’t require any other information to process a payment. You only need to authorize the transaction with a private key — stored safely in your wallet — and that’s it.
A hacker would need to compromise your device or use social engineering techniques, such as phishing, to steal your keys and initiate a Bitcoin payment. However, these problems can be easily avoided by noticing fake websites, storing keys safely or using a multisig wallet.
Business owners can also benefit from Bitcoin’s secure network. The irreversible nature of Bitcoin payments prevents chargeback fraud, where buyers receive goods and cancel the payment later. Businesses won’t be tasked with safeguarding sensitive credit card information, eliminating the need for costly payment card industry compliance measures.
Lower Transaction Fees
Credit card providers charge fees for processing payments, which can be as high as 3% of the original purchase. Since some merchants have low profit margins, they are often left with no option but to pass these costs on shoppers.
Bitcoin isn’t cheap, either; transaction fees can spike, but Layer 2 solutions like Lightning Network can solve this problem. The median fee for processing a transaction on Lightning Network is one satoshi, equivalent to 0.00000001 BTC or $0.0004. With such low charges, it’s easy to understand why businesses are keen on integrating Lightning-powered Bitcoin payments into their revenue model.
Cheap transaction fees benefit both businesses and shoppers. Business owners wouldn’t have charges eating into their profit margins, while customers can pay for products without taking on extra costs. If that sounds like a win-win solution, then you’re starting to see the true value of Bitcoin.
You can’t just waltz into a bank, say “Hey, can I get a credit card?” and expect one to magically appear. Nope. Every bank you visit will have you complete a lengthy registration process before issuing a card. The process is the same, if not longer, for merchants looking to set up point-of-sale systems with a credit card provider.
With Bitcoin, all you need to do is set up a wallet and generate your keys to start receiving and sending payments. There are many free Bitcoin wallets you can use, either as mobile applications, desktop software or web applications. And the sign-up process is usually simple enough for even the most nontechnical people.
The benefits of Bitcoin’s simplicity may not seem obvious, especially if you live in a Western country with well-ordered banking systems. In developing countries, where things like creating a bank account or getting a credit card are nearly impossible for most individuals, Bitcoin’s peer-to-peer cash system is a godsend.
Bitcoin can improve commerce by allowing unbanked individuals to pay for products provided they have an internet-connected mobile device. It could also make it easier for small businesses to set up payment channels sans the usual paperwork.
Privacy And Anonymity
By design, Bitcoin transactions are pseudonymous: the blockchain only records the public addresses of parties and the amount exchanged. No one can know who you are or what you paid for by looking up a transaction on the blockchain.
Many people associate Bitcoin’s anonymous transactions with right-wing extremists, terrorists or other criminals who need to sidestep traditional banks. However, even regular people buying legal goods may not want their identities linked to purchases for different reasons.
For example, a person purchasing an adult toy online would prefer a more discreet method of purchase than a credit card. Besides, payment providers have been known to block purchases of products like marijuana despite them being legal.
Even if you’re not making transactions that need to be kept private, you should think twice about buying goods online. It’s an open secret that credit card companies sell user data to advertisers and fuel ad-targeting campaigns.
Every time you pay online with your credit card, someone is using that data to target you with ads. Ordered a Dyson vacuum last night? You can expect some “Best vacuum cleaner for your home!” ads to start popping up every time you open a page.
Businesses don’t store your information when you pay with bitcoin, so you can make purchases in peace. They cannot sell your data to advertisers either, so your browser isn’t about to get filled with intrusive ads.
Although Bitcoin gets a lot of negative press, its value as an efficient payment system cannot be denied. For businesses, accepting bitcoin payments means reducing wait times for transactions, reducing chargeback fraud, and paying lower processing fees. For buyers, Bitcoin offers a secure, private, fast and simple way to pay for products and services.
With new improvements like the Lightning Network, acceptance of bitcoin payments will only keep growing. In time, Bitcoin might just do both consumers and merchants a favor and end the monopoly of credit card providers.
This is a guest post by Emmanuel Awosika. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc. or Bitcoin Magazine.