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Bitcoin for Merchants, Part I

author: Vitalik Buterin
published: 2011-07-14 22:22:32 UTC

With immediate hopes of Bitcoin's value exploding past $100 shattered, the community's focus has now moved to improving Bitcoin's viability as a currency, finding ways to make it easier to use for customers and merchants. According to Pirate Party founder Rick Falkvinge, gaining a significant foothold in merchant trade could increase Bitcoin's market value by a factor of 12500. Bitcoin has some highly specialized use cases where it could truly shine, mostly having to do with circumventing legal obstacles, whether to buy illegal goods like drugs or to move money across borders, and there is considerable room for expansion in these areas, but, looking at Bitcoin specifically, Rick Falkvinge's analyses on illegal trade and international trade and, looking at society in general, the trend in personal computing technology of the last few years toward smartphones and applications for them both show that the greatest success can be found by catering to the average user.

There are two types of commerce that individuals engage in: shopping in physical stores and shopping on the internet. This article will talk about the former, and the next part of this series will talk about the latter. A strong argument can be made that physical stores will be one of the last niches occupied by Bitcoin if it expands that far due to network effects - it's a lot harder to find enough customers to maintain a store if they all have to be within travelling distance of you. However, the community effect can partially counteract this weakness by encouraging people to seek out Bitcoin-accepting stores specifically; this mechanism is already supporting Internet-based Bitcoin stores like BitMunchies. Also supporting expansion of Bitcoin into physical space is the fact that, as illustrated by this real time transaction map, Bitcoin adoption is highly centralized into parts of central Europe and the northeastern US, so Bitcoin-accepting communities in a few large cities can open up and begin operating in a self-sustaining way without large scale global adoption. A restaurant in New York has gained some publicity for accepting Bitcoin already.

But as an internet-based currency, there are unique challenges that are faced by Bitcoin users who wish to employ it in physical stores. The first is a convenient method of payment. The people ordering from the restaurant in New York with bitcoins have to go through a complex procedure to get the bitcoins sent:

I transferred this address onto my laptop and logged onto my Mt. Gox Bitcoin exchange market account. In the meantime, the owner took out his own phone, looked up the current exchange rates, and told me he wanted 0.52 Bitcoins for my lunch. I asked Mt. Gox to send 0.52 Bitcoins to 1MTbKpYWnzqmsLvCjdTtwrvuX81g3HCgC and about three minutes later the restaurateur received an e-mail on his phone indicating that the coins had arrived.

Having to take out a laptop, connect to the internet, open up the Bitcoin application and send coins is fine when you're sitting at home and the first three steps are already done, but it's unacceptable for a grocery store or a restaurant - paying for a product or service should not take two minutes per customer. The solution to this is an obvious one; the Meze Grill customer herself mentioned it, and it has already been mentioned in this very article: smartphones. Recently, an Android application has been released that simplifies the process of paying with Bitcoin to scanning a QR code with a smartphone camera and hitting "send". This removes the need to deal with laptops, allowing payment with Bitcoin to be just as easy as payment with credit cards, but there is still one obstacle: the transaction time. There are three levels of transaction acceptance:

• 0/unconfirmed - the transaction has spread through the network to the destination. This happens almost instantly.
• 1/unconfirmed - a block passed while the transaction was unconfirmed. Reversing a transaction at this stage is extremely difficult. This takes 10 minutes.
• X confirmations - a miner put the transaction into a signed block, and the transaction is official and irreversible. This takes 10 minutes to over an hour, although if a transaction fee is used the transaction will almost certainly be included in the first block.

With the first and the second, a double spending attack can be pulled off but is difficult as eventually (which can be in as little as a few seconds) the node will discover both transactions, while with the third a double spend is impossible without extreme unforeseen circumstances like a bug in Bitcoin itself or someone maliciously exploiting a computing cluster with over 50% of the Bitcoin network's power. Clearly, waiting for even 10 minutes is unacceptable in a grocery store, so the third level of acceptance is impractical. There are two solutions to this problem:

1. Accept 0/unconfirmed and rely on trust. It is not too difficult to run out of a restaurant paying nothing or paying only part of the bill - the latter option allows you to claim that you simply made a mistake if you ever get caught, and it can be trivial to walk into a convenience store, steal something quickly off the shelf and walk out, but this does not happen that often, and in first world countries people have decided that the effort of securing oneself against these types of attacks is not statistically worth it. Such attacks do need to be protected against on the internet, and security is an important issue, but the risks of trying to double spend Bitcoin in physical space are considerable, and there is no "sorry, that was an accident" escape - an attempted double spend attack requires deliberate effort to pull off and cannot be disguised as anything else. Even if the fraud is noticed too late, with security cameras the perpetrator faces the same risk of being caught as he would if he had just stolen the goods.
2. Add a centralized layer to Bitcoin. This is the solution that MtGox released recently. Under this solution, users can create voucher codes that are redeemable with MtGox for bitcoin, so a user can send a code to the merchant who can then use the code to check that MtGox has the bitcoins. Centralization is a weakness of this system, and MtGox and its main potential competitor in such a service, MyBitcoin are both known for less than perfect security, so while this is the most efficient solution it is important to tread carefully here - in the long term there is a risk that such services will be integrated into society and will be required by all merchants, so we would end up with a new Paypal, Mastercard and the like but simply backed by a different currency. The relative ease of setting up a centralized bitcoin proxy would allow for far more competition, so the situation would not be as dire as it is now, but the possibility is there especially if such services become regulated.

All in all, it seems that the merchant ecosystem for Bitcoin is approaching completeness before there is enough demand for such an ecosystem to even exist. Integrating all aspects of technology - internet, smartphones and desktops, allows people to pay each other with unprecedentedly high privacy and efficiency and unprecedentedly low transaction fees. The Bitcoin community's dream to create a currency to escape the wrath of Western governments' monetary policy through deflationism is for now put on hold until the Bitcoin economy expands, but Bitcoin is well on the road to succeeding in a goal which was once secondary but is now becoming more and more central to its existence: creating a strong competitor to credit cards and conventional payment systems, and removing the Visa/Mastercard/Paypal tax from the economy.

The next installment of this series will discuss the challenges of Bitcoin payment over the internet, and challenge a key assumption prevalent among the Bitcoin community.

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