Reforming a dubious past
Can the notorious, high-flying, volatile, and unpredictable Bitcoin system be gainfully deployed for legal and legitimate business models that have the potential of disrupting the existing world of banking and finance?
This article explores an interesting attempt by a start-up called Abra to develop a master plan for a global payment system not by using bitcoins directly as the exchange currency but by using the Bitcoin system as the reserve currency to hold and exchange value.
Abra claims to be the answer to the reductive and rhetorical question, a favourite of hack writers and professional conference presenters: “Who will be the Uber of banking and payments?”
Legitimate businesses have stayed away from investing in Bitcoin (embracing instead, all too enthusiastically, the underlying blockchain technology that forms the backbone of the Bitcoin system). This is because of Bitcoin’s central role in many a shady enterprise.
Its high valuation, now over the $4.5 K mark, unimaginable even just a few days ago, is driven by the naked forces of demand and supply and not by the good or bad policies of a government or central bank. That is a good thing.
But this upward trajectory has been motored mainly by illegal and illicit activities. Gathering momentum, the increasing valuation is further helped by a feeding frenzy of speculative market sharks.
Making a criminal
Bitcoin, a cryptocurrency system, designed to operate in decentralised environments without the need for a central authority, has served as the primary payment instrument for all sorts of dodgy digital deals.
It was the de-facto settlement currency for the Silk Road, the dark web marketplace that was the ebay for illegal products (drugs, armaments, false identities, and stolen credit cards), and services (hackers for hire, the occasional hitman).
The site shut down when its founder, Ross Ulbricht, a.k.a Dread Pirate Roberts, was nabbed in the San Francisco Public Library running his billion-dollar empire from a humble laptop.
Silk Road was taken off the dark grid but others appeared: Silk Road 2, Silk Road 3, BMR, Pandora, Hydra, Agora, Evolution, AlphaBay etc. Law Enforcement authorities in the United States have been playing cat and mouse with these sites shutting them down only to find others popping up elsewhere. None would have been able to operate without Bitcoin.
Added to the long list of criminal activities, there is also a relatively new one called “ransomware”, described as “cryptoviral extortion” in which malicious software is used to block access to a distant computer or destroy data, unless a ransom is paid.
In the wake of its remarkable success, other newer and lesser known cryptocurrencies are appearing on the scene as alternatives and substitutes to Bitcoin. In 2016, Monero, a cryptocurrency which possesses “significant algorithmic differences relating to blockchain obfuscation” make it virtually untraceable, has gained popularity and saw its value increase from 50 cents to $12.
Reforming a criminal
One start-up that is attempting to develop a legitimate Bitcoin based business (and in the process to change the world of payments) is a start-up called Abra so named, presumably, because of its magical business model.
At a very high-level, Abra is a Bitcoin exchange and a device based digital wallet. Its initial focus is on international remittances and particularly the significant United States to the Philippines corridor. Ultimately it wants to be a low cost universal provider of global money remittance services.
Like the proverbial onion, Abra aims to provide services in several layers – each with an increasing level of complexity and difficulty.
Layer 1: A (simple) Bitcoin exchange and wallet
Abra is a Bitcoin exchange and provides a digital wallet to its customers. Users can transfer funds from a bank account in the US to buy bitcoins which they can hold in the wallet or send to another Abra wallet. The wallet holder can monitor their bitcoin balance. A receiver in the Philippines can sell the incoming bitcoins credited to their wallet and transfer the money to their bank account.
Assuming there are no legal and regulatory wrangles (KYC, AML etc.) the model should work fine provided the sender and receiver want to exchange bitcoins and the transaction can be completed within an intuitive user interface and in a simple manner. Abra’s CEO Bill Barhydt emphasises Abra wallet’s simplicity. In a recent interview he said, “My mother cannot use an off-the-shelf, pure bitcoin wallet app, but she can use Abra [with] no problem.”
Layer 2: A (real) currency wallet
This is where Abra thinks it has made a breakthrough. Wallet holders will also be able to hold funds in “fiat” currency (such as dollars or any of the other currencies supported by Abra). So, if a customer transfers $100 from their bank account, their Abra wallet will show $100.
Simple as this sounds, only licensed financial institutions such as banks, are allowed to take and maintain deposits. Abra plans to do this without being a bank. It will leverage the Bitcoin system and its blockchain technology. Abra will buy bitcoins worth $100 for the customer which will be stored on their wallet. The customer does not need to know any of this or that their wallet balance is represented by bitcoins. They only need to know that their wallet balance of $100 is guaranteed.
Because the value of bitcoins can fluctuate widely, there is a problem. If the price rises, the customer will continue to have $100 in the wallet and Abra and its partners will pocket the difference. But if the price drops, the $100 in wallet will be backed up by bitcoins worth less than $100.
Abra says its partners will “hedge” the price drop through smart contracts (hedging is common in commodity and currency trading). This is the clever piece of financial engineering that Abra says it has cracked.
Layer 3: An agent network
This is where Abra gets ambitious (and possibly delusional).
Abra is developing a network of agents or “tellers”, M-Pesa style, who will facilitate cash top-ups or withdrawals. Tellers are free to charge any fee they like but must pay a percentage to Abra. Abra says it will not regulate what tellers can charge. Ultimately in a free market, inter-teller competition will drive fees down but whatever they charge is likely to be a lot lower than what the traditional money remitters charge.
Here is the inevitable comparison to Airbnb’s disruptive business model which empowers anyone with a car to take on the organised taxi industry.
The growth idea is that as agents will be able to earn income for rendering deposit and withdrawal services and practically anyone with a small investment can become an agent, the network will grow by itself making Abra’s services readily available wherever needed.
However, coming up with an idea that has an incentive based growth model built-in is great. But developing it into a self-sustaining network and a growing eco-system is an all-together different proposition.
Some of Abra’s strategic challenges and operational risks presented below can be applied to any start-up that aims to disrupt banking and payments. Others such as hedging through smart contracts are peculiar to Abra.
Where is the problem?: The strategic blind spot of many promising “customer facing” technologies and innovations, at least in banking and payments, can be best described by the proverbial “solution seeking a problem”. If there isn’t anything that a new service offers that significantly makes life easier (or cheaper) for the customer, it is likely to be treated with apathy. Will a clever crypto mobile remittance service make customers switch their existing providers (keeping in mind that there are several layers of competitors in the market ranging from large banks to disruptive Fintech companies), is a gargantuan challenge that an innovator like Abra can only ignore at its peril. Some innovators have rightly focused on solving a known problem. Take for example, Flywire, a company which targets international payments made for education (international student fees) It makes it easier for colleges to keep track of and reconcile student tuition fee remittances. This has resulted in colleges instructing international students to pay via Flywire rather than normal bank transfers which carry very little ancillary information and are difficult to reconcile.
Trust and familiarity: International remittances represent a unique industry with some very specific customer dynamics at play. Migrants who need to send money often use the services of those they trust or those who have connections with their community which is why there are a number of small country specific remittance companies that profit from loyal customers who speak the same language and understand the culture of the migrant community. The market is hotly contested. There are Fintech companies such as Transferwise, Transfast, Azimo, and Remitly targeting the remittance sector as a whole but none has had real success. Banks from the receiving countries also offer remittance services free of charge (they make their money by adding a margin on currency conversion). Abra may do things entirely differently but ultimately it is vying for the same consumers that the established incumbents and their potential Fintech disruptors are targeting. Celebrity endorsements such as Sir Richard Branson’s investment in Transferwise or in Abra’s case, Gwenyth Paltrow acting as an “advisor” helps raise awareness but changing customer habits and engendering trust is the really difficult bit that takes time.
Critical mass: Perhaps the greatest challenge any new payment system faces is whether it will be able to reach critical mass. M-Pesa, the most famous agent-based cash transfer system in the world achieved success for several reasons. It was pushed by the dominant mobile operator in the market which held a near monopoly position; the regulator decided not to interfere; the agents had a financial incentive to sign up other agents; and of-course, it was and still is dangerous to carry cash in Kenya. This led to the agents working as “human ATMs”, a description used liberally by Abra in describing its business model. However, even M-Pesa has not succeeded in international remittances nor has it achieved material acceptance outside Kenya.
Hedging contract fulfilment: The least tested and riskiest part of the business model is Abra’s hedging system that will shield wallet holders from Bitcoin’s price volatility. First, it will not be easy to scale this type of hedging. Then there is significant risk that the whole system could potentially be compromised if the bitcoin price nosedives. A potential price crash scenario may result in Abra’s hedging partners finding themselves unable to honour their part of the deal – smart contract or no smart contract. That would sound the death knell for the entire Abra system.
Falling foul of regulation: Any business model linked to Bitcoin carries inherent regulatory uncertainty. Abra is unclear on the compliance side of things and suggests that tellers do their own legal homework. It encourages them “to talk to a lawyer who is knowledgeable about your local laws concerning p2p bitcoin sales.” Not very helpful because even the top and most expensive lawyers are unsure of how regulators in their markets treat, or will treat, Bitcoin based money transfer systems.
Money laundering: The transfer values are expected to be low value but those laundering money have always used the old “bundling” technique – breaking up a large value transaction into several small value transactions. If money launderers or those wishing to pay for illegal goods and services, find Abra a useful utility, Abra may have a problem on its hands. Theoretically, there is no way Abra will be able to police if its customers use the wallet to pay or receive funds for illegal activities undertaken on other sites. The Bitcoin system itself is beyond the reach of regulators but any system that uses it is not. If regulators find evidence of illegal activity, they are likely to shut it down for good.
The Abra wallet may remain confined to niche applications. The idea, that Abra does not hold customer deposits but guarantees them but uses bitcoins as the reserve currency guaranteeing the funds in the wallet, will work provided there is no bitcoin price crash and its plans to hedge price fluctuations is feasible.
Somehow amazingly it must also pass unscathed through regulatory head winds which are always present.
The underlying guarantee of value is derived not from the central bank of a country or any other centralized authority but from the forces of demand and supply as experienced through a decentralized self-sustaining mathematical commodity like Bitcoin. But it is the inherent volatility of this mathematical commodity that puts every idea and business edifice built on it susceptible to an unpredictable and catastrophic upheaval in the future.
But if Abra is able to surmount these challenges, even in a handful of remittance corridors, it may become a takeover target of an established money transfer operator such as Western Union or Moneygram even before it turns a profit and investors will be able to generate substantial gains on their investments in Abra.