Smart contracts on mobile devices set to shake the financial ecosystem… Samsung Electronics on ‘emergency alert’

The Bitcoin Conference opens in Miami, in the United States, on April 6. As I write, the conference has not yet begun. Jack Mallers, the Strike chief executive officer (CEO) who last year made the surprise announcement that El Salvador would adopt Bitcoin as legal tender, has hinted that he has some major announcement to make concerning Apple. Just how far Apple intends to step into the cryptocurrency industry has become the biggest question of this conference.

A decade into the payments war among IT companies

Because the iPhone's moves are directly linked to Samsung Electronics, Korea's flagship company, this amounts to a state of emergency for Korea, on the premise that Bitcoin really is a financial innovation. Not many in the younger generation will remember that only fifteen years ago Nokia was the company that dominated mobile phones. Even Nokia, with market power that seemed impossible to lose, was culled in the course of the transition to smartphones. If, as the Bitcoiners argue, Bitcoin is a monetary phenomenon, and if Apple's iPhone plants its flag on that phenomenon one step ahead, Samsung Electronics could lose the initiative entirely in a new converged industry.

The world's information technology (IT) companies have been waging a payments war for the past ten years. Apple Pay, Samsung Pay, Google Wallet, Kakao Pay: the payments and finance projects each IT company is attempting show more than adequately how important and how fierce this war is. But why, in this war, should Bitcoin of all things be the thing to watch?

In truth, the IT companies' payments war is not a contest of technology. The technologies now on display have been possible for a long time. The problem is the cobweb of regulation created by collusion between incumbent industry and government. Of course, each individual regulation was clearly devised for reasons that made sense in their own terms. But once created, a regulation also functions as a moat protecting the ecosystem of the incumbent industry, and so it readily blocks technology and imagination.

The food chain of the incumbent financial companies, more complicated even than the complicated regulations, is precisely why Bitcoin cannot help but become the IT companies' breakthrough. In fact, Samsung Pay is hard to regard as a model of mobile finance. In order to satisfy all at once the card readers already installed, the security-network management companies, and the card companies, Samsung Pay puts a digitized credit card inside the smartphone and lets a credit card reader read it. It amounts to nothing more than a dramatic improvement in consumer convenience. It means that Samsung Pay does not make Samsung Electronics a financial company. Amazon's prepaid card system is, if anything, closer to a financial business than Samsung Pay.

So what is it that Apple intends to do with Bitcoin? First, it is worth noting that CEO Jack Mallers is a Bitcoin maximalist and an expert on the Lightning Network (an instant-payment solution for Bitcoin), which was built for those who are not satisfied unless they buy their coffee with Bitcoin despite its expensive fees. Apple once blocked personal wallet applications for Bitcoin and other cryptocurrencies, but that is a thing of the past. So the mere fact that the iPhone would carry a Bitcoin wallet and let users send and receive bitcoin from smartphone to smartphone would hardly make news. That is already possible on both the Galaxy and the iPhone.

To state the conclusion first: the iPhone or the Galaxy can become the hub of global consumer finance, serving as the collateral in smart contracts and dispensing with credit card companies and financial companies.

Nick Szabo, the cryptographer suspected of being Bitcoin's creator Satoshi Nakamoto, published an essay titled ‘Smart Contracts’ in 1994, when most people would have been encountering the internet for the first time. It was a kind of logical thought experiment holding that a contract could be completed automatically without the intervention of the judiciary or a financial company. He used a car key as an example. He explained that when the car loan installments went unpaid, control over the car key, in electronic form, could pass to the bank. In other words, for a contract to be completed without the help of the judiciary or a financial company, one needs a means of settlement possessing finality, together with collateral whose value can be controlled in electronic form.

Bitcoin is a means of settlement possessing finality and at the same time collateral controllable in electronic form, and so it satisfies every premise of the smart contract. The Lightning Network is a payment method that uses precisely these properties of Bitcoin, creating between frequent counterparties a ledger separate from the Bitcoin blockchain so as to cut fees while ensuring that neither party need fear the other's betrayal.

For example, you could create a joint wallet with the owner of the café in front of your office that you mainly use. Moving the bitcoin held in that wallet requires the agreement of both parties. You place bitcoin in it as collateral and buy coffee every day. The price of the coffee moves in bitcoin to the café owner, but because it is not yet posted to the Bitcoin blockchain, there is no fee. If you are transferred elsewhere and have no further reason to use that café, you post the latest state of the ledger to the blockchain at that point and have it confirmed. Because the fee is paid only once at that moment, people say the Lightning Network has almost zero fees.

But the Lightning Network faced criticism from the moment it was set out in a paper. The most frequent criticism concerned the problem of centralization arising from differences in the wealth available to post bitcoin as collateral, a practical consequence of the gap between rich and poor. One person can open Lightning Network channels with a hundred people, while another can open one with only a single person. And yet the Lightning Network is a smart contract that uses cryptography. Even people who have no direct channel can transact at almost no fee by stringing together the Lightning Network connections that each of them holds. The party who has opened channels with many people cannot help but become a hub of trust. It is a paradox that Bitcoin, which by its birth cannot abandon the ideal of decentralization, ends up creating vast centers called hubs of trust in order to solve the fee problem. That said, one cannot necessarily say that the Lightning Network's being organized around hubs of trust damages Bitcoin's decentralized character.

The smartphone as the ‘hub’ of cryptocurrency transactions

In any case, in practical terms the Lightning Network is growing at a frightening pace. As of this past March, $149.22 million worth of bitcoin had been deposited in it, and the number of nodes had passed 35,000. Its payment processing speed reaches 1,660 times that of Visa. The growth of the Lightning Network means that, setting aside those who merely trade bitcoin on exchanges for investment purposes, the number of people around the globe who need bitcoin in order to use it is increasing.

For Apple's iPhone and Samsung's Galaxy, this carries a special meaning. In Africa and Southeast Asia, more than half the people never open a bank account in their lifetime. A credit card is out of the question. Yet they own a mobile phone of some form. The smartphone in particular is an extremely precious piece of property to them. Imagine that the iPhone or the Galaxy opens a one-to-one Lightning Network channel with each of its owners. It becomes the largest hub of all. Users could deposit a small amount of bitcoin on the smartphone and use it for payments. Because the price of bitcoin fluctuates, the two companies could offer a special service. They could give users the option of freezing the value at the current price or marking it to the market price each time. If it is frozen, the user need not worry about volatility. If the price rises, the iPhone or the Galaxy takes the gain; if it falls, the loss is the company's. But with many users this can be managed statistically, and the company has various ways to spread the risk. In any event, the iPhone or the Galaxy could be reborn as a financial company holding more deposits than any bank. What is more, because it comes close to the ideal, electronically controllable collateral asset that Nick Szabo imagined thirty years ago, it is also free of problems such as credit card fraud.

Above all, because the smartphone and the cryptocurrency's private key are themselves the authentication, it is free of the wrestling match, joined even by the regulators, over whether the user's information should be kept on the smartphone or on the credit card company's servers. In other words, the many stakeholders who had to be persuaded when Samsung Pay was built are all dispensed with.

Which of the two, Apple or Samsung Electronics, will grasp this meaning first and act on it? At the execution stage there will be no shortage of technical obstacles, but it is bound to be far simpler than persuading the incumbent financial ecosystem while integrating with mobile. Once the management of the two companies grasps what the combination of Bitcoin, smart contracts, and mobile will bring, the existing financial companies will face a tsunami. And more than two billion people who have been excluded from the financial network will each come to own a simple bank in the form of a smartphone.

If the Lightning Network cannot escape the reality of being hubs of trust connected by highways between those hubs, then the modest wish of Korea's Bitcoiners can only be that such a hub should be a Korean company.

Oh Tae-min, author of ‘Bitcoin Was Strong’ and ‘Bitcoin: A Genealogy of Wisdom’