A critical point of any settlement system is the confidence that transactions that occur are indeed permanent.
Many forms of digital currency have been founded over the years, however it is only when Bitcoin was released that there was a digital currency whose state could be trusted with confidence without a central authority.
There are some important points to consider when discussing the term irreversible and if Bitcoin transactions indeed are, let’s dive in.
A merchant’s point of view
Merchants accepting payments via any means, be it traditional payment systems such as credit cards, or simply cash or any other digital payment system such as PayPal, require confidence that the money paid will indeed be there in perpetuity, or at least until they wish to spend it.
After all – if a payment had no reasonable confidence that the payment was secure, the merchant would be out of pocket for any goods or services sold.
The key term here is confidence, probability can be applied to any payment system, credit cards could be stolen, or a fraudulent payment made. Cash taken can be uncovered as counterfeit and buyers using PayPal can report items non-received. All these systems mean that money can literally be taken from under a merchant’s nose. This has the effect of driving up costs to the consumer to cover these damaging eventualities for businesses.
The reason they are so popular, is that they have high confidence in this not occurring. The penalty for making a fraudulent transaction is a fine or more severe action, counterfeiting cash can carry lengthy prison sentences.
If a merchant has a high confidence that for a transaction made, they will receive the necessary value from that transaction they will of course accept that form of payment.
Thus, the key is not to ask if Bitcoin payments are irreversible, but ask what the probability of this happening is. So that businesses and payment gateways such as ChainPay can take the appropriate precautions.
How Bitcoin transactions work
To gain an understanding in the factors affecting confidence for Bitcoin transactions, we must first understand how they work.
John has a number of Bitcoins in their wallet. They then construct a payment for 10 Bitcoins of Janet. At this point no one including Janet is aware of this payment. The confidence applied to this payment is of course zero. If no one knows about it, we have no confidence it will actually happen.
To increase confidence (and of course make the payment), John transmits this transaction to other Bitcoin users, in a peer to peer (P2P) fashion. People receiving this transaction verify that the payment is indeed valid, and transmits it again. Thus the transaction propagates throughout the Bitcoin network. At this stage we have a little better confidence that the transaction will happen, lets take this as 50% confidence. As John has signalled to all involved in the Bitcoin network that they intend to make this payment. If we had 100% confidence in the user, we would have 100% confidence in the transaction, of course this is never the case, so we accept the transactions 50% confidence.
At this point, a select merchants delivering low value or high profit items on a tight time schedule may accept this confidence level as sufficient. Especially items which could be revoked. For example if a user was paying for a streaming video service, the service provider could begin streaming the film. This ensures an excellent user experience, whilst giving the service provider the ability to cease streaming the film should the transaction be reversed or denied.
For a more traditional merchant selling for example consumer electronics, they require more confidence. Lets see how confidence improves further along the process.
Having the transaction made by John been propagated throughout the Bitcoin network, the next stage is for a Bitcoin miner to include this in a block. Bitcoin mining and blocks are best explained in another post, for now we will only cover the basics.
Transactions included in a block are marked as permanent history, transactions that attempt to reverse this payment are denied by the Bitcoin network, so the confidence we have that this transaction can be reversed can again be increased, lets choose 85% confidence now. Merchants on a time sensitive transactions but with larger value at stake may wish to preserve their time sensitive nature could release this payment, however for merchants that have to perhaps ship items by post, it makes sense to continue waiting for more confidence before actually shipping the item, whilst sending the instruction to the warehouse to begin picking the items.
So we have seen a transactions confidence go from 0% to 80%, obviously we need much higher confidence before releasing goods and services that would adversely affect our business if the transactions were indeed reversed.
How do we get the last 20% confidence? Simple, we wait for more blocks to be issued by the Bitcoin network. The critical part of the Bitcoin network is that confidence increases exponentially as more and more blocks are added to the chain.
By waiting for two or three more blocks, or confirmations we can raise our confidence to 99.5%. In order for a transaction to be reversed now, either a disaster needs to befall the Bitcoin network, or a very powerful (such as a small country) malicious actor to be involved.
At this point, Janet can deliver the items John paid for with confidence that Janet will not be forced to relinquish the payment made by John.
Can we ever reach 100% confidence?
By understanding all the factors involved, there will always be a miniscule probability that a transaction could be reversed. The only way to clear this completely is have a level of trust that exists outside the Bitcoin network, a guarantee from the company handling the payment that even if a disaster befalls the Bitcoin network, or a very small probability of a transaction failing actually occurs the merchant will be protected.
A key factor of ChainPay is that we separate this level of confidence for our partners. Once a transaction has achieved 3 confirmations, we guarantee the funds for settlement. This means that after the transactions has been included in a block, and two more blocks have been circulated throughout the Bitcoin network, you are guaranteed to be able to settle the funds transmitted.
How does this compare to credit cards?
To individuals not aware of how card payments occur, the above mechanism for achieving confidence in payments may seem overly complicated, however in actuality card payments have much less total confidence in any one particular payment.
Often fraudulent transactions are never traced, reports of stolen cards never followed through. The cost of covering these often occurring transactions are covered by payment gateways through high costs, and indeed by the business charging an extra fee for customers paying by credit card.
In conclusion, payments made by credit cards can be reversed by the sender after even 90 days, with no recourse for a merchant to cover the loss of the payment. Introducing a payment system that can deliver 100% confidence in only 3 – 6 hours is a benefit that businesses today, can no longer ignore.
ChainPay provides integration services for merchants with a large transaction count, email email@example.com to discuss, and don’t forget to sign up to try ChainPay for yourself.