Bitcoin is a cryptocurrency which allows financial transactions between users, independent of financial interme- diaries such as a payment processing providers like Visa/Master Card. Bitcoin validates transactions through a distributed consensus mechanism which circumvents the need for a financial intermediary; this allows it to have potentially low transaction fees. Using a game theory model involving Bitcoin, traditional channels of verification, and users, we study how Bitcoin would disrupt the payments processing industry. There are a few subtle but important differences between the value propositions offered by Bitcoin and traditional channels. For example, post-transaction services (e.g., reversal of an unintended or fraudulent transaction), which are readily available on traditional channels are not present on Bitcoin. We show that owing to this difference, the presence of Bitcoin leads to a filtering effect - the proportion of transactions needing post-transactions services increases on the traditional channel in the presence of Bitcoin. Since it is costlier to process such transactions, the transaction fee charged by the traditional channel increases.
We also find that Bitcoin pricing mechanism makes is more suitable for high value transactions as users compete fiercely to use its limited throughput. Developers have been investing significantly to increase capacity and achieve a solution that allows micro payments. We show limited throughput is not a technological shortcoming but a key property that keeps the platform stable. Overall, the transactions of small sizes, which are not suitable for Bitcoin and need to use Visa/Master Card, have to pay a higher transaction fee on the traditional channel in equilibrium. Therefore, paradoxically, even though Bitcoin increases competition in the payments processing industry, the users who need to process transactions through the traditional channels end up paying higher transaction fees.