Bitcoin accepted here? Part 3: Payments made easy

By John Enoch, UK

Part three of a six-part blog series exploring the history, potential and implications of virtual currencies as they become more widely accepted.

What'€™s so good about virtual currencies?

There is one distinction to make right away '€” are we talking about Bitcoin as (a) a store of value, either short-term or long-term, or (b) as a method of facilitating transactions?


The first definition implies speculation as to the future value of the currency units you hold. I will say nothing about either the ethics or the financial soundness of Bitcoin speculation (because I do not give any '€˜investment advice'€™), beyond making the obvious point that, as is common in more or less every embryonic and/or limited supply market, those that made their move into Bitcoin at the right moment made enormous returns, while late-comers who piled in at the top of the market have seen substantial reductions in the value of their Bitcoin holdings.

For the record, I hold no Bitcoin or other virtual currency and never have done, because I want to be able to talk about them without having any axe to grind. I would also add a word of caution that, when reading articles heavily promoting the future prospects of a currency, it is worth checking whether the writer happens to have a large holding in that currency him or herself.

Payment Method

bitcoin3Bitcoin is of course designed to be an alternative method of payment to traditional '€˜fiat'€™ currencies. One key distinguishing feature '€” which was a principal philosophical motivator '€” is that the currency is not issued by a central bank or other regulatory authority, but is generated on a decentralized basis. Many people find this hard to understand.

When presenting on Bitcoin, I use the analogy of the spider'€™s web and the fishing net. Traditional currencies have a spider at the centre and rings of banks of decreasing size around them, with consumers around the outside. The spider eats all sorts of things that get caught up in its web. With a fishing net, though, each node can be a currency generator and/or user '€” there is no centre. The fishing net part is not that accurate technically, but audiences understand the difference between that and the spider'€™s web. (If anyone has a better analogy, please let me know.)

I divide the attractions of Bitcoin and co into eight categories. These are in no particular order, because what matters most to one user may well be different to the key attraction for the next user.

1. Lower transaction costs

Assessments vary, but a recent European Banking Authority (EBA) report estimated that transaction costs related to conventional (e.g. credit card or cheque) payments average out at 3-4% in countries with developed financial networks. In less-developed countries (i.e. fewer banks), the costs could rise to 8% or 9%. In all countries, it tends to be the poorest people who pay the highest charges. Those percentage points reflect a creaming off by banks, credit card companies, payment processing firms and similar organizations. It is not only consumers who pay the charges, but retailers do too, and these are particularly burdensome on small transactions, i.e. those worth only a few dollars.

Bitcoin transaction costs can be as low as zero, but may average 1-2%. This could increase over time, as there are likely few people who would accept that success in mining coins is adequate recompense for making transaction power available to others. However, those savings are worth having, either as an individual or as a retailer, and it is one of the reasons why virtual currencies are undoubtedly here to stay. There is a real, tangible, financial benefit to using Bitcoin, as opposed to traditional methods.

To some degree, this saving is only notional, though. Because of the volatility of Bitcoin prices, the majority of retailers who accept virtual currency, as far as I know, exchange it into legal tender at the end of every business day. This limits their currency risk to movement in the exchange rate in 24 hours or so. However, there are costs associated with this exchange, which may largely eliminate the savings they received in the transaction costs. This will only change when the retailers have sufficient confidence in the stability of the currency to hold it for longer periods.

The EBA points out that one of the reasons why conventional currency costs are higher than virtual currency costs is because of banking regulation fees, which are not incurred by virtual currencies. It holds that consumer protection requires regulation, and the absence of regulation makes dealing with virtual currency high risk for consumers. But then, the banking regulator would say that, wouldn'€™t it? The EBA also points out that it is taking measures to reduce costs associated with traditional banking, particularly for cross-border transactions.

Even if the transaction costs advantage of Bitcoin over conventional currencies reduces over time, it is hard to imagine that it will disappear, given the enormous overhead costs that traditional banks and other financial institutions have to recoup from their customers.

2. Irreversibility

Once a payment is made with Bitcoin, there is no going back. This provides certainty for both parties to the transaction. There are no bouncing cheques or declined credit card payments. In this respect, Bitcoin is cash-like.

3. International convenience

Cross-border transactions are on the whole easier and more convenient with Bitcoin than with conventional currency, because there is no need for currency exchange. US residents can buy in Canada and vice versa, or anywhere else for that matter, with buyer and seller either keeping the virtual currency or exchanging it locally themselves.

The largest (non-speculative) transaction to have been made thus far with Bitcoin is said to have been a $500,000 purchase of a property in Bali, Indonesia, by an overseas buyer. The time and cost saving of using virtual currency rather than waiting for funds to be converted into the Indonesian rupiah will probably have been considerable.

4. Portability

Bitcoin can be carried from place to place without the need for a heavy suitcase full of cash or gold bars, and little risk of being stopped at border crossings. All that is needed is access to the Bitcoin keys when you reach your destination.

That is in essence not much different from online banking, but there are some circumstances where people may prefer not to use conventional systems.

5. Speed

Speed is relative. A blockchain that only updates every 10 minutes, and the need to wait for confirmation to be sure that a transaction has completed, mean that, in electronic terms, Bitcoin operates at snail'€™s pace. Some competing virtual currencies have sought to address this by using shorter cycle times.

However, in comparison to arranging conventional bank transfers, particularly across borders, a Bitcoin transaction can be lightening fast. The EBA proudly points to the Single European Payments Area (SEPA) initiative, whereby banks will have to ensure funds are credited the next working day. Nice, but not quite ten minutes.

6. Hedge against inflation, currency controls or sanctions

This advantage may more properly be classified under the '€˜speculation'€™ category, but I put it here because the motivation of the user is generally not to make a speculation investment gain. Rather, they are hoping to either prevent value erosion through rapid inflation of the national conventional currency, or to enable transactions that would otherwise be barred by national or international regulation.

Research has suggested that on a per capita basis, Bitcoin usage has been high in countries such as Cyprus, Greece and Spain, at a time where the local economies were under pressure, as well as certain South American countries, and Iceland, when currency controls were in place. It has also been highly used in Iran, where international sanctions could have prevented transactions through the conventional banking system.

7. Privacy

One can debate the extent to which Bitcoin transactions are anonymous, or perhaps more correctly pseudonymous, given the blockchain record of all transactions. Law enforcement agencies have managed to track down some Bitcoin users, but my understanding is that this was on account of their incautious failure to keep their virtual currency identities sufficiently separate from those provided to retailers in conventional transactions.

A virtual currency is not as anonymous as cash, but for most people, it will still allow transactions to be carried out without any government, regulator, bank or big business knowing who has bought or sold the goods or service in question.

8. Ideology

With the inventor of Bitcoin being unknown, one can only speculate as to his/her motivation. However, it is without doubt true that many of the early and present champions of Bitcoin '€” and even more so the champions of the 200 or so other virtual currencies '€” have been motivated by a desire to take the control of money away from central government and rich banks and give it to ordinary people.

Some commentators within the '€˜crypto-geek'€™ community (their word, not mine) believe the '€˜Bitcoin mafia'€™ (ditto) have lost sight of this fundamental principle and are seeking to impose controls not unlike those of the despised central regulators. Enthusiasts for the decentralised, unregulated principles of virtual currency tend to move to new ventures as the ones they have championed become more embroiled in politics or procedural straightjackets.

For virtual currency to become a successful, mainstream product, it may need to accept some measure of regulation, whether from its own governing foundations or a more conventional financial regulator. That does not mean that the ideology needs to be abandoned, however, and the fight to prevent virtual currency from simply becoming the next plaything for private equity millionaires and big business is worth fighting.

In next week's post I will look at the implications for financial institutions.