Bitcoin: Speculative Investing Fad or Real E-Commerce Value?

By D.J. Murphy, Editor-in-Chief

Last week, over an astonishing few days, the exchange rate for Bitcoin, the decentralized virtual currency that had been enjoying a run up in value for several months, went crazy. So crazy, in fact, that comedian Stephen Colbert devoted an entire segment to the issue on his Comedy Central show on Wednesday night, entering Bitcoin in the pop-culture zeitgeist. Throughout 2012, Bitcoin increased in value from a price of $4.72 to $13.51. In the first few weeks of April, the price of Bitcoin rocketed to $260. Speculation abounded that the financial crisis in Cyprus and other euro nations was leading investors to stash their money in the anonymous digital currency. On April 10, the largest Bitcoin exchange, Mt. Gox, began to experience technical problems that produced increasing lag times in trades. That led to Mt. Gox suspending trading and the value of Bitcoin plummeted.

As of this week, the price of Bitcoin is vacillating wildly around the $60 mark, wiping out about $2 billion of value in a few days. $60, however, represents the price of Bitcoin only a month ago—higher than it had ever been in its history. According to Vitalik Buterin, a member of the community of enthusiasts that grew up around the Bitcoin phenomenon in its earliest days and online writer for Bitcoin Magazine , volatility will be the name of the game, at least until the exchanges can upgrade their technology and until the currency achieves more adoption.

“Bitcoin is still small, so its behavior is pretty typical of stocks in that price range,” Buterin says. “Also, of the time the value was falling so steeply, Mt. Gox was down for half of it and for the rest of the time there was a one-hour lag in trades. The only thing that will fix that is for Mt. Gox to fix their systems and, over the next few months, we need to have more alternatives to Mt. Gox.”

So, is Bitcoin a currency that will set online commerce free from the high costs of payment acceptance, or is it more like a penny stock: a place for investors to park some money and see if they can ride the volatility to big gains?

Buterin and other true believers think the value proposition Bitcoin presents for merchants and consumers means its adoption will continue and an increasing array of merchants will begin to accept it. For merchants, Buterin says Bitcoin’s value lies in its ease of implementation, low transactional cost and its efficacy as a seamless international medium of exchange online. And, using a Bitcoin processing service can smooth out the volatility for merchants.

“A processor such as BitPay lets a merchant accept Bitcoin and have a Bitcoin immediately converted into U.S. dollars and deposited in their bank account,” he explains. “The big advantage of that is merchants are completely protected from volatility. The fee for BitPay is .99 percent per transaction and its costs 1 percent to buy Bitcoins. So a total of 2 percent is quite a bit less than PayPal or payment cards. Also, Bitcoin works everywhere except North Korea. It’s easy to set up and money can be sent from anywhere to anywhere without borders.”

For consumers, the internationality of Bitcoin is also a major advantage, according to Buterin.

“You can buy online no matter where in the world you are,” he says. “Depending on where you are, just the fact that it makes e-commerce possible is huge. Try setting up a PayPal account in Africa. You can’t.”

Finding merchants that accept Bitcoin isn’t easy, but Buterin notes that worldwide, the number has risen to about 2,000 and just a month ago an online electronics store launched that accepts nothing but Bitcoin, and offers consumers a heavy discount as well.

Despite Buterin’s contention that there are services that can smooth out the speculative peaks and valleys for merchants, however, Bitcoin’s lack of a central authority means the only thing keeping it afloat as a currency is the confidence of its users. And, without the backing of a government or central bank, that confidence can be ephemeral, as last week’s events illustrate.

For any currency, virtual or otherwise, trust among the community of people that use and accept it is paramount, according to Nathan Hecht, CEO of Kurrenci. Like Bitcoin, Kurrenci is a virtual currency for use online. Unlike Bitcoin, Hecht says Kurrenci is working within the established financial system.

“I’m a big believer in virtual currencies,” Hecht says. “I believe eventually Bitcoin and others like it will find their place, many merchants will accept them and a small percentage of consumers will adopt them. As it stands today, however, the volatility [that Bitcoin showed last week] makes it prohibitive for merchants to accept it.”

Hecht says he believes Kurrenci, which is pegged to the U.S. dollar, is the “correct virtual currency for the Internet.” Bitcoin’s decentralized nature, at this point in its development, is causing volatility that will render the currency simply a speculative investment rather than a medium of exchange. Pegging its virtual currency to the dollar lends Kurrenci legitimacy and solidity Bitcoin doesn’t have, Hecht says.

“The fact of the matter is that great democracies worldwide are built on their financial institutions,” he says. “Some say they’d rather not have a central bank, but the fact is that the Federal Reserve and the U.S. Treasury have allowed this country to flourish and become the greatest democracy in the world. Other great democracies—England, Israel, Japan—are built around their central banking systems.”

Hecht adds that Kurrenci is registered with the federal government as a money services business and registered in 48 states as a licensed money transmitter. It has fully fleshed out AML and KYC policies. The businesses and exchanges that have sprung up around the decentralized Bitcoin are scrambling (and even approaching Kurrenci to partner, Hecht says) after recent guidance from the Financial Crimes Enforcement Network (FinCEN) that said the U.S. government considers someone who sells Bitcoins in exchange for “real currency or its equivalent” to be a money transmitter subject to the registrations Kurrenci has already undergone.

As Bitcoin continues to receive media attention, it will continue to receive regulatory attention—particularly since its ability to facilitate anonymous transactions has resulted in a reputation for use in criminal endeavors.

That image problem notwithstanding, Bitcoin has the potential to be an important payment method, especially for cross-border e-commerce payments to and from developing economies where financial institutions and payment infrastructure are hard to find. But, despite the media attention around its run-up and crash, Bitcoin’s survival is not assured. That threat, alone, may be enough to scare merchants away. And, without a place to spend it, money loses its raison d’être.

As Hecht laments: “The trust isn’t there. It’s the biggest question we have with Bitcoin.”

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