In 2009, bitcoin became the first decentralised cryptocurrency to enter circulation. At the time of its creation, the value of one bitcoin was practically zero because it had few users – mainly cryptography fans ‘playing’ with the new currency. Fast-forward to early 2011, and bitcoin reached parity with the US dollar before experiencing the first of a number of bubbles that year, rising to $31 per bitcoin. Since then, bitcoin has experienced dramatic peaks and troughs, famously reaching over $1,250 in November 2013. The value has since fallen quite dramatically and, at the time of writing, sits at around $200/300 per coin.
How do cryptocurrencies work?
Despite growing mainstream coverage, to many casual observers the conversations around cryptocurrencies remain full of jargon and complex concepts – and above all, for many corporates, they seem irrelevant. But before we begin to examine the arguments for and against bitcoin, let’s take a look under the hood of the cryptocurrency.
According to the Oxford English Dictionary, a cryptocurrency is “a digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of a central bank.” Unlike traditional fiat currencies that are printed by a central bank, cryptocurrencies are ‘mined’ by individuals and now, more commonly, by specialised mining groups. To mine a cryptocurrency, specialist software and hardware are needed in order to solve complex mathematical algorithms that become increasingly difficult the more coins that are mined. The process is often compared to the mining of commodities, such as gold, that are finite and become increasingly problematic and costly to attain.
The computer power that is used to mine a cryptocurrency is what maintains and keeps the network alive, and at the heart of this network sits a decentralised public ledger (more on this later) that records every transaction made using the currency in real-time. All users are given their own unique bitcoin address and the cryptography built into the chain maintains its integrity and chronological order. As such, it is easy to see how much value belongs to a certain address at any point in time. It also makes adjusting the chain very difficult, so it is nearly impossible for a bitcoin user to spend more than they have.
Once mined, bitcoins can be held as an investment, converted into fiat currency or used to purchase goods and/or services. Statistics released by bitcoin payment processor BitPay show that the majority of merchants currently using the cryptocurrency choose to convert their bitcoins into fiat currencies.
A game changer?
One of the most commonly mentioned benefits of a cryptocurrency is its decentralised nature. Cryptocurrencies, such as bitcoin, are built on a decentralised ledger that is built and maintained by its users. Transactions take place on the network peer-to-peer or through an exchange and are automatically recorded on the ledger. Essentially there is no need for any of the traditional financial infrastructure to exist – and the costs associated with it – for cryptocurrencies to be used. For corporates, who in recent years have been tasked with doing more with less and have been focusing closely on transaction banking costs and looking to reduce fees where possible, this may sound appealing.
As all treasurers know however, there is no free lunch and transacting in cryptocurrencies doesn’t change this. There is a transaction fee that is applied when using the various exchanges. This currently sits around the 1% mark, however when compared with the 4% fees charged by card providers such as Visa, MasterCard and American Express, the attraction is clear.
In addition to being independent from the traditional financial system, cryptocurrencies also transcend nations, their borders and governments. There is no jurisdiction or economic underpinning to cryptocurrencies and this may have a benefit to corporates operating across borders. For example, cryptocurrencies are not subject to the rules and protocols that dictate the movement of fiat currencies across borders (although they are subject to some regulation in certain countries – more on that later). In theory, this means that a cryptocurrency could be used as a vehicle to move cash out of those countries where it has often been trapped.
A third characteristic that could make cryptocurrencies an attractive proposition for some corporates is that payment is entirely irrevocable. Traditional clearing and settlement systems involve – to a greater or lesser extent – the issue of revocation of payment instructions, particularly in the international system. Because of this, corporates are often faced with the risk of the payment being recalled. Products exist that look to mitigate this risk, letters of credit for example, but there is a cost involved in using these.
Those analysts in favour of cryptocurrencies also believe that they offer a new way for corporates to look after their customers – and protect their data. Consumers who use them will not need to provide any personal payment information. Comparisons here can be drawn to PayPal. However, cryptocurrency advocates suggest that it is more secure than PayPal because they have no database of information that can be leaked if an account is hacked. And while individual crypto-wallets have been subject to such attacks, new security developments, such as multi-sig technology are making this more of a challenge for cyber thieves.
As such, accepting cryptocurrencies may prove an innovative way to attract business from security-conscious consumers. Indeed, computer giant Dell, a company who began piloting the acceptance of bitcoin in the US in July 2014 and have since expanded this to the UK and Canada, is seeing positive feedback from its customers. Paul Walsh, Chief Information Officer at Dell Commerce Services told Treasury Today in 2014: “We’re pleased by the initial response to our current bitcoin pilot on Dell.com for consumer and small business shoppers in the US and purchases have exceeded our expectations.”
Some big barriers
According to bitcoin payments processer BitPay, in February 2015, 100,000 merchants worldwide accepted bitcoin as a means of payment. As we have seen, Dell is one of these companies but others include Amazon, Microsoft and Subway. While this is a fairly large number it is by no means widespread. It is also worth noting that for many of these large companies ‘accepting’ bitcoin, that they themselves are not accepting it and have partnered with various bitcoin partners who accept the coins, convert them into USD and then pass these onto the company.
This rather slow rate of adoption comes as little surprise when you consider the deluge of negative press that surrounds the cryptocurrency. In late 2014, Bloomberg classified bitcoin as the world’s worst currency that year. And given that the value of bitcoin dropped 56% against the USD during 2014, it’s easy to understand why.
The cryptocurrency’s volatility is a huge barrier to adoption, not least in the corporate sphere. In 2013, bitcoin was on average ten times more volatile than the S&P 500 and 15 times more volatile than the EUR:USD currency pair. Against this backdrop, can treasurers really afford to embrace bitcoin?
The argument against bitcoin is made even stronger when we consider the high-profile controversies that it has encountered during its short life span. Most notably the collapse of Mt. Gox, the Japanese-based exchange that in 2013 handled 70% of all bitcoin transactions, which ‘lost’ 850,000 bitcoins valued at more than $450m at the time. Although 200,000 coins have since been recovered the reason for the disappearance of the coins remains unsolved and many are concerned that something similar could happen again.
Compounding matters, cryptocurrencies cannot be held in a bank account, with the long established security protocols that support this. Traditionally, the currency is instead held in a bitcoin wallet. The digital wallet can come in multiple guises including in the cloud, on a hard drive, or even on a device locked away in a safe. All current methods have their own issues, firstly the security of the cloud solution needs to be optimal, as security around bitcoin has been under the spotlight with a number of high profile breaches and ‘heists’. So-called ‘cold storage’ (storing the bitcoin on a device that is not connected to the internet, be it a hard drive or physical coin) on the other hand, may be a safer option as the wallet is disconnected from the internet and therefore away from hackers. That said, it poses its own challenges because it is not easy to access the wallet quickly or conveniently to make and accept payments.
The Mt. Gox affair also highlights a separate issue: namely, the anonymity that cryptocurrencies offer. Although any transaction that occurs will appear in the blockchain (the decentralised public general ledger) for that day, the lack of identifying information available and the lack of forensic tools to analyse the blockchain can make following transactions extremely difficult, if not impossible. Hence why cryptocurrencies are often associated with ‘dark net’ trades. So while anonymity is a selling point to some, it is more a barrier for corporates.