Cryptocurrencies: cracking the code

Published: Feb 2015

The rise of the volatile and decentralised bitcoin has not only seen the term ‘cryptocurrency’ entered into the Oxford English Dictionary, but it has also made headline news and – for some – is seen to be the future of finance. But do cryptocurrencies really have the potential to create such seismic shifts and are corporates aware of their possible application within treasury and the wider financial industry?

Bitcoin representation

Five years ago, British pop star Lilly Allen was offered payment for an online gig through a then obscure and unheard of means – bitcoin. Understandably, the singer rejected the seemingly paltry offer, with no inkling of how popular and valuable the cryptocurrency would become. If Allen had accepted the hundreds of thousands of bitcoins and held them until their December 2013 peak (when each coin was worth $1,240), she could reportedly be six times wealthier than she is today. Such is the benefit of hindsight.

What this story illustrates is that, since its creation in 2009, bitcoin has gone from being a virtually worthless computer algorithm lost in the depths of the internet to being touted as a genuine rival to fiat currencies. And despite there being over a hundred alternatives, bitcoin has become synonymous with the term cryptocurrency. For Gautam Jain, Managing Director and Head of Client Access at Standard Chartered, this is because “bitcoin has ultimately promoted itself better than any other cryptocurrency, it consequently has had the backing and investment, helping it to become the market leader.”

The bitcoin lifecycle

Despite growing mainstream coverage to many, cryptocurrencies remain an area full of jargon and unnecessarily 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.

The Oxford English Dictionary defines a cryptocurrency as ‘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, specialised software and hardware is 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 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. And the number of such merchants is growing as the benefits of bitcoin become clearer.

Revolutionary properties

For Ian Benson, Director at law firm Maclay Murray & Spens, the cryptocurrency’s decentralised nature is a key attraction. “Bitcoin operates using a decentralised ledger and on a peer-to-peer basis,” explains Benson. This means that it can be used independently of the finance sector – and the fees that are associated with doing this.” This may spark the interest of corporates who in recent years have been focusing closely on transaction banking costs and looking to reduce fees where possible. Nevertheless, bitcoin transactions are subject to a fee if made through an exchange – this is currently around the 1% mark. But for merchants who may have to stomach fees of up to 4% from card providers such as Visa, MasterCard and American Express, the attraction is clear.

Aside from being independent from banks, cryptocurrencies are also independent from national governments. “There is no jurisdiction and no economic underpinning,” says Standard Chartered’s Jain. This has benefits for corporates who are engaging in cross-border activity as it is not subject to the rules and protocols that dictate the movement of fiat currencies across borders. Exchanging bitcoin across borders not only again escapes the often expensive transaction fees, but also avoids FX exposure and any value date issues – bitcoin transactions are made in real-time.

A third characteristic that could make cryptocurrencies an attractive proposition for some corporates is that payment is entirely irrevocable. “Traditional clearing and settlement systems to a lesser or greater extent involve the issue of revocation of payment instructions, particularly in the international system,” says Benson. “Corporates are always faced with this risk and that is why we see companies use letters of credit to mitigate this risk, because these can’t be reversed but of course they also involve paying fees to the issuer.”

Analysts in favour of the cryptocurrency also believe that bitcoin offers a new way for corporates to look after their customers – and protect their data. Consumers who use bitcoin will not need to provide any personal payment information. Comparisons here can be drawn to PayPal. However, bitcoin advocates suggest that it is more secure than PayPal because bitcoin has no database of information that can be leaked if an account is hacked. And while bitcoin 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 bitcoin may prove an innovative way to attract business from security-conscious consumers. Indeed, computer giant Dell, a company currently piloting the acceptance of bitcoin, is seeing positive feedback from its customers. “We’re pleased by the initial response to our current bitcoin pilot on for consumer and small business shoppers in the US and purchases have exceeded our expectations,” says Paul Walsh, Chief Information Officer at Dell Commerce Services.

Despite these apparent benefits, uptake still remains small in the corporate world. According to data from CoinDesk’s ‘State of Bitcoin 2014’ Q3 report, just under 80,000 companies now accept bitcoin.

Treasury tribulations

This lack of, or at least 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 the fact 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? Jain takes an open-minded approach in answering this question. “Corporates need to understand what the underlying value against the USD is, for example, and then understand why this goes up and down,” he says. Like gold, the price of bitcoin is driven by supply and demand but also by trust – and it is this third element that may be key to a more stable price, he explains.

Benson, on the other hand, points to the derivatives market as a potential solution to bitcoin’s volatility. “This is the single most important development that bitcoin can have,” he says. “A futures and options market will assist in taking the volatility out of the currency and also assist corporates in hedging any balance sheet risk.” There are already some companies in the market that are beginning to offer these services, including LedgerX , which hopes to launch the first US-regulated option exchange, and BitMEX, which recently launched the first 30 day Historical Volatility Futures Contract for bitcoin. “Products such as these have the potential to transform the market just as they did the traditional commodities market,” Benson notes.

Case study

Air Lituanica joins the bitcoin revolution

In August 2014, Air Lituanica announced that passengers could now purchase their plane tickets using bitcoins. Speaking at the time of the announcement, Simonas Bartkus, Director of Commerce at the company said: “Bitcoin payments are highly beneficial for the aviation market – this currency helps to attract more buyers from abroad as bitcoins can be used anywhere in the world. The money transfer is fast and there are no added taxes otherwise deducted by banks and agents.”

Since then, Sandra Meškauskaitė, the company’s Communication Manager, has spoken with Treasury Today and explained a little more about the company’s decision to accept the cryptocurrency. “Bitcoin is the most universal and reliable currency in the world. We installed it on our flight tickets booking engine and this has been a very popular decision – it is used by international customers all over the world.”

One of the drivers behind the decision was to give customers more real-world payment choices. What’s more, it’s simple to use. “When customers choose to pay by bitcoin, they are redirected to our payment service provider’s webpage (MisterTango) where they can find a QR code or bitcoin address which they can use to send the currency to. Once the payment is processed, we receive confirmation from our payment service provider and we then sell the ticket to the customer.”

In terms of security and risk management, Air Lituanica does not store payments in bitcoin. “MisterTango sells the bitcoins on the exchange and we receive euro in return. That is why we do not have a lot of risk associated with bitcoin and we treat it like a faster, more convenient payment method for our customers.”

While the company is only using bitcoins for simple transactions at present, Meškauskaitė believes that it has far wider applications and that customers will become increasingly interested in using bitcoin. “It is an extremely useful innovation and in the future it may eliminate current online payment methods,” he notes.

Safe as houses?

The next big issue that bitcoin is yet to fully overcome is security. Instances of security breaches, or ‘heists’, involving bitcoin exchanges have been well-publicised. The most high profile case involved the now infamous exchange Mt. Gox, which in early 2014 announced that approximately 850,000 bitcoins were missing, presumed stolen. The value of these coins, which belonged to both the company and its customers, at the time accounted for over $450m. In more recent months, 200,000 of the coins have been found by the company on an old hard drive, yet the rest remain at large.

This incident highlights a separate issue: namely, the anonymity that cryptocurrencies offer. Although any transaction that occurs will appear in the block chain (the decentralised public general ledger) for that day, the lack of identifying information available and the lack of forensic tools to analyse the block chain can make following transactions extremely difficult, if not impossible. Hence why they are often associated with ‘dark net’ trades.

Corporates holding bitcoin will also need to be aware of the myriad security issues as the cryptocurrency cannot be held in a bank account, with the long established security protocols that support this kind of structure. Instead, it is 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) 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 neither easy to access the wallet quickly nor conveniently to make and accept payments.

Progress is being made in this space, however, including the development of multi-sig technology. “Multi-sig technology is the equivalent to a safe deposit box that requires two people to access what is inside,” says O’Brien. “This means that one person with one key to the bitcoin wallet can’t access it and steal what is inside – it is an extra layer of security.”

Whether developments such as these will do enough to ease corporate fears over bitcoin security remains to be seen, however.

Regulation in uncharted territory

Elsewhere, regulation around bitcoin is a genuine concern. In early 2014, US Federal Reserve Chairperson Janet Yellen announced that; “It’s important to understand that this (bitcoin) is a payment innovation that’s happening outside the banking industry. The Federal Reserve simply does not have the authority to regulate bitcoin in any way.” With this statement many in the industry breathed a huge sigh of relief that they did not have to worry about the Fed cracking down on the currency. However, bitcoin has gained the attention of other global regulators both at state and local level.

“Regulation is incredibly important, ultimately it will make or break bitcoin,” says Nathalie Reinelt, analyst with US Boston based research firm Aite Group. And while many experts who commentate on the currency also share this view it remains a bone of contention in the cryptocurrency community. Cryptocurrencies, by their very nature, are decentralised and not tied to governments, yet as they become more popular, and are used more by consumers, there will need to be regulation. “It is a catch-22,” says Reinelt, “as much as those in the bitcoin industry are concerned about regulation and don’t want it, they ultimately need it in order to attract more mainstream users.”

But who can, and should, regulate the space? “There are questions surrounding whether it should be regulated on a country-by-country basis, or if there should be the creation of a global framework,” says Standard Chartered’s Jain. Currently the currency falls under the watch of a wide range of regulators at both national and local level. For example, New York State has been cracking down on those in the industry and in the summer of 2014 issued subpoenas to many bitcoin executives, in order to understand their business practices. Following this, the state launched its BitLicence, a licence that will be required by bitcoin companies operating in New York in order to do business and send the currency to residents. To be awarded the licence, companies must be in compliance with anti-money laundering and consumer protection requirements.

At the other end of the spectrum, in China, a country that bitcoin was once very popular in, the regulators have come down hard and restricted its use. Other countries such as Iceland have been even more extreme and classed bitcoin as a foreign currency that cannot be bought or sold in the country.

The Iceland example throws up another interesting question: what is bitcoin? Is it a currency, is it a commodity or something else entirely? And the lack of agreement from regulators seems to suggest that they really don’t know. In the UK, it is classed as private money. In Australia it is seen as property. Inconsistencies such as this place a huge burden on companies accepting bitcoin when it comes to reporting, auditing and tax.

“Ultimately, these issues need to be resolved – otherwise, there will not be mainstream consumer or business adoption,” says Reinelt. “Many bitcoin companies, especially those in the financial institution (FI) space, are in legal limbo regarding being banked and what to do with their earnings. Banks are not banking them because they just cannot stand up to their AML KYC standards.” In essence, bitcoin FI firms are asking to play in the same space as traditional financial services companies but not by the same rules. “This just isn’t going to happen,” notes Reinelt.

Benson thinks regulatory frameworks are what is needed to overcome these hurdles, as a means to standardise its use, as FinCen in the US and BaFin in Germany have started to do. Reinelt doesn’t see this as a realistic proposition, however. “I don’t think it will be possible to get that many regulators to agree,” she says. “I think the best outcome will be if countries watch what the big nations do; the US, UK and China for example, do and then augment those regulatory concepts to meet their own needs.”

A true alternative?

With so many question marks hanging over cryptocurrencies, is bitcoin ever going to be part of day-to-day treasury business? “It’s hard to say,” says Jain, “like with any new technology you really can’t predict what will happen. It may fizzle out, remain a niche, or it may become one of the world’s key technologies moving forward. And this will only happen with wide adoption across the supply chains – and won’t happen without regulation.”

Benson believes that bitcoin’s future rests on the development of the decentralised ledger and its ability to transform the transaction space. “At the beginning of the dotcom era, there was lots of confusion around what it would actually be. Was it going to be a new sector or something else? If we then look at how the internet has radically transformed all facets of life over the last 15-20 years – you can say a lot about that in relation to cryptocurrencies.” Benson doesn’t believe that banks and traditional currencies will disappear but he does expect to see some fairly significant changes. “Bitcoin is the same as the internet – it will just become another way that we do business and construct business models, it will add another dimension to commence.”

Bitgo CEO, Will O’Brien, believes (somewhat unsurprisingly) that bitcoin will be more revolutionary. “I think bitcoin will become more integral to our lives than we can possibly imagine. If you look at the early days of the internet who would have thought we would have companies like Google, Facebook and Twitter and all the effects they have on our world,” he says. “Bitcoin is following the same trajectory. Not everyone will know what it is or have one, but it is superior to our current financial system and it will eventually displace and replace the backbone of finance, capital markets and commerce.”

For Reinelt, it is the platform, built around the concept of a decentralised public ledger (block chain) and not the currency that will be the main talking point moving forward. “We are starting to see companies emerge, like Ripple, who have shifted away from making their cryptocurrency the primary product and focused more on offering the platform as a business to business service that allows FI to move money internationally for lower fees than traditional systems. So just in the way that Napster paved the way for digital content platforms, cryptocurrencies will lay the platform for cheaper, quicker and safer international monetary exchange built around the block chain concept.”

Work has also already begun on looking at how the decentralised ledger can assist corporates outside of the payments space. “At its most basic level, the block chain is used to securely transact. So this doesn’t have to be a monetary value that gets exchanged, it can be exchange of any value,” says Jain. “Theoretically, whenever there is any exchange that needs to be done securely, it can happen on the block chain. eBAM is one area that the block chain may fit comfortably into to; as are agreements and certificate exchanges, such as bonds and share certificates. Transferring letters of credit, and all the instruments associated with this, could also be built around the block chain moving forward.”

While investigations into the full potential of block chain technology are in their infancy, it is certainly an interesting space – and one that may eventually eclipse the debate on cryptocurrencies altogether.

Companies that accept bitcoin:


US customers can now upload bitcoin to their Windows Store account and make purchases through this.


US customers can make certain purchases on Dell’s website using bitcoin.

The online fashion, cosmetics and homeware merchant is Europe’s largest company that accepts bitcoin.


The online travel agent accepts bitcoin for travel bookings.


Established the first bitcoin ATM in the UK and also accepts payments in stores across the UK.


Those looking for love can purchase a subscription to the dating website using the cryptocurrency.

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