Derided as a Ponzi scheme, a currency of choice for drug dealers and money launderers, an impractical currency with no intrinsic value, bitcoin has seen its share of skepticism. The crypto-currency’s meteoric rise, fall and daily price gyrations continue to add to the skepticism. Balance all that negativity with growing venture investment in bitcoin startups and the rising number of merchants accepting bitcoins and you have the makings of a head-scratcher! Bitcoin is gaining ground as a viable store of value but is still far away from the tipping point.
Bitcoin is a decentralized crypto-currency operated and generated by an algorithm. Its appeal is inherent in its model—no intermediaries between the consumer and the merchant and unregulated in most countries. An individual can choose to make money through bitcoins by either mining or trading the currency. Mining refers to the competition between bitcoin users to utilize their computers to solve complex mathematical problems. The individual’s computers do the computations and forward the solutions to bitcoin server. The winner of the competition currently wins 25 bitcoins approximately every 10 minutes. Through mining, users essentially contribute to the computing power of the network and the production of bitcoins, which is capped at 21 million bitcoins by 2140. Alternatively, bitcoins can be acquired through trading. Prices are determined by supply and demand, exposing the currency owners to wild fluctuation—driven in most cases by speculators.
Bitcoins have been around for more than six years, but gained attention at the end of 2013. Demand for the currency spiked a whopping 5,000 percent, driving the price of a bitcoin from about $13 in January to more than $1,000 in November, largely because of demand in China. In October, prices slipped when the FBI busted Silk Road—an online terminal for criminals—for a $28 million illegal bitcoin activity. Shortly after, prices peaked at $1,145, but when China cracked down on bitcoin use, forbidding financial institutions from dealing in the currency, prices plunged precipitously.
Today there are over 700 or so digital currencies in circulation. Bitcoin, the most recognized of them all, has become the poster child for digital currency with over 14 million coins in circulation in over 20 countries. There are over 5.5 million bitcoin trading accounts, known as “wallets,” and over 100,000 businesses worldwide that accept bitcoins in lieu of traditional currency for payments. Some of the marquee businesses include Dell, Expedia, Microsoft, PayPal, Reddit, Subway, and Time, Inc.
Bitcoin’s future, as with any virtual currency’s future, relies on people’s willingness to accept it, use it and think it has some value. For all the advantages of bitcoins—no intermediation, voluntary processing fee, no monetary policy manipulation, and others—there are still several barriers to overcome, including concerns about online security, a lack of regulation and the anonymous nature of transactions. Additionally, banks are not fully on-board with the idea of trading virtual currencies, although they are beginning to look at it more closely.
Nevertheless, bitcoin has found a strong footing in certain niches of the economy: small business market, peer-to-peer (P2P) money transfers, unbanked and underbanked population in the developing countries.
Small business owners have found bitcoins to be a promising payment alternative. Merchants can receive payments from transactions within 10 minutes. Because payments are processed through the bitcoin network, banks and other financial intermediaries stay out of the picture. Accordingly, there are no holds, blocks, or interest fees on merchants’ bitcoin wallet. The actual payment process—scanning of the QR code—can be a convenient switch for both the merchants and the consumers. With a few cents for the voluntary processing fee, merchants can choose to expedite the payment process. Further, the ease of exchanging bitcoin online could strengthen merchants’ online storefront sales. Finally, bitcoin transactions could help simplify merchants’ bookkeeping procedures since each transaction is final and payments can only be refunded at the merchants’ discretion, unlike in the case of credit cards.
Bitcoin’s P2P lending market is a nascent and highly promising market. The three major bitcoin platforms offering the service include BTCJam, BitLendingClub, and Bitbond. Cumulatively, the interest rates on loans can vary, starting from a 6.7% base point. Although BTCJam and BitLendingClub make short-term loans, Bitbond competes with the fiat money lending giants like Prosper and Lending Club through its 3-5 years loan offerings. Due to the instability of the currency itself, bitcoin lending market is volatile. Lack of information disclosure, high default rates, and marginal chances of recovery after default add to the risk of exchange. However, investors are often compensated for undertaking such risks. BTCJam, for instance, offers investors up to 19% APR. Further, the three platforms have introduced many features to enhance their appeal. BitLendingClub and Bitbond use a reverse auction system to let lenders bid offers to the borrowers, BitLendingClub provides a built-in amortization schedule to investors, and BTCJam allows lenders to sell off their portion of a loan through a trade on its website. The momentous growth of Bitcoin’s P2P lending market can be gauged from its expansion in more than 180 countries around the world.
Bitcoin has a larger appeal in the international markets. Take Latin America, where approximately 90% of the population does not have a credit card, but a high percentage has smartphones. An individual looking to make payments can easily use his or her smartphone to go online and follow a simplified procedure to complete the transaction. With no transaction fees to divide his or her revenues, the merchant, too, would rather prefer bitcoin than credit card payment.
Not surprisingly, venture capital investments in the bitcoin ecosystem has been gaining momentum. According to market data from CoinDesk, the fourth quarter of 2014 saw a record-setting $130m of new venture capital invested in bitcoin startups – nearly double the $64m raised in third quarter. As of Dec 31, 2014, a total of $433m had been invested in bitcoin startups since 2012, with 77% of that total ($335m) coming in 2014 alone. The 2014 publicly disclosed VC investment in bitcoin startups also equals three times more than the total investment VCs made in bitcoin startups in 2013. Additionally, the number of countries that received VC investment grew from 8 to 18 in 2014, with half of the new countries located in Europe, followed by countries in the Middle East.
So, has bitcoin adoption reached the tipping point? The answer is not yet, but it is moving toward it, albeit slowly.
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