Consumers Pay More When They Pay With Bitcoin

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7:00 AM EDT May 20th, 2014

By : Benjamin Edelman, Associate Professor Harvard Business School

Payment gurus are buzzing with excitement about Bitcoin. A decentralized peer-to-peer payment system with no one to impose arbitrary rules as well as a cutting-edge technical underpinning—it’s no wonder Bitcoin gets praise from sources as diverse as venture capitalist Marc Andreessen and former treasury secretary Larry Summers.

But will consumers actually want to use Bitcoin? I’m less sure.

At its start, Bitcoin attracted buyers drawn to its black-market sellers. For example, Silk Road sold weapons, drugs, and even murder for hire. Those services don’t accept payment through mainstream systems like credit cards, so their customers were willing to learn the ins and outs of Bitcoin. These distinctive sellers attracted initial consumers, but they were largely unlawful and unsustainable. (Indeed, the FBI shut down Silk Road in 2013.) Illegal sales won’t drive Bitcoin’s growth.

In its most ambitious form, Bitcoin could seek to join the ranks of standard consumer payment systems—letting consumers buy things from Main Street merchants. But Bitcoin is poorly positioned to compete in that market. Experience from other payment systems is instructive.

Usually, consumers pay the same bottom-line price no matter what payment mechanism they choose. Cash, credit, and (perhaps) Bitcoin are all the same price. Savvy consumers choose a payment mechanism based on benefits, seeking the best rebates or points. This market structure has predictable incentives: I choose a Visa Signature Preferred card with 2.2% cash back not because it’s the cheapest to merchants (it’s not) but because it’s the best for me. (It’s hard to find a card with a larger rebate.) Indeed, to a merchant, my Signature Preferred is surely the worst of Visa’s offerings because it carries the highest interchange fees (charged to credit card processors, and in turn to merchants) of any Visa card. But a consumer has no reason to consider or care about those costs to merchants.

How does Bitcoin fit in? Suppose I wanted to buy shoes at Overstock that cost $100. If I pay by credit card, the receipt says $100, but my card’s rebate means I actually only pay $97.80. If I wanted to pay with Bitcoin instead, I’d need to open a Bitcoin wallet and pay $101 to Coinbase to get $100 of Bitcoins (at the current exchange rate). (The extra dollar covers a 1% fee to Coinbase.) If I hurry straight to Overstock, my Bitcoins should still be worth $100. (They’re as likely to go up as down in the time I have to wait.) But notice: The transaction ends up costing me $101 by Bitcoin, versus $97.80 by credit card. I might try it once as an experiment. But I have every incentive to stick with my credit card going forward.

To spur consumer adoption of Bitcoin, merchants should offer discounts for consumers who use it. Suppose Overstock’s credit card processor charges 2.9%, a relatively standard fee. Is there a discount that makes Bitcoin preferable to credit cards both for me and for Overstock? It turns out that there is not. If Overstock reduces its price to me by 2.9% when I pay by Bitcoin, I still have to pay 1% to get the Bitcoins, which means I pay $98.10 to get the shoes. That’s still more than the $97.80 I would pay by using my credit card.

Even if I already have some Bitcoins, paying with Bitcoin still isn’t a no-brainer. Suppose I have $100 of Bitcoin. I could use that $100 to pay Overstock. Or, I could cash that out and get $99. Notice: With $99, I could pay my $97.80 credit card bill and still have $1.20 leftover. So even if I already have enough Bitcoin, I’d rather pay by credit card.

The crux of the problem is price coherence—a market structure wherein buyers pay the same price whether buying directly or via an intermediary. Consider: paying cash versus credit card, reaching a merchant by typing in its domain name versus clicking an ad on Google, or booking on an airline’s site versus an online travel agent like Expedia. In this market structure, intermediaries don’t compete to offer lower prices to merchants. Rather, they compete to offer buyers as much benefit as possible. To tempt me away from my 2.2% Visa card, MasterCard needs to offer a 2.3% alternative. To keep me searching at Google (rather than switching to Bing), Google pays engineers to build ever-cleverer search functions. The same is true of other affected markets. Of course merchants and advertisers then face ever-higher fees—the predictable effect of this market structure. (For details, see my working paper with Julian Wright: Price Coherence and Adverse Intermediation.)

Bitcoin doesn’t play this game. There’s a certain appeal to rejecting the escalating benefits and ever-higher fees to merchants. But consumers have little reason to forego these benefits—all the more so if Bitcoin then rejects the important consumer benefits (consolidated billing, 30 to 60 day float, and dispute resolution rights) that accompany mainstream payment models.

Perhaps Bitcoin shouldn’t be chasing Main Street merchants after all. Summers sees opportunity in the most inefficient parts of the financial system, so we might especially look to markets that are badly served by credit cards and other payment incumbents. I’m struck by the market for international payments—sending money to friends and family in other countries—where fees were historically quite high. Would Bitcoin work well there? Consider Bitcoin’s unpredictable exchange rates, technical complexity, and lack of accountability if something goes wrong. These features are a poor fit for customers of modest means who may not speak English natively and who are in no position to gamble on uncertain technology. Meanwhile, Western Union will send $1000 to dozens of countries for just $8. Running the same transaction through Bitcoin and Coinbase would cost $20 (1% to send, 1% to receive). Bitcoin fees need to drop threefold to be cheaper than Western Union, even putting aside service differences.

Recent surveys reveal consumer interest in Bitcoin not as a means of paying, but as a store of value that could gain future appreciation. But Bitcoins have no intrinsic value. These consumers might as well invest in tulips.

Bitcoin’s technical architecture—the distributed transaction register—is a clever innovation. It’s a fine addition to the Internet, and surely it will find some appropriate uses. Ex-Googler Mike Hearn says Bitcoin’s block chain algorithm could help run a more efficient taxi dispatch system or help an online review service recommend restaurants. I suspect those benefits could be provided just as well—and much more simply—through other designs. But if the future of Bitcoin shifts from payments to data storage and data processing, Bitcoin’s role will be correspondingly less revolutionary. As to the prospect of regular folks using Bitcoin payments day in and day out: Don’t hold your breath.

  • spoken01

    alt currenices need more common increments for spending and pricing purposes. The current system is fine for buying and selling on the coin markets but not for buying and selling goods and services. Also just as gold is not commonly used for day to day purchases , bitcoin itself may not be the preffered payment method, other currencies are compared to bitcoin value as a sort of
    standard to judge their current value. I see bitcoin as more comparable to gold which also has
    price fluctuations. Our own currency(US) also has these fluctuations but the average person does not see this until the cost of goods and services starts to increase. This absolutly impacts the costs of foreign produced products. If you were paid in digital currency you would also not have the aqquisition fees that you were reffering to. The other problem is that not everyone has the
    sky high credit scores that you apparantly have to get these cards and many of us will never have
    the ability to get high rebate cards. The other problem with that is the interest rate that you failed to mention as most people do not pay off their credit cards every month. Life simply don’t work that way for the majority of us. So I wouldnt write off a one percent payment system as compared to a 10-25 percent system. The other issues are things like banking fees, remember the 1000.00 you sent to Western union?? How about the checking account fees?? How about the untrustworthy banks that at the first chance will increase these fees and bump your interest rate on your cards. Not to mention ATM fees. This is new and there are many nuacnces to work out, but our financial system is rife with fees, taxes charges and gevernment meddling in the value. It will be a slow adoption but I see digital currency of some form as an escape from all of this skimming of everyones increasingly meager paychecks.

  • Gil Luria

    You may be right if these facts were straight. As it happens:
    – Very few people have access to cards that provide 2.2%
    rewards. 1.5% is currently the best available broad offer. More
    than 1/2 of online purchases are not made with a credit card, so earn no
    rewards whatsoever.
    – Overstock has provided rewards to bitcoin users and can do so
    in the future with the savings from lower acceptance costs in order to
    encourage usage.
    – The 1% price point for Coinbase was early monopolistic
    pricing. The second entrant (Circle) has already lowered the price of
    buying bitcoin to zero.

    • GSukenik

      Plus the whole idea of incorporating the purchase of Bitcoin into the price of purchasing other goods makes no sense. Obviously, converting currencies adds cost. Just like if I had Euros and had to convert to dollars for a dollar-denominated purchase. People with Bitcoin already have Bitcoin.

  • Carl Mullan

    Nice article, but I believe you are looking at this the wrong way. Many, if not most, of those shopping online with Bitcoin have no plastic cards. They don’t have access to online shopping because the banks have shut them out or they live in an area where there is no access to conventional banking such as the countries in Africa. You would have a good story and another article if you compared MPESA to your cash back USA credit card because there is no discount for MPESA shopping and payments. But again, here you have a payment systems that extends utilities to those without access to conventional banking. If Bitcoin attracted every unbanked person in the world, but never converted on VISA shopper to altcurrency, could you still say…”Hmmmm, that not going to be a successful payment system?” I don’t think so.

    Another important point is the fact that most credit card users carry a balance from month to month. While cash back may be an exciting sexy feature of some credit cards, the monthly interest rates being paid by the consumers on that card is usury.

    You present a one sided, good ole USA point of view in your article but I’ll tell you people using alternative currency systems aren’t comparing bank options, they have none. That is what drove them to use it. The guy paying his AMEX bill each month has no reason to switch and is not a fair comparison.

    • Chris Farlee

      Where do you get statistical information on the demographics of people shopping online with bitcoin? I would love to peruse that data.

  • gitterdunne

    What is your Western Union data from? I just priced sending $1000 at (for cash pickup at an agent location) and they show it costing at least $20 while taking 3 days to get there…or, if I want it there ‘now’, I’d need cash (at an $86 fee) or a credit card and have to pay a $95 fee. Since bitcoin transfers take under 10 minutes, I think the fair comparison would be the $86 or $95 fee option. The cheapest ($5) option requires sending from a bank account to a bank account and waiting 6 days for settlement/clearing. On top of all that, the effective FX rate used by WU is approximately 4.7%. So, even if you were to use the $5 bank-to-bank option, the total cost would be over $50 by the time the money was available to the recipient 6 days later. And, if you did the cash option (to have speed equal to bitcoin transfer), you’d pay $86 + $47 = $133. Twice paying 1% to Coinbase or 0% to Circle sounds comparatively reasonable…especially considering they’ve yet to achieve scale and amortize their costs and lower their prices yet.

    • Andre

      Hear, hear. If I send €50 from the Netherlands to Indonesia with Western Union, I pay €9 to do so. Make it €100, and I “only” have to pay €12.

      If I send money by bank from the Netherlands (ING) to Malaysia (MayBank), I pay €6 to ING, RM 5 (~€1) to MayBank, and I get an exchange rate that is about 1.5% below the market rate. So if I send €100 this way, it costs me €8.50. And it takes three working days.

      Bitcoin wins hands down, both in costs and in speed.

  • hughht5

    “Meanwhile, Western Union will send $1000 to dozens of countries for just $8.”
    However they will charge between 5-15% on the forex rate depending which currency you are converting to.

  • Vinny

    Hi Ben, the article has definitely provoked some thought from the foray of comments. Some other facts that you can bake into consideration:
    – PSP kind of providers like coinbase say ‘merchant acceptance is free’ 0% cost to merchant; it is true. However, what is not mentioned is that it is the holder of the Bitcoin (XBT) that pays for the transaction
    – The PSP provider earns money by purchasing XBT from consumer at a discount to the value it is sold on the exchange. In essence the XBT holder purchasing goods from likes of Overstock pays for the transaction
    – In case we wish for PSP’s to reflect transparency, it will be good to see at what rate the XBT were purchased from customer and what rate were they sold to the exchange for converting to local fiat currency
    – My brief review of some providers shows that that PSP offer rates ~2 to 4% worse than the current exchange rate. It is easy to check on the Blockchain on rate offered to customer and rate at which XBT sold at exchange during that exact moment.
    – Thus merchant gets the transaction for free, however it is the customer that pays for the transaction.
    – XBT PSP’s pay between 0.1% to 0.5% for exchange sale of XBT. Most PSP’s have bank accounts outside of US, thus requiring wiring the money or holding funds for ACH payment to merchant account. Adding all these costs, PSP’s using XBT can be profitable only by charging customer to cover costs plus revenues.

    From my research so far as an independent consultant have found out that cost of transaction – irrespective if the merchant pays for it or customer pays for it (hidden in exchange cost) is no different than traditional card payments.

    Having said that XBT is a new currency that has been in existence for just about 3 years, it is imperative to note that the onset of merchants and businesses is not significantly increasing the number of XBT transactions(~65,000 per day). Most XBT today still continue to be used as an investment vehicle with the holder looking forward to undertake the risk for a higher upside.
    Merchant transactions have not reached a significant mass as yet and it will take time for XBT to even come closer to mainstream e-Commerce transactions by traditional players.

    What XBT brings to the fore is a technology protocol and Blockchain, if used effectively by traditional payment providers it can streamline some of the pain points. I foresee XBT protocol i.e. Blockchain to help provide a underlying technology to help traditional players. That is where the convergence of the new world and old players will create a more efficient, secure and trusting network using existing payment forms / new virtual currencies.

  • Markus Virba

    Bank held my check deposit and processed 15 coffe transactions first. Putting my account negative at 35 dollars per each 5 dollar coffee.
    You tell me that was not programmed to rob me.

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  • Tom Thompson

    Well, there were a few associate professors that rabidly claimed that the earth was flat a few hundred years ago; until someone actually circumnavigated.

    With the frequency of “articles” like this in recent months, I say Satoshi Nakamoto is clever to opt to remain elusive else the establishment would have roped him in something by now. Funny how this PROFESSOR poisoned the water very early in the article with “silk road”.


    Bitpay charges ZERO, nothing for a bitcoin transaction. Already this assumption is blown out of the water. The thought behind this post is lame. Surely Harvard can do better. I dunno.

  • Nelson Hermance

    Edelman is clearly biased.

    He dissects problems/issues with Bitcoin like a surgeon but on the other side gives the rosiest picture possible (2.2% cash back, yeah right!) and ignores many of the fees and problems with the traditional payment system altogether.

    For instance: he ignores the annual fees charged for Visa and MasterCard altogether. Bitcoin has no annual fee.

    For instance: merchants pay a % on every transaction *and* an annual fee. Mr. Edelman astutely dissects both sides of the Bitcoin transaction and the risks in the middle but completely ignores the merchant side of the traditional payment processing system. Merchants pay as well. A fair comparison shows 2 sides of one system vs. 2 sides of the other. Not the costs of only one side of the traditional payment system vs. BOTH sides of Bitcoin.

    Looks to me like Edelman may be just another high paid tool of the rich and powerful. Using his intellectual capital to attempt squelch or compromise (or just slow down) something that might undermine the power of US money center banks.

    Maybe you think I’m exaggerating? Google his name and see what he did to a small business in Mass. A small Chinese Restaurant who made a minuscule error that he jumped all over.

    I think he is a bully who makes his money by attacking the little guy – and tools that might help the little guy – like Bitcoin.

  • Nelson Hermance

    To see where Mr. Edelman is coming from in general see:

    “If you’ve ever wondered what happens when a Harvard Business School professor thinks a family-run Chinese restaurant screwed him out of $4, you’re about to find out.”

    and that was not his only scrap with a small family run business. He had another scrap where he threatened to destroy another small business by using his connections to remove their liquor license.

    Because he was charged 2 to much for a drink. In his opinion.

    A series of letters with threatening legal language. Over 2 dollars.

    Fact: Bitcoin is widely seen as a tool that threatens to free the average person/small business from various forms of financial abuse at the hands of the traditional payment system.

    Given Mr. Edelmans track record of hostility against the small businesses/the little guy I think we can deduce where he is coming from.

  • Johnny Goldwater
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