Lots of folks have opinions on the pros and cons of Bitcoin, and last week, the House Committee on Small Business heard various views on the benefits and risks associated with small businesses dabbling in the cryptocurrency.
No one really questions the cost benefits associated with bitcoin acceptance. Yet a variety of unknowns are generating concerns about the cryptocurrency’s viability and the potential impact that could have on small businesses in particular, many of which have their own inherent viability issues. In various testimony during the hearing, some tried to allay such concerns, while others clearly indicated that it’s best to keep a close eye on Bitcoin to prevent long-term negative implications.
In his prepared testimony, Jerry Brito, senior research fellow at the Mercatus Center at George Mason University, noted that virtual currencies have existed for decades – from World of Warcraft Gold to Facebook Credits to e-gold. The same is the case for online payments systems, such as PayPal.
But what makes Bitcoin different is that it’s the world’s first completely decentralized digital currency, which lowers transaction costs, making it particularly attractive to small businesses he said. …
“It could also be an attractive electronic payments option for consumers, including the unbanked and underbanked,” Brito said. “Risks include volatility and security, but these are not problems inherent in Bitcoin’s design.”
Small businesses accepting credit card payments often face fees of around 25 cents for each card swipe, plus 2 percent to 4 percent of the sale, Brito noted. “If you are a small-margin business, those fees can really eat into your bottom line,” he said. “This is why we often see small businesses like dry cleaners or convenience stores display signs limiting credit cards to transactions over a certain amount.”
In contrast, businesses that use a merchant processor like BitPay or Coinbase pay fees of 1 percent or less on Bitcoin transactions, and for a small-margin business, the difference could doubling its profits, according to Brito.
Indeed, Fitch Ratings last week came out with a report suggesting that anything that results in regulating Bitcoin as a conventional currency, “its appeal as a low-cost means of exchange would decrease significantly.”
According to the Fitch report, in February total Bitcoin transactions averaged $68 million per day, up more than 10 fold from a year earlier, but still insignificant compared to Visa and MasterCard, whose transaction volumes averaged $19 billion and $11 billion per day in 2013 respectively.
In his prepared testimony, Brito noted that small businesses also are attracted to Bitcoin because, like cash, all transactions are final; and because there is no central intermediary; there is no third party that can reverse a transaction. Thus, small businesses are protected from charge-back fraud, which often results not just in the loss of the sale, but also in penalty fees. Such “friendly fraud” accounts for 41 percent of all claims, Brito said.
“Moreover, there are over 50 countries that traditional payment processors do not serve, often because of high fraud rates. Because Bitcoin payments are global and final, doing business with consumers in those countries is now feasible,” he added.
But there are risks associated with Bitcoin, chief among them being Bitcoin’s historic volatility. It has traded from a low of pennies when it was first introduced in 2009 to a high of $1,200 last December, with wild short-term swings, Brito said.
Volatility because ‘it’s a new currency’
“However, there is nothing inherent in Bitcoin’s design that makes it naturally volatile,” he added. “Its volatility is likely attributable to the fact that it is a new currency, still in the process of discovering its stable price.”
As a nascent currency, it is very thinly traded and, as a result, a single, large-enough trade can affect the exchange price substantially. “If Bitcoin’s use continues to expand, we should expect to see volatility subside,” Brito said.
Additionally, derivatives that allow investors to bet against the price of Bitcoin will soon become available, and this should help stabilize the price as well. Small businesses also can use Bitcoin entirely as a payment system, and this is what most do, he added.
Moreover, merchants using a merchant-service company, such as BitPay or Coinbase, do not need to be exposed to Bitcoin volatility. Merchants can denominate prices in dollars, accept bitcoins for payment at the current exchange rate, and then immediately convert those bitcoins to dollars, Brito said. In that case, a business that accepts Bitcoin payments never has to hold bitcoins.
Adam White is director of business development and sales at Coinbase, which was founded in June 2012 with the goal of making it easy for merchants and consumers to transact with bitcoins. In his prepared testimony he noted that more than 1 million consumers use Coinbase as their bitcoin wallet. White also spoke last month in a podcast interview about the company with MPD CEO Karen Webster.
Some 27,000 businesses use Coinbase to accept bitcoin payments on their behalf using our payment tools, including large, enterprise-level businesses such as Overstock.com and Big Fish Games, as well as a myriad of small businesses like Tealet, Tuft & Needle, and Mondo Cellars, he said.
White agreed with Brito’s assessment that the inherent benefits of Bitcoin in commerce include the elimination of fraud and reduction of transaction fees.
Bitcoin, he said, enables individuals to push payments to merchants without having to share personally identifiable information that can be intercepted by criminals and used for fraudulent purposes.
Bitcoin’s ‘push’ functionality
“This push functionality gives Bitcoin a unique characteristic that eliminates the risk of fraud, something that merchants, card processors, and banks spend billions of dollars per year combating,” White said. “With Bitcoin, for example, the Target data breach that compromised over 70 million consumers’ credit card information would not have been possible.”
Additionally, many card issuers use fraud-detection systems that are overly sensitive to trigger activities for card-not-present transactions. Initial estimates suggest that some merchants turn away nearly 8 percent of incoming orders due to suspicious activity, many of which could, in fact, be legitimate, White added.
Mark Williams, executive-in-residence and master lecturer at Boston University School of Management, noted in his prepared testimony that U.S. small businesses could either accept Bitcoins as payment (or use them for paying employees and vendors) for either legitimate or illegitimate reasons.
The poster child for illegitimate purposes was Silk Road, an online purveyor of drugs, guns and prostitution that accepted payment only in Bitcoin. The FBI shut down Silk Road in October, and the Silk Road case elevated public awareness of Bitcoin as the designer currency of choice for the criminally inclined, Williams said.
“The anonymous nature of Bitcoin, and the fact that transactions are irreversible, make it an ideal way for criminals to launder money, buy illicit goods and avoid taxation with little chance of detection,” he said.
In terms of legitimate purposes, bitcoin helps merchants gain marketing exposure, Williams said. Bitcoin has gained increased media attention and, as a result, more small businesses view accepting Bitcoin as a way to gain market exposure. Posting a sign on a door front, on website or gaining local media coverage increases free advertising and brand awareness, he testified.
Third-party vendors that create and hold e-wallets perform a deposit-type function. However, unlike banks, these vendors lack regulatory oversight, minimum capital standards and don’t provide consumer protection against loss or theft, William said. “Once created, e-wallets generate a public and private key. Small businesses need to have strong controls in place around the storage of e-wallets and of the private key,” he explained.
This is particularly important given that Bitcoin is an anonymous currency that is irreversible once transferred. “Bitcoin features make it an ideal target for cyber criminals,” Williams said. “If an e-wallet is hacked and coins stolen or transferred by mistake, they are lost forever. If a computer is infected with a virus, it could wipe out the hard drive and the stored value of all e-coins.”
Internet access needs
L. Michael Couvillion, associate professor of economics at the Plymouth (N.H) State University College of Business Administration, testified on the various advantages and disadvantages as well. Among the financial advantages,he said, Bitcoin makes possible very secure cash flow payments, especially if existing two-factor authentication practices are used.
Among the financial disadvantages, Couvillion said, were that Bitcoin is a 100% digital method of remittances. Therefore, any small business that chooses to use it must have reliable access to the Internet whenever any transaction is initiated.
Moreover, the business must link its business checking account with a traditional bank to the accounts of the online wallet provider. This link enables seamless transfer of cash to Bitcoin and vice versa. “If its commercial bank is reluctant to do business with a Bitcoin entity, some integration problems will occur. Such problems are more likely with overseas banks than U.S. banks,” Couvillion said.
Exchanges have own volatility issues
In the past, many Bitcoin exchanges have failed, he added. If a small business chooses to use an exchange that is not professionally managed and does not employ best security practice, it is possible that Bitcoin exchange balances might be compromised as the affairs of the failed exchange are resolved.
“Since the exchange may well be located in a non-U.S. country, such resolution can take many months and result in significant loss of working capital for the small businesses and customers affected,” Couvillion said.