Bitcoin: to use or to hoard, that is the question

By:
Solomon Teague
Published on:

Bitcoin faces an uphill battle to satisfy the conventional functions of money as a medium of exchange, store of value and a unit of account, participants say at a leading conference on the digital currency this week.

The jury is still out on what role Bitcoin can play in the world economy.

For some, the ambition is for a currency with a practical application, used as a medium of exchange alongside national currencies – and, perhaps, in some cases, one day replacing them.

Yet for others it is principally useful as a store of value, digital gold, protecting investors from future inflation and thereby encouraging saving and restoring balance to the economy.

In reality, the two are inextricably linked. The value of the currency is likely to be determined in large part by its usefulness, and the more transactions are conducted using bitcoins the higher the price is likely to go.

Conversely, if people are unable to use the currency in real-world transactions, its store of value is likely to decline as the novelty wears off.

However, it’s a long and winding road until bitcoins can be used for tangible transactions.

Yoni Assia, CEO of eToro
There are not yet enough merchants using bitcoins to give the currency real-world value, says Yoni Assia, CEO of eToro – a social trading platform that allows users to monitor and replicate other users’ trades – who estimates that speculation constitutes around 95% of its underlying price.

“The price of Bitcoin is based on volume and the volume is based on volatility,” he said at the Bitcoin London 2013 conference on Tuesday. “The more media coverage there is, the more people talk about it, the higher the volume of trades and the higher the volatility.”

It is likely to be some time before the currency achieves the same levels of interest among users as it has among speculators. “That will come over the long term,” says Jaron Lukasiewicz, CEO of Coinsetter, a retail FX trading platform for Bitcoin. “At the moment, Bitcoin scares the hell out of people.”

Before Bitcoin can make the transition – and become less scary, and more accessible to the public – it needs to overcome this catch-22 situation, increasing liquidity and reducing volatility. But more than anything else Bitcoin needs time.

“The longer it exists, the more attractive it will become,” says Luzius Meisser, founder of the Bitcoin Fund.

This is because there are still serious risks to investing in Bitcoin. Its regulators stigmatize the currency, dismissing it as nothing but a tool for money laundering and drug dealing, triggering fears that the price could be driven down permanently.

It could also be replaced by a superior digital currency. But the integrity of the underlying protocol looks relatively robust – or more than its detractors claim, having withstood the efforts of hackers for several years.

Merchants will not be attracted to Bitcoin until their customers are, yet merchants are the ones with the most to gain transacting in bitcoins, says Grzegorz Luczywo, co-founder of SecurityKiss, an online security firm.

SecurityKiss offers a 50% discount to customers transacting in bitcoins, in recognition of the reduced cost of processing such payments.

“Most people don’t know that the cost of the payment process is incorporated into the product price,” says Luczywo. “Even people who don’t use PayPal or credit cards are paying to subsidize the people who do. So it is important that merchants offer discounts, otherwise there is no incentive for them to use Bitcoin.”

Yet despite the substantial discount, only 5% of SecurityKiss’s revenues are earned in bitcoins, says Luczywo.

Merchants are also less exposed to fraud when transacting in bitcoins, says Luczywo, though the irreversible nature of transactions, denominated in the digital currency, will offer unscrupulous merchants opportunities to rip off their customers.

He says an uptick in fraud is likely as the currency’s use becomes more widespread. As the currency matures, he predicts an escrow service will develop as one way of protecting consumers.

However, merchants that invite Bitcoin transactions will face other challenges, principally relating to accounting.

The big four do not recognize Bitcoin as a currency, meaning any corporate funds held in bitcoins will not show up on the balance sheet. Until this changes, corporates will probably have to convert revenues earned in bitcoins into a traditional currency for accounting purposes, taking on the additional cost that entails.

In the meantime, Bitcoin might prove most useful for transactions involving certain types of digital products, where shoppers do not have to trust merchants to physically deliver the goods.

In the short term, perhaps it is more useful function is as “an IP address for money”, says Coinsetter’s Lukasiewicz.

It can bridge different apps and provide the much-needed interoperability between them, allowing people to make cash-to-cash payments between them without needing to have the same apps on their phones.