Entrepreneurs from Silicon Valley to Wall Street say they don’t care much for Bitcoin as a currency to supplant the U.S. dollar. As a payment technology they could use to undercut Visa Inc., Western Union Co. or Citigroup Inc., they say they like it a lot more.
As Bitcoin’s value gyrates, these investors have said that the headlines about its price and chatter about which retailers accept it obscure the real merit of what Satoshi Nakamoto, the name given to the anonymous person or people who created Bitcoin, delivered five years ago.
“At some point, I had an ‘aha!’ moment and realized that Bitcoin was best understood as a new software protocol through which you could rebuild the payments industry in ways that are better and cheaper,” Chris Dixon, a partner at Menlo Park, California-based venture capital firm Andreessen Horowitz, wrote in a blog post.
Bitcoin enthusiasts say they are building a system to move money across the Internet securely and at a lower cost than existing wire transfers, bank debits or remittances. If they can eliminate the friction created by middlemen and create easy-to-use consumer tools, Bitcoin businesses may claim a piece of the revenue and still deliver lower costs.
Already, some retailers are paying 1 percent to process transactions in Bitcoin, improving profit margins. Taking debit or credit cards, they may pay more than 3 percent to issuing banks. Bitcoin transactions log immediately, and are confirmed in as little as five minutes.
Skeptics counter that Bitcoin’s volatility -- the price swings resemble those of a thinly traded currency -- could wipe out cost savings in what is still a small business. They also say the startups, in addition to facing entrenched incumbents, will layer their own costs onto Bitcoin transactions, undermining the goal of a cheaper system.
A lower-cost virtual currency-driven payment system could take business from companies like Western Union that specialize in foreign remittances, as well as Visa and MasterCard Inc. Banks such as JPMorgan Chase & Co., Citigroup and Bank of America Corp. reap billions in fees from the use of credit and debit cards, and are the main players in the direct-debit system.
“Perhaps the rise of Bitcoin will put pressure on big banks to get us a more modern payment system,” said Jennifer Tescher, president of the Center for Financial Services Innovation, a Chicago-based research group.
Bill Carcache, a Nomura Holdings Inc. analyst in New York, said any disruption is bound to move slowly. Visa and MasterCard have 35 million locations globally that accept their cards, and as many as 2 billion account holders.
“I’d never dismiss the risk posed by a new technology, but I think the network effect that Visa and MasterCard have achieved creates a high hurdle for new competitors seeking to disintermediate them,” said Carcache, who reiterated buy recommendations on Visa and MasterCard in a client note last month.
Bitcoin’s potential as a payments system is “an exotic topic within an exotic topic,” said Arjan Schutte, founder of Los Angeles-based Core Innovation Capital, which invests in financial-services startups. It’s also the driver behind the most important venture capital investments in virtual currencies, according to Schutte, far more important than the price of Bitcoins.
“I have no interest in owning Bitcoin,” he said. “What I am entirely interested in is frictionless money transfer.”
The global integration of financial markets obscures a central and costly problem: Moving the most basic asset, cash, can be expensive, slow and at times fraud-ridden.
When a consumer swipes a debit card at a store, the amount is immediately subtracted from the customer’s available cash. The merchant is paid only when the next collection of transactions clears, usually in a day, but sometimes at the cost of higher fraud levels, according to Shirley Inscoe of the Boston-based consultancy Aite Group LLC. When an immigrant gives cash to a Western Union agent, such as a convenience store, the money may be available quickly to a family member in another country only if the customer pays a premium.
Businesses paying suppliers through the automated clearing system to which all U.S. banks belong have no guarantee that payments will clear the same day, and the process uses a 40-year-old software protocol. International wire transfers can take four or five days, and are costly enough to make small payments uneconomic, Inscoe said.
Merchants pay about $48 billion in fees to banks for their customers’ payment-card use and banks pay much of that to Visa and MasterCard, according to Aite Group. Unauthorized charges, sometimes linked to data breaches like the one at Target Corp., cost about $5 billion per year. Remittance providers such as Western Union Co. reap about $37 billion in fees each year from people sending money home, according to the World Bank.
The Federal Reserve in September began a process for revamping payment systems. State banking supervisors also have formed their own group to examine how to reduce costs and increase speed, said Charles Vice, the commissioner of the Kentucky Department of Financial Institutions.
“We’ve not had a substantial look at clearing of payments in 40 years,” Vice said.
Paul Cohen, a Visa spokesman, and Seth Eisen at MasterCard declined to comment on Bitcoin’s role as a payments technology. Andrew Silver, a Western Union spokesman, said in an e-mailed statement that the company is tracking the Bitcoin market while for now handling only regular currency. Like many banks, Wells Fargo & Co. is consulting “internal and external experts” to learn more about virtual currencies, spokeswoman Richele Messick said.
The chief innovation of Bitcoin involves a solution to what is known as the double-spending problem. Any payment that is not cash handed over in person, such as entries in a bank account, could be duplicated, allowing people to spend the same money twice. A trusted third party, such as a payment system run by Visa or MasterCard that confirms identities and ownership, adds costs while preventing double-spending.
Nakamoto solved the problem by creating a public ledger that establishes ownership by anonymously recording who owns what Bitcoins. A volunteer network of computers validates every single transaction on the network by performing computations that prove they’ve done the work, and receive new Bitcoins in return, eliminating the need for a third party.
“That was the ‘breaking the sound-barrier moment’ for virtual currencies,” said Tony Gallippi, who co-founded BitPay Inc., an Atlanta-based Bitcoin payment processor.
Bitcoin transactions could mitigate the risks of breaches of the type reported by Target, Neiman Marcus Group Ltd. and other retailers, said Jerry Brito, director of the technology program at George Mason University’s Mercatus Center. With Bitcoin, a customer doesn’t leave behind the credentials necessary for additional, fraudulent transactions.
“You’re not giving the retailer anything but your Bitcoin address, the one from which you send the currency,” Brito said.
That address, revealed during the all-digital transaction, is useless without the private encryption key, which the customer does not reveal. By contrast, when using a payment card, a customer reveals an account number and pass code to a retailer.
“Think about that for a minute,” Gallippi told a congressional committee. “Why would you ever give someone full access to your $20,000 line of credit to pay them $20?”
In the jargon of the industry, Bitcoin is a “payment rail,” like Visa, Western Union or the bank-debiting system. Unlike those systems, Bitcoin is also the currency.
Bitcoin is “a bearer instrument,” said Dixon, the partner at Andreessen Horowitz, in which Bloomberg LP, the parent of Bloomberg News, is an investor. “You don’t need to know if I have the money -- it exists by virtue of the instrument,” he said.
The fact that it is a volatile currency is viewed by some as a downside in its use in transactions. A Bitcoin was worth about $875 on the CoinDesk Bitcoin Price Index yesterday, up from $609 a month earlier.
Some merchants use San Francisco-based Coinbase to process payments and immediately convert the virtual currency into dollars. Jeff Klee, chief executive officer of Bitcoin-accepting airline ticketing site Cheapair.com, said the emerging exchanges help mitigate the exchange-rate risks.
“If the price of Bitcoin dropped to zero tomorrow we would not feel the effects at all,” Klee said.
Mark Williams, a lecturer in finance at Boston University, said this model underscores how Bitcoin as a payment system cannot be divorced from Bitcoin as a currency.
“Companies that are claiming they accept Bitcoin as payment are actually accepting the coin only if someone else accepts the price risk,” Williams said.
The Institute of International Finance, an association of major global banks like Goldman Sachs Group Inc. and Citigroup, said Bitcoin’s volatility will limit its appeal. “It deters most large companies from accepting the digital currency as a form of payment,” the group said in a recent report.
The need for other companies like Coinbase to manage the Bitcoin-dollar nexus also undermines the goal of eliminating costly middlemen, said Aaron Greenspan, chief executive of Think Computer Corp., a software developer in Palo Alto, California.
“We’re going in circles here,” Greenspan said. “Bitcoin is supposedly decentralized but we’re creating these exchanges that centralize the trading, and at a cost.”
Peter Vessenes, the chairman of the Bitcoin Foundation, said the virtual currency, with software protocols open to any developer, won’t allow any exchange to become dominant, and therefore expensive.
“Because the Bitcoin network is open, it’s fundamentally different than, say, a Visa network,” Vessenes said. “You can’t build a propriety network and keep other competitors out. There is no centralization of power.”
Coinbase charges its merchant clients 1 percent to cash their Bitcoin into dollars, and the first $1 million in transactions are free.
Vinny Lingham, CEO of gift-card seller Gyft, said accepting Bitcoin still saves money even though it converts most of its Bitcoins back into dollars. He said that Gyft, which is based in San Francisco and sells cards for retailers including Amazon.com, Nike Inc. and Target, saves about 3 percent in swipe fees and fraud charges, and returns most of that to consumers in the form of redeemable points that can be redeemed for cards.
“If you really adopt Bitcoin as a company, you need to pass back the benefits to the consumers,” Lingham said. “You need to give people a reason to make payments” in Bitcoin.
Patrick Byrne, CEO of online retailer Overstock.com, estimates that 1 percent of its 2014 sales, or $13 million, will come from Bitcoin. Since its net margin is only 2 percent, the lower fees are a substantial savings.
Jacob Farber, a lawyer with Perkins Coie in Washington, said the uses of Bitcoin as a payments system could extend to bank treasuries moving cash within companies, wiring money overseas or sending money to other banks.
“Bitcoin could easily get picked up as back-office infrastructure for payments around the world,” Farber said.
That would jibe with how payments work today, since most consumers don’t know how payment cards work, only that they do, said Mary Dent, who runs the Palo Alto, California-based consultancy dcIQ.
The virtual currency’s success may be measured by innovators’ ability to create a new system while ditching the Bitcoin label. In the future, consumers may pay in dollars and merchants may receive the same, with Bitcoin having only an intermediary technological role.
“Who knows SMTP or HTTP?” Dent said, referring to the coding systems for e-mail and the World Wide Web. “Barely anybody. You just know that you can e-mail people and surf the Web. Someone is going to figure out how payments can be as easy and cheap as e-mail.”
That outcome would be very different than what a lot of libertarian-minded Bitcoin enthusiasts envisioned as its future: a decentralized currency free from the influence of governments or big banks, Williams said.
“If Bitcoin becomes commercialized, to be successful it will have to look and operate a lot like the financial firms the movement derided when this e-currency protocol was created,” Williams said. “Many Bitcoiners will view this as a sell-out, as the capital raise needed to fund the commercialization of this venture would require large Wall Street backing.”