Will Bitcoin replace Paypal?

Michael Hendrix
Director, Research & Emerging Issues
U.S. Chamber of Commerce Foundation

Bitcoin isn’t real money. It isn’t a unit of account, doesn’t store value, and is a poor medium of exchange. Bitcoin is simply a payment technology—in the midst of what looks like the biggest bubble in recent memory. If bitcoin is to have a future, it needs to grow up and realize its true potential. That means serving less like crypto-libertarian Monopoly money and becoming more a digitally savvy PayPal.

Bitcoin was introduced to the world in 2008 by Satoshi Nakamoto, the pseudonym of a secretive programmer (or programmers). It’s a decentralized digital currency set upon a peer-to-peer computer network. New Bitcoins are introduced as users “mine” a fixed supply of 21 million coins through increasingly difficult number-crunching tasks. Bitcoins or fractions of Bitcoins are bought and sold over the Internet through highly complex and opaque networks. The result: A total market value that recently topped $8.5 billion. That’s a lot of money. It’s also simply on par with your average mid-cap stock. 

Bitcoin has value, but it’s found in other currencies. It’s rarely used as a unit of account. As Ryan Avent explains, “Almost every good one can purchase with Bitcoins is actually priced in dollars and sold at a Bitcoin price reflecting the prevailing exchange rate.” Even the Bitcoin Foundation sets its employees’ salaries in dollars. Unlike state-backed currencies, bitcoin has no intrinsic value, only speculative. Everything priced in bitcoins is exposed to exchange rate volatility, like its recent one day swing in value from $500 to $900 and back again.

Even as some merchants choose to accept Bitcoin as payment, it still lacks trust. It’s “every man for himself” with no central authority to fool around with. Bitcoin’s boosters see this is a perk—I see it more as a flaw. One reason we use money is because it’s backed by something we trust, whether god, gold, or the government. There’s an institutional authority behind money that’s based in society. Bitcoins are frictionless, anonymous, and secure, which means they’re far too perfect for us to fully trust. There’s nothing human about it.

What’s real about Bitcoin is its extreme volatility, which is driven by 5 factors:

  1. The closure of online drug site Silk Road, which transacted in bitcoin.
  2. A virus that holds computers hostage while demanding bitcoin as ransom.
  3. A rise in theft from bitcoin exchanges.
  4. New computers purpose-built to mine bitcoin.
  5. Demand from China to feed its new bitcoin markets.

Normal currencies would have suffered for these faults. Instead, Bitcoin is hailed as a mark of independence from a spendthrift Fed. I think that hope is misplaced.

Bitcoin is far more valuable as a global payment network. The attributes that work against it as a currency enable a clean and simple means of exchange across the world at incredibly low cost. Fed chairman Ben Bernanke appears to agree, having said recently that virtual currencies “may hold long-term promise, particularly if the innovations promote a faster, more secure and more efficient payment system.”

Money transfers are normally routed through a maze of intermediaries. If the cash happens to cross a border, even more middlemen step forward to take their cut. It’s an ancient system that’s costly in both time and money.

This is where Bitcoin could help, functioning as an invisible intermediary in global transactions. Traditional currency would sit in bank accounts at both ends and in the middle would be a secure virtual wallet. Your dollars would be converted into Bitcoin, placed into the wallet, and seamlessly ferried to a bank account on the other end, ready to be converted back into any fiat currency. No fees, no processing costs. And these wire transfers would occur so fast as to make Bitcoin volatility a sideshow. As Kevin Roose describes, “It would make sending cash around the world as easy as sending e-mails.”

We shouldn’t get our hopes up just yet. Today’s money movers will likely remain the dominant players in the future. Bitcoin remains vulnerable to fraud and theft, and questions remain over the market’s ability to maintain sufficient liquidity. More generally, large financial institutions rightfully place a premium on trust. Bitcoin will have to work well to earn it.

Yet Bitcoin has never been about large institutions anyway. Its strength lies in enabling peers to smoothly transact on a level playing field. Focus on what Bitcoin does best—channel it into a secure and cost-effective digital payments platform. Ironically, that’s the best hope Bitcoin has for one day becoming a workable currency. Just not yet.

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