The Future of BITCOIN

The world’s first cryptocurrency—and the blockchain technology it introduced—slowly gains acceptance as challenges persist

By Christine Umbrell

Bitcoin—the original cryptocurrency—has made headlines this year, first for a meteoric rise in value over the first six months, followed by a dramatic plunge in July and “split” August 1. Its volatility makes it difficult to predict just what will happen next, and whether more Americans will embrace the concept of virtual currencies. But some of the recent activities in this space provide clues as to the future of Bitcoin and similar currencies.

Bitcoin hit the alternative payments scene in 2009 as the first completely decentralized digital currency, implemented as open source code. The currency was an instant game-changer in that it allowed for transactions to be made without revealing personally identifying information, was operated by a decentralized authority, and offered lower transaction fees than traditional online payment mechanisms. The introduction of the currency also marked the debut of “blockchain technology”—a peer-to-peer distributed ledger of timestamped transactions.

Fast-forward to 2017, and Bitcoin has seen more than its fair share of ups and downs. “There’s people from all over different countries doing really amazing, and reckless, things with these types of technologies,” says Josh Mather, technology evangelist at Vantiv, who spoke during the “411 on Blockchain” session at TRANSACT. Globally, the currency is most popular in early adopter nations, such as Denmark and the Netherlands, as well as in countries with cash and economic stability issues, such as India and Venezuela. In April, the Japanese legislature officially categorized Bitcoin as a prepaid payment instrument and passed a law bringing Bitcoin exchanges under that country’s anti-money-laundering/know-your-customer rules.

Here in the United States, the currency has seen a great deal of activity in 2017. The price of Bitcoin tripled between January and June, trading at more than $3,000 at its peak. Several events may have contributed to the surge in popularity, including the legislative activity in Japan and the expectation that countries such as South Korea and Malaysia could follow suit. But the value of Bitcoin headed downward in July, falling well below $2,000—and demonstrating the continued volatility of the cryptocurrency.

In a recent turn of events, key miners and developers of Bitcoin have adopted a new way of operating the cryptocurrency, called Segwit2x, in an effort to speed transaction times. But a rival system, called Bitcoin Cash, also has emerged, meaning the Bitcoin market is effectively splitting in two directions.

Unpredictable Yet Intriguing

While the recent fluctuations in value have been concerning to those who leverage the cryptocurrency on a regular basis, “the volatility of Bitcoin over time has decreased,” says John Sedunov, professor of finance at Villanova University and an expert in alternative investments. “But it’s still more volatile than the price of gold and other currencies. That’s a problem for acceptance.”

While not a lot of business is being conducted in the United States with Bitcoin right now, many people are using it as a “value store,” Mather explains. “There’s a lot of people in the U.S., and China, too, that have a lot of money that are storing a lot of value in Bitcoin.”

Many Americans are looking at Bitcoin, which is not associated with a central bank, much differently than they view dollars. “I might wake up tomorrow and the value of my Bitcoin may be drastically reduced,” Sedunov acknowledges. “The point of having a central bank is, in part, to defend the currency’s value.”

Linda Coven, CTP, a senior analyst at Aite Group, also sees Bitcoin’s ever-changing value as a difficult concept for some potential adopters. “There’s a question of how much it’s worth,” she says. The value of one Bitcoin today “may change tomorrow. That [volatility] is very disruptive in any kind of transaction… . If it’s a one-time [transaction], it may be OK. But if you’re going to hold on to the [currency], that may be a problem.”

In addition to the cryptocurrency’s volatility, security issues related to public ledgers moving transactions also give some would-be users pause, according to Tony Rose, director of product, mobile, and emerging payments at Vantiv, who also spoke during the blockchain session at TRANSACT. “With the Bitcoin network, if someone were to hack it and somehow take over that network, they could control quite a bit of actual value.”

Yet despite volatility and security concerns, many Americans are intrigued and are slowly testing the cryptocurrency waters. Sedunov cites three categories of early adopters: people who mine the currency, institutional investors, and consumers. “The anonymity is appealing to some,” he says. (See sidebar “How Anonymous Is Bitcoin?”)

The market for Bitcoin has been on a slow path to growth since its introduction, says Sedunov, who believes the sluggish pace of acceptance is to be expected of a digital currency. “The technological aspect of it might demand that the time to greater acceptance is longer” than for traditional currencies, he points out. The complicated nature of adopting Bitcoin—which involves downloading software, visiting an online exchange, and remembering a permanent password—comprises a technological barrier that may take some time to overcome.

Addressing Transaction Speeds

There are several reasons why sudden price drops may occur and why some remain hesitant to explore cryptocurrencies. This year, the currency transaction speeds have been slowing—a challenge related to the blockchain technology itself. “A blockchain is a database that has solved some really hard problems in computer science, around the ability to have network integrity, when you have a network of nodes that are trying to have one state of truth,” explains Rose.

“Bitcoin is the biggest blockchain out there, currently … it really was solving this data integrity between a distributed network of nodes problem that is the key innovation there. By solving this problem, they’ve unlocked a lot of really interesting use cases that many people are excited about, with the potential to disrupt the industries—from payments, to supply chain, to health care,” says Rose.

But with increasing numbers of individuals making Bitcoin transactions come slower transaction times. “One of the things Bitcoin gets a lot of flak for is that it can only currently process about six transactions per second, so there’s really big scale issues with large public networks,” notes Rose.

During the first seven months of the year, the average time it took to approve or make an official transaction was steadily increasing, according to Sedunov. Bitcoin transactions are processed in “blocks” that involve complex cryptography. Those blocks are used to record transactions on the Bitcoin network, and, until recently, had a maximum size of 1 megabyte. “When fewer transactions were happening, this was fine—but now there’s a backlog,” says Sedunov.

Complicating matters, Bitcoin users may choose to pay a fee to have their transaction processed more quickly—meaning that those who pay lower or no fees must wait hours or even days for transactions to be completed. The longer the wait times, the higher the fees for quicker transactions. This is problematic because most Bitcoin users prefer to complete their transactions quickly—before the currency changes value.

Two competing groups have suggested “fixes” to alter the Bitcoin blockchain to solve the transaction delays, and August 1 marked a turning point in the tug of war. “There are two solutions to this problem: Segwit2x and Bitcoin Cash,” explains Sedunov. “Both plans revolve around changes to the blockchain, which is the log of all previous Bitcoin transactions. The changes are both related to the size of the blocks in the chain. Bitcoin Cash will expand the size of each block from 1 megabyte to 8 megabytes, while Segwit2x moves some data on to a parallel track and eventually allows the block size to double to 2 megabytes.”

Segwit2x seems to be the solution that has the most traction, and key players agreed to adopt the Segwit2x technology around August 1. “However, some believe that Bitcoin Cash is a better solution to the problem,” explains Sedunov. “Because there are two different solutions to the problem, separate blockchains will be created, and Bitcoin Cash will be a parallel currency to Bitcoin.”

Sedunov predicts that, from a transaction standpoint, Bitcoin Cash should work in the same way as Bitcoin. “However, what will be interesting to observe is whether the prices of Bitcoin and Bitcoin Cash move in parallel,” he says. As of press time, Bitcoin Cash was worth only a fraction of the price of one Bitcoin.

“It is uncertain what will happen next, and really it will depend on whether Bitcoin Cash thrives or fizzles,” Sedunov says. If Bitcoin Cash survives, the cryptocurrency market will be further fragmented. But either way, if the August 1 changes result in faster transaction times and lower costs, “then this is good news for those who plan to use Bitcoin in a retail setting, and may have the effect of setting a roadmap for solving these problems, should they show up again in the future.”

Integrating Into the U.S. Payments Landscape

While Bitcoin is not currently accepted by the majority of U.S. merchants, there are some exceptions. Overstock.com became one of the first retailers to accept Bitcoin in early 2014, and several additional names now accept the currency, including Expedia, eGifter, Subway, Microsoft’s Xbox and Windows store, Reddit, Steam, and more.

Some merchants and consumers are trying to get past the stigma first associated with Bitcoin, when rumors swirled about its use for gambling purposes and for other illicit activities. “The reputation holds that the only people who are using it are people who wouldn’t want to bank—which most companies don’t want to be associated with or be considered ‘promoting,’” says Coven. She predicts that cryptocurrencies that are associated in some way with banks—such as ZCash, which is accepted by JPMorgan—may have an easier path to acceptance.

But Sedunov believes Bitcoin’s “bad rep” is dissipating over time—and Rose agrees that more legitimate use cases are evolving. “Mexico as a country is about to introduce legislation that accepts [these] currencies as part of their economy,” he says. “We have countries, like Venezuela, where they’re using Bitcoin because their economy has collapsed.”

For more U.S. merchants to begin accepting cryptocurrencies, there will need to be increased consumer demand because retailers will need to adjust their payments infrastructure to accept it, says Sedunov. He also notes that retailers who are considering accepting Bitcoin may feel obligated to accept other cryptocurrencies, adding to the complexity.

Mather and Rose do not believe blockchain technologies and digital currencies are ready to take over the traditional U.S. financial payment system. “But the maturity of a public coin or public token can grow… . It is possible that given the maturity of these tools, that over time, it could offer at least an alternative or a primary mechanism for a payment system,” says Rose.

If and when cryptocurrencies become more commonplace, there may be new opportunities for acquirers. “From an acquirer perspective, our job is to give the merchant money the consumer wants to give them, using technology—whatever technology that could be. If there’s ways and new technologies that are emerging that could make the transaction overhead less [costly] to do that, the merchant doesn’t necessarily want to set up a bunch of wallets or manage a bunch of public or private keys, so someone still has to do that for them,” says Rose. “So there’s still a function to provide services around payments. A lot of the different use cases just make the way the current systems work more efficiently, so someone will come and offer those services at a reduced cost.

“Whether it displaces existing legacy middlemen, or those middlemen evolve to offer these services in more efficient ways—that’s more the question than ‘Will middlemen be removed?’ There’s always room for services and added value between parties,” Rose continues. “A given merchant could go set up a Bitcoin wallet and accept payments from consumers that have gone and done that as well. But there’s going to be other players that bring it to scale,” he says. “Everyone can benefit from reduced processing overhead and reduced operational processes that can be made more efficient. So I think that’s where the real value lies, and that’s where the opportunity lies, is to really look at those types of use cases.”

Mather agrees that there could be opportunities for growth with the expansion of distributed ledgers. “There is an underpinning shift that will occur in certain areas of the ecosystem, and, depending on how people roll with it, they could become irrelevant, they could become a new player in the market, [or] they could continue operating the way they are, depending on what their role is in the ecosystem,” he says.

Mather notes that current technologies would need to evolve before a major transition can occur. “The technology replacement—there’s a lot of hard work that needs to be done there, because there’s a lot of reasons that a lot of those pieces of technology are in place,” he says. “And there’s a lot of reasons that these layers of bureaucracy exist, and the regulation exists for these systems. And so when something comes along that offers efficiency and other types of optimizations, people take a hard look at it and start implementing it slowly. No one wants to jump into the system and ruin their mothership. But we may see that transition slowly.”

Keeping an Ear to the Ground

The recent surges and dips in value are keeping the experts guessing as to how quickly Bitcoin and Bitcoin Cash will gain greater acceptance. But cryptocurrencies—whether Bitcoin or other iterations—are likely here to stay. “I don’t think we can ignore cryptocurrencies such as Bitcoin, but several challenges remain before digital currencies can become viable and commonly used for payments, especially B2B,” Coven suggests.

Payments professionals should understand how digital currencies work and determine what types of value they can provide should more merchants accept these types of payments. “This is early-stage technology, so you should try to gain a working knowledge of it. We’re trying to figure out what the roadmap really looks like, beyond the hype cycle,” says Mather.

While regulations will be needed if cryptocurrencies become more widely used in the United States, regulators are not in a rush to address the issue due to the current limited number of transactions. “The market cap is so small [compared] to other currency exchanges,” says Mather. “There probably isn’t a push to regulate something like that for currency manipulation, at this point.”

Coven predicts we will see the pool of players investing in cryptocurrencies expand as different groups test the waters, and then contract once some are adopted and others abandoned. For the cryptocurrencies to really take hold in the United States, the Fed will have to get involved “and set some of the rules,” says Coven. Right now, Bitcoin and other cryptocurrencies are “playing outside the rules” put in place post-9/11 to ensure that banks know their customers, and their customers’ customers. “That’s what makes this so interesting,” she explains. “With Bitcoin, there’s no accessible information.”

Sedunov doesn’t foresee the U.S. government accepting Bitcoin as a legitimate currency anytime soon. In March, the U.S. Securities and Exchange Commission (SEC) denied a request by investors Cameron and Ty Winklevoss to list what would have been the first U.S. exchange-traded fund built to track Bitcoin. The SEC’s decision stated that “based on the record before it, the Commission believes that the significant markets for Bitcoin are unregulated. The Commission notes that Bitcoin is still in the relatively early stages of its development and that, over time, regulated Bitcoin-related markets of significance may develop.”

Of course, as more digital currencies emerge, increased volume may bring the need for federal oversight to a tipping point. “Then, regulation will probably happen, and that will go a long way toward determining the future of Bitcoin,” says Sedunov.

But massive change is not likely to happen overnight. There is plenty of time for payments professionals to develop a cryptocurrency strategy. “Are we going to see payments being replaced? Probably not anytime soon, but certain use cases will disrupt certain areas,” notes Mather. “So I would say to an acquirer, try and figure out what the product roadmap really looks like on the horizon.” TT

Christine Umbrell is editorial/production associate for Transaction Trends. Reach her at [email protected].