Bitcoin's comeback: should Western Union be afraid?

Eugen Leitl eugen at leitl.org
Thu Dec 22 03:09:50 PST 2011


http://arstechnica.com/tech-policy/news/2011/12/bitcoins-comeback-should-western-union-be-afraid.ars

Bitcoin's comeback: should Western Union be afraid?

By Timothy B. Lee | Published December 21, 2011 12:40 PM

Bitcoin's comeback: should Western Union be afraid?

A sign advertising the acceptance of Bitcoin at Neil's Bodega in British
Columbia

The last time we wrote about Bitcoin, in October, the currency's future
looked grim. A series of security incidents had created an avalanche of bad
press, which in turn undermined public confidence in the currency. Its value
fell by more than 90 percent against the dollar.

We thought Bitcoin's value would continue to collapse, but so far that hasn't
happened. Instead, after hitting a low of $2, it rose back above $3 in early
December, and on Monday it rose above $4 for the first time in two months.
It's impossible to predict where the currency will go next, but at a minimum
it looks like the currency will still be around in 2012.

This presents a bit of a puzzle for Bitcoin skeptics. The original run-up in
prices could easily be explained as a speculative bubble, and the subsequent
decline as the popping of that bubble. But if that were the whole story, then
the value of Bitcoins should have continued to decline as more and more
people lost confidence in the currency. That hasn't been happening.
bitcoincharts.com

Of course, the value of Bitcoin could resume falling at any time, but the
currency's apparent stability over the last month has inspired us to give it
a second look. How can an ephemeral currency without the backing of any large
institution be worth $30 million, as the world's Bitcoins currently are? In
the short run, a currency's value can be pumped up by a speculative bubble,
but in the long run it must be backed up by "fundamentals"bproperties that
make holding it objectively valuable.

Dollars are valuable because they're the official medium of exchange for the
$14 trillion US economy; euros and yen are valuable for similar reasons.
Bitcoin boosters have traditionally suggested that Bitcoin is an alternative
to these currencies. But we'll suggest an alternative explanation: that
Bitcoin is not so much an alternative currency as a "metacurrency" that
allows low-cost and regulation-free transfer of wealth between nations. In
other words, Bitcoin's major competitors aren't national currencies, but
wire-transfer services like Western Union.  Bitcoin is a bad currency

    While Bitcoin isn't a very good currency, it has the potential to serve
as a "metacurrency": a medium of exchange among the world's currencies.

The traditional argument for Bitcoins has positioned the peer-to-peer
currency as an alternative to conventional currencies like dollars, euros,
and yen. Bitcoin boosters point to two major advantages Bitcoins have over
dollars: price stability and lower transaction costs. As we'll see, neither
of these advantages is compelling for ordinary consumers.

The argument from stability mirrors the traditional argument for a gold
standard. The dollar has lost about 95 percent of its value over the last
century. The Bitcoin protocol is designed to never allow more than 21 million
Bitcoins to enter circulation, and supporters argue that this guarantees the
currency maintains its value over time.

The obvious problem with this argument is that Bitcoins have lost more than
90 percent of their value in five months. It would be pretty foolish for
someone worried about the dollar's 3 percent inflation rate to put their life
savings into a currency with that kind of volatility.

Bitcoin boosters forget that the value of a currency is determined by supply
and demand. Demand for dollars is driven by the size of the US economy, which
doesn't change very much from year to year. But the demand for Bitcoins is
primarily driven by speculative forces, causing its value to fluctuate
wildly.

Another oft-touted benefit of Bitcoin is lower transaction fees. Banks make a
tidy profit charging merchants to complete credit- and debit-card
transactions, and these fees raise the price consumers pay for goods and
services. Fans tout Bitcoin payments as a low-cost alternative to traditional
credit card transactions.

But this argument ignores the fact that credit cards provide important
benefits in exchange for those transaction fees. If you buy something with a
credit card and get ripped off, you can dispute the charge and get your money
back. In contrast, Bitcoin transactions are irreversible. If you pay a
merchant in Bitcoins and he rips you off, (or someone hacks into your
computer and makes a fraudulent payment), you're out of luck.

Of course, third parties may offer Bitcoin-based payment services that offer
features such as chargebacks and fraud protection. But such services don't
come free; consumers or merchants would have to pay fees to use them. And
there's no reason to think Bitcoin-based banking services would be any
cheaper than traditional ones in the long run.

Paying with Bitcoins also introduces the inconvenience of fluctuating prices.
When people buy things with cash or credit cards, their purchases are
denominated in the local currency. Dealing in Bitcoins means customers and
businesses must regularly convert between dollars and Bitcoins, and must
therefore worry about the fluctuating exchange rate between them. That's a
headache few people want.

So Bitcoins are not a compelling alternative to conventional currencies.
Although there are a few isolated examples of traditional businesses
accepting Bitcoins as payment, these seem to be driven more by the novelty of
the concept than by compelling economic or technical advantages.  Bitcoin as
a metacurrency

While Bitcoin isn't a very good currency, it has the potential to serve as a
"metacurrency": a medium of exchange among the world's currencies. In this
role, it has the potential to be a powerful competitor to wire transfer
services like Western Union.

    The longer Bitcoins continue to exist, the more confidence people will
have in its continued existence.

The wire transfer industry is much less consumer-friendly than the credit
card industry. Wire transfer fees can be much higher than credit card fees,
and wire-transfer networks offer much less robust fraud protection services
than do credit card networks.

Moreover, the flow of funds across national borders is heavily regulated.
Governments monitor the flow of funds in an effort to stop a variety of
activities they don't like. In the US, the focus is on terrorism, tax
evasion, gambling, and drug trafficking. (Carrying cash across borders in a
suitcase invites similar government scrutiny.)

Bitcoin allows wealth to be transferred across international borders without
the expense or government scrutiny that comes with traditional wire
transfers. An American immigrant wanting to send cash to his family in India
needs only to find someone in the United States to trade his dollars for
Bitcoins. He can then transfer the Bitcoins to his relatives in India, who
then need to find someone willing to take Bitcoins in exchange for rupees.

This decentralized money-transfer process will be much harder for governments
to control than a centralized money-transfer company like Western Union. And
that will make the world's governments upset, since the same technology can
be used by an American drug dealer to send profits back to his partners in
Latin America.

But there may be little governments can do about this. They can attempt to
mandate the reporting of Bitcoin transactions, but there's no obvious way to
enforce such a regulation, since Bitcoin transactions are easy to obfuscate.
At most, governments could prohibit the conversion of funds between local
currencies and Bitcoins, but this will merely push the currency underground,
not eliminate it altogether.

If Bitcoin's value stabilizes, it will also become a way to store wealth
beyond the reach of any government. Cash and gold are bulky, hard to move,
and subject to confiscation. In contrast, the encrypted credentials of a
Bitcoin wallet can be stored securely on a server anywhere in the world. This
could make the currency appealing to anyone wanting to place his wealth
beyond the reach of the lawba corrupt government official wanting to hide
ill-gotten gains, a political dissident who fears his life savings will be
taken, or an ordinary citizen worried about the solvency of traditional
banks.

Bitcoin's role as a way to move and store wealth does not depend on Bitcoins
being widely used for commerce. For Bitcoin to work as a viable
"metacurrency" only requires that there be a liquid market between Bitcoins
and national currencies. Such a market already exists for several major
currencies.  Chicken and egg

Of course, there's a circularity to this argument. Bitcoin's value as a way
to move and store wealth depends on the value of Bitcoins being relatively
stable against conventional currencies. And the continued value of Bitcoins
depends on people finding nonspeculative uses for it. But if the currency
continues to retain its value in the coming months (a big if, admittedly)
this would be a sign that the chicken-and-egg problem has been solved. And
the longer Bitcoins continue to exist, the more confidence people will have
in its continued existence.

Western Union moved $70 billion across borders in 2010, earning about $1
billion in profits. There's no Bitcoin Inc. to compete directly with Western
Union, but the owners of Bitcoins can be thought of as shareholders in a
decentralized Western Union alternative. If the Bitcoin network captures a
small fraction of Western Union's money-transfer business, the currency's
current "market capitalization" of around $30 million could wind up looking
downright puny.





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