Cover Story: Bitcoin’s Bid For Acceptance

Merchants are starting to accept the fast-rising digital currency, including big names like Overstock.com. But for now Bitcoin’s volatility and other issues may outweigh its advantages for merchants and acquirers.

By Peter Lucas

“In response to Bitcoin’s rise in popularity around the world, Zynga, with help from BitPay, is testing expanded payment options for players to make in-game purchases using Bitcoin.”

Online game provider Zynga’s January announcement on Reddit that it will test BitCoin acceptance

No sooner had online-game site Zynga posted its plans in the blogosphere to test acceptance of Bitcoin than the Bitcoin buzz rose to deafening levels. The same thing happened a few weeks earlier when Overstock.com announced plans to begin accepting Bitcoin mid-year.

What spiked the volume on these two announcements is that, for the first time, the chatter about Bitcoin was focused more on the prospects for the controversial crypto currency to become a mainstream payment mechanism than on its volatile value.

That’s a major step forward for Bitcoin, which, since the first Bitcoins were mined in 2009, has been viewed primarily as a speculative investment currency along the lines of gold and silver. Not surprisingly, such perceptions have not played all that well in the button-down world of payments, where currencies are expected to be backed by the international monetary system.

Volatile Value

Unlike credit and debit cards, paper money, or even precious metals, Bitcoin is not based on any monetary standard or backed by any central government. Instead, it is an open-source, mathematically-based digital currency managed by a loose confederation of evangelists.

These volunteers update the so-called Bitcoin blockchain, a public record of each Bitcoin transaction that contains encryption keys to allow the owner of one Bitcoin wallet to transfer Bitcoin to another wallet.

Bitcoin derives its value from speculators, who set its price on global trading exchanges. The currency’s volatility is such that a Bitcoin worth $1,000 at the start of trading can be worth less than half—or double—that amount by market close. For merchants that expect to be reimbursed the full purchase price of a Bitcoin transaction, that makes accepting the currency a very risky—or rewarding—proposition.

Like any traded commodity, Bitcoin’s value can be influenced by world events, such as governments regulating use of the currency and law-enforcement agencies cracking down on criminals laundering money through Bitcoin (for more on the legal and regulatory issues surrounding Bitcoin and other virtual currencies, see “So You Want To Get Into Digital Currency,” July 2013).

During the first four months of 2013, for instance, speculators drove the value of Bitcoin up from $13 to $230. The value quickly dropped in October after the FBI arrested the founder of Silk Road, a nefarious online black marketplace, and seized his stash of Bitcoins, which totaled tens of millions of dollars.

In late November, speculators drove the price of a Bitcoin to a record high of more than $1,200. As of mid-January 2014, Bitcoins were valued at more than $800.

About 12 million Bitcoins are in circulation. That means 9 million more can be mined, since there is a 21-million limit programmed into the system, though reaching that limit will take decades.

“The volatility around the value of a Bitcoin accentuates the negative aspects of acceptance for merchants and lessens its appeal to them as a payment option, because merchants have no way of knowing how much they will receive when they convert their Bitcoins to paper currency or sell them,” says Beth Robertson, managing director of Baltimore-based consultancy Robertson Payments.

Low Cost, No Chargebacks

Despite Bitcoin’s valuation risks, it nevertheless remains an attractive payment option for merchants because, unlike cards, its acceptance costs are negligible. Merchants can accept Bitcoin for free for the first $1 million in Bitcoin purchases and as little as 1% of the transaction price after that. In comparison, online merchants pay 2% to 3% or higher to accept credit cards.

Again unlike cards, there is no such thing as a chargeback with Bitcoin. Once consummated, all transactions are irrevocable.

What makes Bitcoin so inexpensive to accept is that it is the equivalent of a cash transaction, for which merchants typically don’t pay acceptance fees. Add in the fact there is no risk of fraud or data breach with a Bitcoin transaction and that encryption keys within the Bitcoin algorithm help protect it from being counterfeited, and it is no wonder that Bitcoin is getting more attention from merchants—as well as from those that sell payment acceptance to merchants.

“The advantages of accepting Bitcoin for merchants are straightforward: no chargebacks, no fraud claims, no waiting days to access their revenue, and minimal transaction fees,” Marco Santori, chairman of the regulatory affairs committee for the Washington D.C.-based Bitcoin Foundation, says by email. “I think that we are not far off from seeing mass adoption by retailers around the world.”

Landing a large and well-known retailer like Overstock.com can help pave the way for other large merchants to accept Bitcoin by increasing its utility for consumers. As more large merchants accept Bitcoin, consumers have more opportunities to spend the digital currency for everyday purchases, rather than hold it as a speculative investment. Broader acceptance and utility ultimately lead to mass consumer appeal, which grabs merchants’ attention.

Still, Bitcoin specialists understand that if they are to get merchants excited about accepting the digital currency, they must address concerns about its volatility. Atlanta-based BitPay and San Francisco-based Coinbase, which has also developed a Bitcoin wallet, are guaranteeing merchants they will receive the full local-currency price of the product purchased with a Bitcoin, regardless if the value of the Bitcoin takes a dive before the merchant converts the Bitcoin to another currency.

“We lock in the price of the Bitcoin at the time of purchase and convert the price of the item as a fraction of a Bitcoin or a whole Bitcoin as needed,” explains Stephanie Wargo, vice president of marketing for BitPay.

‘An Attractive Percentage’

A Bitcoin transaction is unlike a credit card transaction, in which the acquirer deposits the funds for a purchase in a merchant account and settles with the card issuer on the back end. Instead, a Bitcoin purchase is more like a person-to-person transaction, with the Bitcoin being pushed by the consumer from his wallet directly to the merchant’s wallet.

Processors like BitPay provide the electronic pathway to facilitate the transaction and convert Bitcoins into whatever currency the merchant prefers at the end of the day. Merchants can also opt to keep their Bitcoins and sell them later if the price rises.

Wheeling, Ill.-based MistHub, an online retailer of e-cigarettes and hookahs that opened in early 2013, is one merchant looking to leverage the speculative value of Bitcoins for additional financial gain. As its Bitcoin transactions are settled, the retailer converts the price of the item sold into dollars and leaves the profits in its Bitcoin wallet, according to MistHub co-founder Igor Petryuchenko.

While Petryuchenko acknowledges there is a risk that such a practice can reduce the company’s margins on Bitcoin transactions, he adds that having a disciplined trading strategy can reduce that risk. “This is a strategy to manage the volatility of Bitcoin in our favor,” he says.

MistHub, which uses BitPay as its processor, has generated $2,500 in Bitcoin sales since it began accepting the currency in July. Since then, Bitcoin volume has doubled each month. “We believe Bitcoin is the next revolution in payments and it has helped us attract new customers,” says Petryuchenko.

The ability to reach new customers is one reason Overstock.com decided to accept Bitcoin. The online retailer projects 1% to 2% of shoppers, many of whom Overstock believes are not current customers, will pay for purchases with Bitcoin. “While it’s a small percentage of all online shoppers that we believe will pay with Bitcoin, it’s an attractive percentage to us,” says Overstock chief executive Patrick Byrne.

Besides attracting new customers, Overstock stands to significantly reduce its credit card acceptance costs, according to Adam White, director of business development for Coinbase, which is Overstock’s Bitcoin processor.

“For merchants such as Overstock that realize more than $1 billion in annual sales, 1% of transactions is roughly $10 million in sales,” says White by email. “Eliminating credit card fees and fraud on $10 million in sales will have an immediate and significant impact on Overstock’s bottom line.”

Coinbase, which has signed more than 18,000 merchants for Bitcoin acceptance, charges merchants nothing if they do not convert their Bitcoins to another currency. Merchants opting for currency conversion are charged 1% after the first $1 million in Bitcoin transactions. The offer is part of a promotional effort by Coinbase to encourage merchants to take Bitcoin.

In comparison, BitPay offers several pricing plans. Merchants opting to pay as they go are charged 1% for each Bitcoin transaction. Flat-fee packages range from $30 a month for up to 30 Bitcoin transactions to $3,000 a month for unlimited transactions. BitPay has signed more than 20,000 merchants and charities and is adding 1,000 a week. The company processes 4,000 Bitcoin transactions per day on average and receives about 400 daily merchant applications.

‘Bigger Fish To Fry’

Because Bitcoin is a decentralized currency with no central governing body, there is no readily available tally of how many merchants accept the currency. Those figures are kept by each Bitcoin processor.

Merchants accepting Bitcoin cover a broad range of categories from retailers such as Overstock and MistHub to construction and remodeling contractors, optometrists, law firms, and hotels. Consumers can also purchase gift cards using Bitcoin through the Gyft network.

While Overstock is the largest and best-known merchant so far to accept Bitcoin, the big question is if and when a leading retailer, such as Wal-Mart Stores Inc. or Amazon.com Inc., will jump on the Bitcoin bandwagon.

One potential barrier to large merchants accepting Bitcoin is that the blockchain can take minutes to update for a high-ticket transaction, compared to seconds for credit and debit card transactions. Waiting a minute or longer to complete a transaction at the point of sale can seem like an eternity for shoppers conditioned to getting through checkout with as little friction as possible. Indeed, such waiting could potentially harm a retailer’s brand, some experts say.

“The amount of time it takes to update the blockchain is a limiting factor for Bitcoin acceptance, especially in stores,” says George Peabody, a senior director for Menlo Park, Calif.-based Glenbrook Partners. “While some merchants may see Bitcoin as a good fit for their customer base, large retailers like Wal-Mart are going to look at the time it takes and decide they have bigger fish to fry.”

Limited User Pool

Such updating is a necessary evil as it verifies the legitimacy of the Bitcoin wallet and that enough Bitcoins are in the wallet to make the purchase. Bitpay, for example, uses an eight-step validation method as part of updating the blockchain for each Bitcoin transaction. “We can complete some transactions in seconds, but most transactions take two to three minutes to clear,” acknowledges BitPay’s Wargo.

An additional hurdle to widespread merchant acceptance is the limited pool of Bitcoin users. Even if 1% to 2% of online shoppers actively use Bitcoin, that is not necessarily enough to persuade small and mid-size merchants to accept the currency.

“Right now there is not enough consumer adoption to justify accepting Bitcoin. Adoption would have to be well beyond the 1% to 2% of consumers Overstock sees using Bitcoin to make sense for us,” says Andrew Geant, chief executive of Chicago-based WyzAnt.com, which connects tutors with students.

That pool of users could become even smaller if Bitcoin’s value shoots high enough to encourage hoarding, rather than spending, the currency, observers say.

Nor does Geant see transaction speed improving any time soon. “Ultimately, digital currencies like Bitcoin may remove friction between the buyer and seller, but practically speaking, that would be pretty long term,” he says. “Given all this and Bitcoin’s volatility, I am not sure there is much more than promotional value to be gained right now from accepting Bitcoin.”

‘Playing-Field Leveler’

One selling point that may help Bitcoin gain traction with merchants is that it can help make cross-border transactions easier for merchants, a la PayPal.

“What makes PayPal valuable to small merchants is that they can readily accept purchases from PayPal users in other countries at a low cost. Bitcoin offers similar benefits, which is a playing-field leveler for small merchants,” says Dan Schatt, a former PayPal executive and payments expert. “Without the right bank or processor relationship, it is tough for small merchants to tap into cross-border markets.”

Another nascent strategy that can grow Bitcoin acceptance is for processors to persuade independent sales organizations to add Bitcoin to their mix of services. “We are in touch with some ISOs looking to build Bitcoin applications,” says BitPay’s Wargo. “As more companies add utility to the Bitcoin platform, the merchant and user base will grow.”

For all the hype and hope surrounding Bitcoin, it is still just an experiment, which means it has a long row to hoe to gain widespread merchant acceptance.

“While the time for digital currencies has arrived, whether Bitcoin, which has a head start, flourishes as a payment currency depends on the behavior of its stewards and how well they demonstrate its durability and value,” says Glenbrook Partners’ Peabody. “It’s their game to lose.”

Bitcoin 101

How was Bitcoin created?

The Bitcoin algorithm was first published in 2009 by a programmer using the alias of Satoshi Nakamoto. After initially championing Bitcoin as an alternative currency, the mysterious Nakamoto left the project in 2010 and has not been heard from since. A network of volunteers, known as Bitcoin evangelists, has since taken over stewardship of the currency.

What is the blockchain?

While Bitcoin users may remain anonymous, the blockchain provides a public record of all Bitcoin transactions and serves as the backbone of the currency. Using the blockchain, anyone can determine the value of Bitcoins sent to the public address for each Bitcoin wallet.

What makes Bitcoin attractive to merchants?

No transaction fees or fees far lower than credit cards. No chargebacks, as all Bitcoin transactions are irreversible and any refunds must be negotiated between the customer and the merchant. No cardholder data passing between the merchant and their acquirer that can be hacked.

Will more than 21 million Bitcoins ever be mined?

No. The 21-million limit is built in to the Bitcoin algorithm.

Is the Bitcoin cipher unbreakable?

That’s the million-dollar question. While Bitcoin enthusiasts insist the algorithm is completely secure, some cryptology experts argue there is no mathematical proof that any cipher is unbreakable.

Why Not a Bitcoin ATM?

If consumers are to start actively using Bitcoin for purchases, they will need a fast, convenient way to purchase and sell Bitcoins. Enter the Bitcoin ATM, a kiosk that allows consumers to buy and sell Bitcoins anywhere an off-premise ATM can be placed.

In December, Manchester, N.H.-based Lamassu Inc. announced it has received more than 120 orders for its Bitcoin ATM since August. More than a dozen of those orders have shipped, with the remainder expected to ship this spring to 25 countries. Each machine costs $5,000 and there are no franchise or other recurring fees.

To accommodate international consumers, the user interface on the machine has been programmed to support a variety of languages, including Russian, Chinese, and Friulian, a Romance language spoken only in parts of Northeast Italy, Lamassu chief executive Zach Harvey said in a press release.

Meanwhile, Las Vegas-based Robocoin, which saw its first Bitcoin ATM deployed in October in a Vancouver coffee shop, expects customers to install 50 more ATMs, each of which costs $20,000, in Asia, North America, and Europe by the end of March. “We’ve also received inquiries from over 2,000 potential operators,” says Sam Glaser, chief of growth for Robocoin.

In the first 29 days after the Vancouver Robocoin ATM was deployed, it generated 1,576 transactions totaling more than $1 million Canadian. More than half the users were first-time Bitcoin buyers who also created a wallet.

So far, banks have shied away from deploying Bitcoin ATMs, largely because of the volatility associated with the crypto currency and lack of banking regulations around Bitcoin. “The role of the Bitcoin ATM deployer is more likely to be filled by entrepreneurs,” says David Tente, director, USA, for the ATM Industry Association, a trade group for ATM deployers.

Indeed, Robocoin says its customers are entrepreneurs involved in such businesses as commercial real estate and remittance and include a multinational corporation.

“Our role in the Bitcoin ecosystem is twofold: on one hand we’re the onramp to Bitcoin. At the same time, we’re injecting unprecedented liquidity into the market,” says Glaser. “Bitcoin has never been easier to buy or sell.”