Often referred to as a digital currency, digital cash, virtual currency, electronic currency or cryptocurrency, bitcoin does not meet the definition of currency to most economists. Economists define money as a store of value, a medium of exchange, and a unit of account. Most agree that bitcoin does not meet all these criteria.
A bitcoin payment is a direct transfer of value between bitcoin wallets. At the heart of the bitcoin system is a public ledger which records financial transactions in a block chain. Every confirmed transaction is included in this block chain, and the transactions are verified by a process known as mining, confirming waiting transactions and including them in the block chain. The chronological order and integrity of the block chain are enforced through cryptography.
A bitcoin wallet keeps a secret piece of data called a private key or seed. This key is the signature of the transaction, providing a mathematical proof that it has come from the owner of the wallet. That signature also prevents the alteration of the transaction once it has been initiated. All transactions are broadcast between users and are generally confirmed by the network within 10 minutes through the process known as mining.
According to bitcoin.org, the distributed consensus system of mining is used to confirm waiting transactions by including them in the block chain. It enforces a chronological order in the block chain, protects the neutrality of the network, and allows different computers to agree on the state of the system. To be confirmed, transactions must be packed in a block that fits very strict cryptographic rules that will be verified by the network. These rules prevent previous blocks from being modified because doing so would invalidate all following blocks. Mining also creates the equivalent of a competitive lottery that prevents any individual from easily adding new blocks consecutively in the block chain. This way, no individuals can control what is included in the block chain or replace parts of the block chain to roll back their own spends.
This is accomplished without any central authority which is the arguing point for both supporters and detractors. With no central authority, the value of a bitcoin is extremely volatile.
Much like gold, the value is based on current supply and demand. Unlike gold, bitcoin is intangible. There is no use for a bitcoin other than as a speculative investment or exchange mechanism, so the exchange rate is susceptible to wide swings. Over the past year, a bitcoin has been valued as high as $1147 then dropping to a low of $360, fluctuating sometimes by more than 10% in one week.
Whether it is a currency or payment protocol, the fact is that it has become more and more widely accepted as a method of settling transactions on a peer-to-peer basis. For merchants accepting bitcoin, there are two significant benefits over typical credit or debit card transactions.
Most important is the fact that bitcoin transactions do not have the level of fees that a credit card carries. A typical credit card transaction may result in a discount of 2.5 percent to 3 percent or even more of the value of the transaction to the merchant, while the fee associated with a bitcoin payment may be less than .5 percent. In fact, there is no fee required to process a bitcoin transaction, but paying a small fee gives the miners an incentive to process a transaction more rapidly.
The second benefit to the merchant is that there are no chargebacks or declined transactions. Once the payment has been made and settled through the bitcoin network, it cannot be rescinded. Obviously this works in the favor of the merchant and but not directly in the favor of the customer, although the reduced costs of disputes could result in lower prices to the consumer.
Like other merchants, Expedia uses Coinbase as its wallet, and will settle its bitcoin account back into U.S. dollars daily. By minimizing the amount of time it holds the bitcoin value, a merchant decreases its susceptibility to negative exchange rate fluctuations.
That risk is borne by the consumer and the bitcoin payment processor, such as Coinbase or Bitpay, not the retailer. The vendor doesn't hold the bitcoin and is paid in U.S. dollars. As soon as a customer pays in bitcoin, the digital currency goes to the payment processor and the processor immediately pays the merchant, for a fee of less than 1 percent.
"We don't have to deal with the actual holding of the bitcoin: it's the payment processor that takes the currency risk for us," said Bernie Han, chief operating officer at Dish Network Corp, in Englewood, Colorado. "That's what makes it appealing for us and I guess for other merchants as well."
With about $14 billion in annual revenue, Dish started accepting bitcoins in August 2014.
Unlike a credit card transaction, checking out of a shopping cart and paying with bitcoin is not an immediate settlement. The transaction is tentative and the consumer is given a finite period of time such as 15 minutes to complete the transaction through the bitcoin network. If the transaction cannot be completed within that period the purchase is canceled.
Another interesting development in the bitcoin world is the deployment of bitcoin kiosks. Robocoin Technologies has begun installing its ATMs in locations such as Hollywood, Venice Beach, Las Vegas, Austin, Texas, and various other major cities throughout the world. Most notably for Las Vegas travelers, Robocoin ATMs have been installed at the D and Golden Gate properties in downtown Las Vegas where a visitor can convert bitcoins into dollars or purchase bitcoins, as well as redeem their gaming tickets for cash.
There are currently over 60,000 merchants worldwide accepting bitcoin, with a forecast of over 100,000 by years end.
Like any other success, bitcoin has its imitators. Alternative cyber currencies such as Litecoin, Peercoin and Dogecoin have been introduced, some with less volatility and faster confirmation times than bitcoin. None have the wide acceptance currently enjoyed by bitcoin, which has more than 40 times the capitalization of the next nearest alternative.
Recently, a small but considerable number of workers in Canada are rejecting payment in Canadian dollars, instead accepting bitcoin for their wages. The Canadian government considers the payment a “barter transaction,” requiring that the payments must be valued and reported in Canadian dollars for tax purposes.
Bitcoins are used by some Argentinians as an alternative to the official currency, which has been hit with inflation and strict controls by the government, fearful that their savings might be confiscated or taxed. A similar fear during the Cypriot financial crisis cause a substantial rise in the price of bitcoin.
Bitcoin has been linked to black market and drug transactions, and a number of wallet sites have been hacked or shut down by government agencies, but as more legitimate transactions continue to occur, and merchants of all types continue to accept them as payment, the public trust will continue to grow, the value of bitcoin will stabilize, and speculators will continue to find ways to profit.
Bill Geoghegan is a consultant in Las Vegas. He can be reached for comment at Bill@LGTConsulting.com.
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