Can Bitcoin Be Trusted?

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Introduced in 2009 by software developer Satoshi Nakamoto, Bitcoin has a notorious association with illicit activities. Yet in October, when the FBI shut down Silk Road--a Web site the agency alleges was used for the trafficking of illegal goods and services--and seized bitcoins then worth $28.5 million, instead of disappearing like many predicted it would, Bitcoin set off on a trajectory toward mainstream adoption.

The peer-to-peer payment system is a cryptocurrency, meaning it relies on cryptography to control the creation and transfer of funds. Payments are made after a group of network members, called miners, are able to verify and time-stamp each digitally signed transaction; the miners then enter the transactions into the block chain, a public ledger. Though transaction fees--which miners collect in the form of newly minted bitcoins--are charged, they are much lower than those associated with other payment methods. This makes Bitcoin lucrative for retailers as well.

Most credit card companies charge roughly 3 percent for every transaction. The price to process a Bitcoin payment, however, is currently just 1 percent, a rate that proved irresistible for online retail giant Overstock.com. The company began accepting bitcoins at the end of 2013, and, according to CEO Patrick Byrne, initial results appear promising.

"Bitcoin's first day on Overstock was a huge success," Byrne tweeted on January 10. During the first full day, the company saw 840 Bitcoin transactions totaling $130,000, which represents 4 percent of the retailer's average daily revenue. Granted, the success could be attributed to the novelty of paying with a cryptocurrency, but for Bitcoin supporters, this was a reason to be optimistic.

"Historically there were two costs to accepting Bitcoin: the technical cost, which is becoming very low, thanks to [payment-processing] companies such as Bitpay, and the political cost of being associated with something so new and controversial. The latter cost is rapidly falling as Bitcoin goes more mainstream and bigger retailers get on board," Mike Hearn, an independent Bitcoin software developer and senior security engineer at Google, says.

Still, critics express concern over the currency's volatility, and believe Bitcoin's instability is a major obstacle to wider adoption. According to Mark Williams, professor of finance and economics at Boston University, Bitcoin's value can fluctuate by 20 percent to 30 percent on any given day. As a result, choosing to accept bitcoins as a form of payment is extremely risky, and most retailers, including Overstock.com, are not ready to be pioneers.

"What Overstock.com is doing is a publicity stunt," Williams says. "They're not actually taking on any of the associated risk. They're not holding on to bitcoins, but are paying third-party processing companies, like Bitpay and Coinbase, to convert them to dollars. At this point, [bitcoins are] more of a virtual commodity than a currency."

While exchanging bitcoins for dollars doesn't help stabilize the currency, the catch-22 is that hoarding them doesn't help either. Currently, more than 90 percent of bitcoins are being hoarded, Williams estimates. "People are holding on to bitcoins because they think the value is going to go up, but spending needs to occur in order for Bitcoin to have any hope of longevity," Dave Silva Smith, Bitcoin consultant and founder of GoGiveCoin, argues.

Security concerns might also jeopardize Bitcoin's longevity, especially given the controversial currency's black market past. Though all Bitcoin transactions are tracked in an online ledger, many fraud prevention mechanisms that make credit card transactions secure are not in place for cryptopayments. Bitcoin transactions, for example, are not subject to chargebacks, which force merchants to return funds obtained through fraudulent transactions. This leaves consumers liable. "For a currency to be adopted, it has to be trusted, and as it stands, this is not the case with Bitcoin," Williams maintains.

Hearn disagrees. "As a push system [which requires the buyer to arrange for a credit transfer] rather than a pull system [which requires the merchant to use the buyer's payment details to complete the purchase], Bitcoin is inherently more secure than credit cards. But card companies have [used] their overwhelming market dominance to force merchants to swallow the cost of their nonexistent security," he says.

With no verdict on its security and a variety of obstacles to overcome, Bitcoin still has promising potential. "Soon there will be an app or a similar technology that makes Bitcoin more appealing to everyday users," Smith says. "It could make a significant difference for providers of low-cost services, such as airport Wi-Fi, that are hit hard by transaction fees. At that point, the risk is low, the cost is low, and it's a win-win."

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