Bitcoin: opportunity or risk?

Having only been in existence since 2008, the rise of the digital currency Bitcoin has been rapid. It is claimed that there are around one million daily transactions today and according to predictions Bitcoin will become the sixth-largest global reserve currency by 2030.

Now officially treated as a currency in the European Union (EU) for value-added tax (VAT) purposes, its adoption looks set to increase. But what is Bitcoin and what does its increasing usage mean for financial service businesses still working to understand the opportunities and potential threats to their business models?

Bitcoin was invented as a peer-to-peer (P2P) system for online payments that does not require a trusted central authority. Since its inception, Bitcoin has evolved into a technology, a currency, an investment vehicle and a community of users respectively. The key innovation that makes Bitcoin ‘special’ is that it uses consensus in a massive P2P network to verify transactions. This results in a system where payments are non-reversible, accounts cannot be frozen, and transaction fees are much lower.

For many, Bitcoin is still a confusing concept. As a digital currency, it is unique in that it is not backed by any country’s central bank or government, but can be traded for goods or services with vendors who accept it as payment. Crucially, as Bitcoin becomes more prevalent, it is essential that businesses understand how, when and why the currency is seeing such traction, and what this means for the broader economy. One example are the nascent coffee shops in London trading only in Bitcoin.

The Bank of England (BoE) published a report in 2014 saying that the cryptocurrency poses little risk to monetary or financial stability. This is backed up by the fact that the underlying technology supporting Bitcoin, Blockchain, has secured a stamp of approval from nine major, international banks. These banks are interested in adopting the technology due to the fact that “it is hard to fool, making fraud more difficult, could speed up trading systems and make deals more transparent”.

HM Revenue & Customs (HMRC) in the UK has allocated £10m towards research on cryptocurrencies, including developing best practices for consumer protection and identifying and preventing potential anti-money laundering (AML) and counter-terrorist financing risks. Coinbase was launched this year. All of these market moves illustrate that the UK government is keen allow more Bitcoins to flow through the financial services market, to help transform the UK into a global hub for the digital currency.

Pros and cons

Many of the benefits of Bitcoin are easy to understand relative to the enthusiasm by institutions and consumers who are eager to try new forms of payment. Truly global as a currency, there are often no transaction fees – unless the user is drawing coins from many Bitcoin addresses with a large data size; no VAT charges; and no need to share detailed personal information. With increasing acceptance in the market, the digital currency is becoming a viable option for businesses and individuals alike.

However, Bitcoin is still in its relative infancy and hence comes with several warnings which are manifested in the substantial uncertainty in the Bitcoin trading market. For example, there is currently an absence of regulation in place in the UK outside of the new tax laws, so customers can expect little to no support or recourse if they are exposed to fraudulent activity. It could also be argued that the opportunities provided by Bitcoin and the underlying technology, such as reducing risk, speeding up transaction times and lowering costs, are all issues which could be solved with alternative and potentially less risky technologies.

All of the above, together with a spate of high profile hacking incidents such as those experienced by Mt Gox and Bitcoinica, helps to explain why businesses are still unsure of how to approach Bitcoin.

In conclusion, the Wall Street Journal called Bitcoin “one of the most powerful innovations in finance in 500 years” and it has certainly caught the eye of many in the market. More and more ‘use cases’ for Bitcoin emerge every day. The question remains as to whether the Bitcoin ‘bubble’ is here to stay.

Banks are aware that they need to keep up with customer expectations in today’s digital world. What this does not mean is that all banking and financial institutions should rush into implementing cryptocurrencies and blockchain technologies. However they do need to ensure that they understand the potential impact of emerging solutions on their business and put plans in place to ensure that they are on the ‘front-foot’ to adopt these in an agile manner, on a use case basis. Those who choose to ignore the potential of Bitcoin may find themselves quickly left behind.

Other articles by Tony Virdi

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