Virtual Currency: Bitcoin and Beyond, Part 2

• Originally Published June 25, 2014, 12:01 AM ET

Several stubborn challenges may temper enthusiasm in both the public and private sectors for virtual currency technologies.

In the first article in this series, we discuss how bitcoin and other virtual currencies work, and the qualities that differentiate them from other money systems. In this installment, we examine how the public and private sectors are responding to the growth of virtual currency technologies, and the effects security issues, volatility, and regulatory uncertainty, among others, could have on future adoption.

Bitcoin Caveats: Speculation, Regulation, and More

To achieve wider adoption, bitcoin needs to address significant issues related to exchange security, volatility, ease of use, transaction volume, and regulatory uncertainty.

• Security problems, punctuated by highly publicized meltdowns of some bitcoin-based exchanges, have thus far prevented bitcoins from becoming a serious contender as a mainstream currency. The most notorious of these failures, Tokyo-based Mt. Gox, launched in July 2010 on an unstable platform with little security. Over the next few years, it grew to become the most widely used bitcoin-based exchange before suspending operations earlier this year following the discovery of widespread security breaches, fraud, and mismanagement. Mt. Gox was like a bank storing valuables in the lobby entrance. To mature, exchange security needs to be as safe as traditional banks.

• Just as speculators buy and sell global currencies to profit from fluctuations in currency value, increasing numbers of bitcoin speculators are now investing short term in the virtual currency, which in turn fuels volatility. This has reduced bitcoin’s utility as a medium of exchange—no one wants to use bitcoin to make future commitments, or even buy a cup of coffee, when its value can change by 30 percent overnight. Unless bitcoin’s volatility settles, it will be used less as a currency and more as a vehicle for speculation and “get rich quick” schemes, much like penny stocks.

• The challenge inherent in safely storing bitcoins (which are, after all, completely virtual) has created ease-of-use problems. The current leading practice for storing bitcoins includes—and we’re not kidding here—locking flash drives in a bank vault. Mainstream consumers are unlikely to use bitcoin until wallet services develop more user-friendly and secure storage techniques.

• Validating transactions requires significant electricity, bandwidth, and computing power. The resources required to support bitcoin’s relatively small volume of transactions are already being pushed to their limits. Currently, bitcoin averages about 60,000 transactions per day.¹ By comparison, VisaNet, the electronic payment processing network used by Visa, handles more than 150 million transactions daily from 2.1 billion credit cards and over 2 million ATMs.² To support mainstream transaction volumes, bitcoin will likely have to change how it uses these resources to process transactions.

• Finally, the global regulation of bitcoins is in flux. Reports of new government scrutiny or rumors of a policy change can significantly affect bitcoin prices, reducing its utility as a currency. Meanwhile, businesses are unwilling to engage in the bitcoin economy while governments treat it as a fringe movement. As governments begin to issue consistent guidance on bitcoin, businesses may become more willing to accept it as a form of payment.

Despite these obstacles, mainstream merchants are beginning to explore bitcoin. One of the first major online retailers to accept bitcoins, Overstock.com, made more than $124,000 in bitcoin sales in its first day of accepting the currency in January and, by March, had topped $1 million in purchases. The company has revised its bitcoin revenue projection for 2014 from an initial $3-5 million to $20 million.³ According to Overstock, bitcoin’s popularity and its low-fee structure drove new consumers to its marketplace. More large-scale merchants and mainstream actors in the global economy are following suit. Second Market, an online marketplace for buying and selling illiquid assets including venture-backed private-company stock, is opening a bitcoin trading platform for institutional investors.

Going Forward: Government, the Private Sector, and Virtual Currency

Some foreign governments have tried to ban bitcoin by making the exchange of cash for bitcoins illegal. Others have taken a “wait and see” approach, allowing the bitcoin ecosystem to develop while closely monitoring it. In the U.S., government agencies have begun to issue taxation and other guidance, paving the way for entrepreneurs to create a new wave of bitcoin-related companies and large corporations to engage in the bitcoin economy.

Bitcoin is yet another example of how new technologies and trends can pop up seemingly out of nowhere, creating problems for government as it sorts out how to respond. Most governments chose a hands-off approach to the Internet when it emerged in the 1980s. But the lessons of the Internet should be fair warning that these new technologies can emerge suddenly and change everything. Bitcoin’s direct relevance to traditional government domains, such as currency and taxes, merits specific consideration. Given its broad potential impact on activities from contracts to identity management, agencies tasked with diverse operations, from financial markets oversight to border patrol, need to monitor bitcoin’s evolution. Government needs to understand how bitcoin will evolve in the short term. But, even more importantly, they need to explore how the concepts underlying this new technology could intersect with their mission in the future.

In the private sector, many factors will influence bitcoin’s evolution, including regulation, technological innovation, and economic conditions. Predicting the future of bitcoin today is like trying to comprehend the significance of the Internet in the 1990s. Yet uncertainty is no excuse for inaction. As CIOs strive to broaden their focus to include business strategy and innovation, experimenting with potentially transformative technologies like bitcoin could lead to an early-adopter advantage for their companies, and a more influential role within the enterprise for themselves.

—This article was adapted from Bitcoin: Fact. Fiction. Future., by Tiffany Wan, senior consultant, and Max Hoblitzell, consultant, Deloitte Consulting LLP. The original article was developed under the direction of Shrupti Shah, director, Deloitte Consulting LLP’s GovLab program.

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1. Blockchain, Number of transactions, accessed June 4, 2014.
2. VisaNet fact sheet
3. “Overstock CEO Patrick Byrne to Keynote Bitcoin 2014 Conference”, Jon Southurst, Coindesk, March 25, 2014