Merchants, entrepreneurs and investors are buzzing about an emerging virtual currency known as Bitcoin, which has been hailed by some as the payment method of the future and cast aside by others as nothing more than a passing craze.
So what is Bitcoin, how does it work, and if you’re running a small business, should you buy in? Those questions were front and center during a hearing Wednesday on the Hill.
“This technical breakthrough presents both potential benefits and risks for consumers and small businesses,” Jerry Brito, a senior research fellow at the Mercatus Center at George Mason University, told members of the House Small Business Committee. He later added, “the challenge for policymakers is to address the risks while doing no harm to the innovative potential of the technology.”
In short, Bitcoin is a virtual currency that consists of thousands of pieces of digital property, each identified by two unique strands of numbers and letters, and each can be transferred from one person to another over the Internet. In that way, the Bitcoin network operates much like, say, Paypal, in that it facilitates online transactions.
However, it is fundamentally different in two important ways.
One, Bitcoin is the world’s first decentralized, peer-to-peer financial network, in that there is no credit card company, bank or government facilitating or monitoring the exchange of Bitcoins. Instead, hundreds of computers around the world have linked up to process transactions and maintain a log of which individual currently owns each Bitcoin.
And two, the network uses its own unique currency. Unlike Visa and Paypal, which facilitate transactions using existing currencies like the dollar or the yen, the Bitcoin network uses a new currency under the same name. Those Bitcoins ebb and flow in value on the open market, much the way global currency exchange rates change every day.
Already, tens of thousands of businesses across the country have started to accept Bitcoin as a form of payment for goods and services, most of them e-commerce retailers. Most rely on a vendor like start-ups Bitpay or Coinbase to process the transactions, and the vendors allow merchants to either store their Bitcoins on a server or immediately exchange them for cash at the daily exchange rate.
So why are so many companies jumping on board so quickly, and should your small business start accepting Bitcoin, too? During the hearing, Brito and several other experts walked through the potential benefits and inherent risks for businesses thinking about accepting Bitcoin. Here’s what you need to know:
Lower fees: Credit card fees have long been a thorn in the side of small retailers, who often have to fork over as much as 25 cents plus around 3 percent of the sale each time they swipe a customer’s plastic. And particularly for small businesses, which tend to operate on slim profit margins, “those fees can really eat into your bottom line,” Brito said.
Not the case with Bitcoin. There is no credit card company charging merchants to facilitate the transactions, and those third-party vendors like BitPay and Coinbase generally charge fees equaling less than 1 percent of each transaction.
They charge less, the panel explained, largely because the nature of Bitcoin does not require third-party vendors to spend nearly as much on fraud prevention measures as credit card companies (more on that in a moment). And as a result, Bitcoin transactions are much cheaper for small sellers.
“If you are a small-margin business, that difference could mean doubling your profits,” Brito said.
Irreversible transactions: Another byproduct of removing the intermediary is that there is no third party that can reverse a transaction. In a sense, with Bitcoin, all sales are final.
Consequently, small businesses using Bitcoin are protected from what is known as chargeback fraud, in which a customer challenges a payment from, say, their credit card, and the bank forces the merchant to return the payment (and often collects penalty fees).
Moreover, because Bitcoin transactions do not include personally identifiable information like your name (unlike credit card payments), data breaches like the one suffered earlier this year by Target couldn’t happen with Bitcoins.
International payments: One of biggest hurdles for small firms hoping to sell abroad is collecting payments. Most traditional payment processors, for instance, do not serve dozens of countries, often due to high fraud rates and volatile currencies. As a result, U.S. merchants have been unable to push their products and services into those markets.
Conversely, “because of the borderless and global nature of Bitcoin, a bitcoin payment made by customer in New York looks identical to a merchant as a bitcoin payment made by a customer in London, Buenos Aires, or Tokyo,” Adam White, an executive at Coinbase, said during the hearing. In addition, he noted that “there are no international currency conversion fees associated with bitcoin payments, so merchants can sell low margin items just as profitably abroad as they do domestically.”
Price fluctuations: During the first two years after it was introduced in 2009, Bitcoins were trading for a few pennies a piece. By the start of 2013, the value had jumped to $13, and by December, it had skyrocketed to $1,200. Since then, the value has plunged 60 percent to around $460 per Bitcoin.
In a single day, the value often swings as much as 10 percent in either direction, according to Mark Williams, a banking specialist and risk management expert at Boston University. Thus, “a small business owner who accepts this form of payment could see profit margins reduced or completely erased in a matter of days,” Williams told the panel.
His analysis of the currency suggests that Bitcoin is currently seven times more risky than gold and 15 times more risky than the U.S. dollar.
“It could be argued that small businesses that blindly accept Bitcoin are not actually in commerce but are in the high-risk speculative trading business,” Williams said.
Security risks: Bitcoins (or more accurately, those two strands of numbers and letter associated with them) are typically stored in one of two places. Owners can keep them in a cloud-based “wallet” held by a company like Coinbase or BitPay, or they can save them on a hard drive on a computer.
If you choose the latter, forgetting your passwords or losing your laptop could mean losing access to any number of Bitcoins stored on that computer.
But relying on an outside company to hold onto your Bitcoins isn’t foolproof, either. Naturally, those firms are prime targets for hackers, as the largest exchange discovered earlier this year. The company, Mt. Gox, lost roughly $450 million in Bitcoins in an apparent hacking scheme, forcing the firm to file for bankruptcy protection in February.
And that is where small business owners can be left wishing they had a credit card company to call.
“Because Bitcoin is essentially digital cash, securing it is vitally important,” Grito said. “There is no intermediary that can replace your bitcoins if they are stolen.”
Tax questions: Last week, the Internal Revenue Service made an important ruling concerning Bitcoin, classifying the coins as “property” rather than “currency” for tax purposes. As a result, Williams explained, merchants who collect Bitcoin are subject to capital gains taxes based on any increase in value between the time they collect the payment and the time they trade it in for cash, without any exception for low-dollar gains.
That won’t make a difference for merchants that accept Bitcoins and immediately use an exchange to swap them for their equivalent in cash. However, for those who elect to process Bitcoin transactions on their own and may hold onto the money for an extended period of time, that could make tax season all the more tumultuous.
Had it been labeled a currency, capital gains could still be levied, but there is an exemption for any gains of foreign currency up to $200 between the time it is obtained and the time it is either spent or converted.
“That’s something you may want to look into and think about changing for Bitcoin,” Grito told lawmakers.