The eventual goal of Bitcoin is to supplant fiat currency but volatility still remains the biggest barrier.
Ever since Bitcoin’s whitepaper was revealed on October 31, 2008, cryptocurrency purists have had a single goal: Break the hold of the banks and supplant fiat currency. It is safe to say that we’re not there yet. It’s been a goldmine for some speculators, but not for individuals to use like US dollars. And businesses face significantly more hurdles still. But some creative companies have found ways to do so.
The Challenges of Cryptocurrency Are Significant
Cryptocurrency has a lot of potential but it’s difficult for many businesses to justify the risks of using it. Setting aside the regulatory difficulties, which businesses can’t control, there are two interconnected problems to manage: price volatility and scalability.
The reason that fiat currencies work is that they are broadly stable. There might be fluctuations and inflation, but barring a hyperinflation event, businesses know that $1.20 is still going to be around $1.20 at the close of business.
With cryptocurrency, this isn’t the case. Prices can rise or fall rapidly.
This volatility is partially caused by Bitcon’s severe scalability problems. Bitcoin is capable of processing under 5 transactions per second. Traditional solutions, like Visa, are able to process around 1,700 transactions a second.
This makes cryptocurrencies difficult and expensive to be used for small e-commerce or even in-store purchases. And in turn, it hampers adoption, and therefore the number of companies that actually accept cryptocurrency payments.
Businesses Have Found Creative Solutions
These problems are difficult but not insurmountable with a bit of creativity. In fact, some businesses have managed to turn these challenges to their advantage.
One of the best examples is business intelligence company MicroStrategy. Crypto analyst Kevin Rooke estimated that the company had made over $100 million in profits on its Bitcoin purchases made in October. In contrast, the company’s net income from its business operations in the last three and a half years was only $78 million.
Aside from holding Bitcoin as a speculative asset, other businesses have found that offering the opportunity to buy and sell crypto has proven popular. For some time, CFD broker eToro has made it possible to buy and sell crypto. And British company Revolut has made it possible to trade crypto.
For the moment, the majority of non-crypto businesses have focused on making it easier to buy and sell cryptocurrency. This makes sense as the barrier to entry remains a big block on adoption. However, there are signs that big business is coming on board.
Scalability Remains the Real Challenge
Companies are attempting to move beyond speculation and accepting cryptocurrency. Most recently, PayPal announced that it is allowing users to buy crypto and most importantly, use it within their network for goods and services. PayPal has over 350 million users and 26 million vendors in its ecosystem.
Bringing these people into the Bitcoin network would help inject new blood into the system. PayPal’s ease of use would theoretically make it easier for merchants to accept Bitcoin as payment. However, there is still a problem: scalability.
Bitcoin transactions need to be processed via Proof of Work (PoW). This means that networks of specialized computers, or miners, must find solutions to complicated problems in order to process a transaction. For providing their computing power, miners are rewarded with Bitcoin.
This helps to ensure the system is secure but it also means that there is a limit on the number of transactions that can be processed. As demand on Bitcoin’s blockchain increases so does the cost of each transaction. And so does the amount of time a transaction takes.
A Second Layer Could Make Bitcoin Scalable
This means that any sudden influx of users would essentially render Bitcoin unusable. There are a number of solutions designed to resolve this. The most promising is building a second layer for Bitcoin. An example of how this works is the lightning network.
The problem is that currently every transaction needs to be recorded individually. A layer 2 protocol would allow for peer-to-peer micropayments. They essentially create a list of transactions. This would allow instant transactions between merchants and buyers to take place but not be recorded on the blockchain until all transactions have been finalized and confirmed as completed.
Other scalable alternatives are being built for the Ethereum blockchain in the form of DeFi. The Ethereum protocol makes it possible to build complicated financial institutions using smart contracts. They have already built a number of promising crypto derivatives with everything from lending platforms to decentralized exchanges. These are important because they lay the foundations of a proper financial ecosystem.
These new crypto businesses provide a way for Bitcoin holders to make their currency liquid without selling their assets. For example, by putting BTC up as collateral on a lending platform it is possible to gain interest rates far beyond the market average for fiat. This provides an incentive for investors to hold their Bitcoin, rather than trade it, and in the long term should help stabilize it.
Businesses Will Find Ways as Long as It Provides Value
Successful businesses are practical. This is why PayPal is making early(ish) moves into the cryptocurrency sector. This is also why businesses will be willing to accept and use Bitcoin when it makes financial sense on their end.
This will be especially true for businesses that deal with regular currency exchanges or cross-border transfers. Paying in a single currency like Bitcoin could provide them a way to significantly reduce operating expenses.
However, for that to happen, Bitcoin needs the proper infrastructure. Paypal is clearly preparing to build that, but it will take time. Until that happens, most businesses will continue to view Bitcoin as an asset class that can be used to supplement their regular income but isn’t integral to it.