After reaching record highs year-to-date, Bitcoin and Litecoin, dubbed its “little brother”, are making big waves in the crypto-industry. Bitcoin now has a greater total valuation than payment-processing leader PayPal (PYPL) and could be seen as a viable currency for e-commerce businesses processing digital payments.
A cryptocurrency is a digital currency stored on an open and decentralized electronic payment system. Following Nakamoto, crypto-currencies have caught the attention of e-commerce industry, academia and the public at large, with Bitcoin and Litecoin being the most prominent currencies. There are dozens of such crypto-currencies, many running on large and reliable decentralized networks of anonymous computers. This wave has been enabled by an innovative computer science design named blockchain.
The blockchain supports the creation of a decentralized electronic payment system that can be trusted, although none of the system’s servers are individually trusted. The novel blockchain design relies on a combination of cryptography and game theory-based incentives. It has received much public interest on its own right.
The blockchain design enables Bitcoin, Litecoin and other crypto-currencies to function similarly to conventional payment-processing systems such as Fed Wire, Swift, Visa, Mastercard and PayPal. These payment systems are natural monopolies in that they enjoy economies of scale and network effects. Each of them is operated by an organization that determines its rules and modifies them as circumstances change. These rules include how and how much participants pay for using the system.
The innovation in Bitcoin’s blockchain design is in the absence of a governing organization. Rather, a protocol sets the system’s rules, by which all constituents abide. The blockchain carries an economic innovation. Unlike other payment systems, Bitcoin is a two-sided platform with rules that are pre-specified by a computer protocol.
No participant has the power to set or modify fees or rules of conduct or otherwise control the system. Each participant in the market place, users and miners alike, is a price taker. Users are provided protection from monopoly pricing: even if the system becomes a monopoly, there is no monopolist who charges monopolist fees.
As opposed to traditional systems, the Bitcoin system does not require trust in any entity. However, the cryptocurrency system cannot provide some services: a transaction cannot be reversed in case of error or fraud, and users who lose the credentials to their account have no way of retrieving their balance. As such, cryptocurrencies like Bitcoin or Litecoin may be more comparable to cash than to a modern electronic payment system.
PayPal has come to dominate digital payment processing space, allowing users to fund accounts by credit card or bank transfers. It’s true that cryptocurrencies such as Bitcoin or Litecoin have no built in anti-fraud capabilities, whereas companies like PayPal have invested millions of dollars in protecting customers against fraud.
Companies that took the alternative approach of creating digital currencies which were convertible to and from existing currencies, have not been as successful due to a combination of lack of competitive advantages, managerial incompetence, and dubious legality.
But this could change as Bitcoin becomes an increasingly popular form of payment. Major e-commerce platforms, such as Shopify or Woocommerce, provide more tools than ever to accept and facilitate Bitcoin payments on e-commerce websites. The increasing number of Bitcoin transactions, no chargebacks, low to no transactional fees, no PCI compliance regulations, fast international payments and other advantages of crypto-currency, make it a financially viable payment-processing option for e-commerce businesses.