[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
BITCOIN: EXAMINING THE BENEFITS AND RISKS FOR SMALL BUSINESS
=======================================================================
HEARING
before the
COMMITTEE ON SMALL BUSINESS
UNITED STATES
HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
SECOND SESSION
__________
HEARING HELD
APRIL 2, 2014
__________
[GRAPHIC] [TIFF OMITTED] TONGRESS.#13
Small Business Committee Document Number 113-064
Available via the GPO Website: www.fdsys.gov
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HOUSE COMMITTEE ON SMALL BUSINESS
SAM GRAVES, Missouri, Chairman
STEVE CHABOT, Ohio
STEVE KING, Iowa
MIKE COFFMAN, Colorado
BLAINE LUETKEMEYER, Missouri
MICK MULVANEY, South Carolina
SCOTT TIPTON, Colorado
JAIME HERRERA BEUTLER, Washington
RICHARD HANNA, New York
TIM HUELSKAMP, Kansas
DAVID SCHWEIKERT, Arizona
KERRY BENTIVOLIO, Michigan
CHRIS COLLINS, New York
TOM RICE, South Carolina
NYDIA VELAZQUEZ, New York, Ranking Member
KURT SCHRADER, Oregon
YVETTE CLARKE, New York
JUDY CHU, California
JANICE HAHN, California
DONALD PAYNE, JR., New Jersey
GRACE MENG, New York
BRAD SCHNEIDER, Illinois
RON BARBER, Arizona
ANN McLANE KUSTER, New Hampshire
PATRICK MURPHY, Florida
Lori Salley, Staff Director
Paul Sass, Deputy Staff Director
Barry Pineles, Chief Counsel
Michael Day, Minority Staff Director
C O N T E N T S
OPENING STATEMENTS
Page
Hon. Scott Tipton................................................ 1
Hon. Nydia Velazquez............................................. 2
Hon. Sam Graves.................................................. 9
WITNESSES
Mr. Jerry Brito, Senior Research Fellow, Mercatus Center, George
Mason University, Arlington, VA................................ 3
Mr. Adam White, Director of Business Development and Sales,
Coinbase, San Francisco, CA.................................... 5
Mr. Mark Williams, Executive-in-Residence, Master Lecturer,
Boston University, School of Management, Boston, MA............ 7
Mr. L. Michael Couvillion, Associate Professor of Economics,
Plymouth State University, College of Business Administration,
Plymouth, NH................................................... 9
APPENDIX
Prepared Statements:
Mr. Jerry Brito, Senior Research Fellow, Mercatus Center,
George Mason University, Arlington, VA..................... 29
Mr. Adam White, Director of Business Development and Sales,
Coinbase, San Francisco, CA................................ 55
Mr. Mark Williams, Executive-in-Residence, Master Lecturer,
Boston University, School of Management, Boston, MA........ 57
Mr. L. Michael Couvillion, Associate Professor of Economics,
Plymouth State University, College of Business Administration,
Plymouth, NH................................................... 73
Questions for the Record:
None.
Answers for the Record:
None.
Additional Material for the Record:
Journal of Accountancy....................................... 79
BITCOIN: EXAMINING THE BENEFITS AND RISKS FOR SMALL BUSINESS
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WEDNESDAY, APRIL 2, 2014
House of Representatives,
Committee on Small Business,
Washington, DC.
The Committee met, pursuant to call, at 1:00 p.m., in Room
2360, Rayburn House Office Building. Hon. Sam Graves [chairman
of the Committee] presiding.
Present: Representatives Graves, Chabot, Luetkemeyer,
Mulvaney, Tipton, Hanna, Huelskamp, Schweikert, Velazquez,
Clarke, Payne, Meng, and Mclane Kuster.
Mr. TIPTON. [Presiding] Good afternoon. This hearing will
come to order. Chairman Graves will be joining us shortly. I
will fill in for him here in the interim.
I would like to thank all of our witnesses for taking the
time to be able to join us here today.
To be able to gain an advantage in an increasingly
competitive marketplace, small businesses are looking for
innovative ways to be able to cut costs and be able to gain
access to customers. One small way the businesses are doing
this is through the use of cutting-edge technologies that can
provide efficiencies, and Bitcoins may be one of these
innovative technologies.
Bitcoins are a form of virtual currency first introduced in
2008 that allows users to exchange value digitally through the
Internet. Despite not being backed by a government or holding
any intrinsic value of their own, Bitcoins are growing as an
alternative payment method. This hearing will examine the
benefits and risks associated with Bitcoin as a payment system
for all small businesses.
While the origins of Bitcoin remain mysterious, it has
grown rapidly in the last few years. Businesses choose to
accept Bitcoin for many reasons, including to be at the
forefront of new technology, to attract customers now using
Bitcoin, to lower transaction fees from credit and debit cards,
and to eliminate certain kinds of fraud.
Despite these advantages, there are numerous risks that
small businesses should consider before implementing a Bitcoin
payment system. These risks include volatility of price,
security and policy uncertainty. Further, recent developments
in the Bitcoin industry have cast a shadow on its security and
sustainability. Hacking attacks have led to the downfall of a
leading Bitcoin exchange company, while its use for criminal
activity has led to greater scrutiny by law enforcement and
other federal and state banking regulators.
We have invited a distinguished panel of experts who will
explain what Bitcoin is, and we appreciate that, and how it
operates, why it might be a good fit for small businesses and
what the risks are associated with Bitcoin. We hope that by
providing information about Bitcoin, small businesses will be
in a better position to know whether adopting Bitcoin as a
payment system might be a way for small businesses to be able
to gain more customers. This hearing will also inform Members
as we consider implications of policies affecting the use of
virtual currencies.
With that, I would again like to thank our distinguished
panel of witnesses for joining us here today, and I now
recognize the ranking member for her opening statement.
Ms. VELAZQUEZ. Thank you, Mr. Chairman. Good afternoon,
everyone, and thank you for being here today.
American entrepreneurship is closely linked to technology
called innovation. Whether it was the arrival of Google or
Facebook, the widespread use of smartphone apps or cloud
computing, our nation's entrepreneurs drive many technological
developments. Not only do small firms help create new
technologies that drive growth, but they often benefit from new
systems and processes.
The relatively recent arrival of digital currencies is one
technology that presents significant opportunity. Just as the
Internet has empowered entrepreneurs to reach new global
markets and identify more efficient ways of doing business,
digital currencies like Bitcoin can save small firms on
transaction costs. For a small company accepting major credit
cards, each card swipe can cost as much as one-quarter of a
cent in addition to having to return 3 to 6 percent of sales
total to the credit card company. Some credit card companies
also charge businesses to join the network. By contrast, when
utilizing Bitcoin, there is no cost of joining the network.
Fees are less than 1 percent. For large retailers and big box
stores, this cost may sound minor, but among small companies
operating on thin margins, those expenditures are up. Moreover,
should currencies like Bitcoin become widely utilized, they
could create competitive pressure for conventional financial
institutions to lower transaction fees in an effort to retain
small business customers.
Beyond allowing small firms to save on transaction costs,
Bitcoins offer consumers other advantages. For customer seeking
anonymity, Bitcoins provide more privacy than credit card
transactions. Small firms are gradually recognizing the promise
of accepting Bitcoins. In 2012, about 1,000 businesses used
BitPay, the largest processor of Bitcoin payments. Today, more
than 13,000 small businesses in the U.S. employ this service.
While most are online sellers, one in five are traditional
brick-and-mortar operations suggesting the technology is
gaining broader acceptance.
Although this growth sounds promising, a number of
unanswered questions might be impeding small businesses' use of
Bitcoins. Price fluctuation for Bitcoins create complications.
Last spring, Bitcoin's dollar exchange rate rose sharply from
$50 to $350 and then fell to $70. With swings like this, one
has to wonder whether small businesses will find it difficult
to continually price and reprice their products in order to
ensure they receive fair compensation from customers.
There are also security questions. Hacking incidents in
2012 and 2013 endangered many users' Bitcoins. More recently,
the bankruptcy of Mt. Gox, one of the largest Bitcoin
exchanges, was followed by news that the company has lost
hundreds of millions of dollars in Bitcoins. For small
businesses to fully benefit from this currency, customers must
be assured their money is safe and cannot be snatched out of
cyberspace. It also remains to be seen how the IRS's recent
ruling declaring Bitcoin a property as opposed to a currency
will impact this technology growth.
In all these areas, the Committee has an obligation to
ensure small business interests are taking into account. We
want small firms to benefit from this technology, but we must
see to it that there are safeguards protecting them and their
customers. Likewise, we must see that tax regulatory changes do
not preclude the use of this currency.
I expect today's hearing will help us learn about complex
issues like this and assist the Committee as it addresses such
matters going forward. In that regard, I would like to thank
our witnesses for being here, and I yield the balance of my
time.
Mr. TIPTON. Thank you, Ms. Velazquez.
If Committee members have an opening statement prepared, I
ask that they submit it for the record.
I would like to take a moment just to be able to explain
our timing lights. You will each have five minutes for your
testimony. The light will start out as green. When you get into
the danger zone is when it moves to yellow. When it gets to the
red, if you would conclude your statements at that time we
would appreciate it.
So again, thank you, gentlemen, for joining us this
afternoon.
Our first witness is Mr. Jerry Brito, senior research
fellow at Mercatus Center at George Mason University. Mr. Brito
focuses his research on technology, Internet policy, copyright,
and regulatory process. Mr. Brito is the coauthor of Bitcoin: A
Primer for Policymakers.
Mr. Brito, thank you for being here, and I look forward to
your testimony.
STATEMENTS OF JERRY BRITO, SENIOR RESEARCH FELLOW, MERCATUS
CENTER, GEORGE MASON UNIVERSITY; ADAM WHITE, DIRECTOR OF
BUSINESS DEVELOPMENT AND SALES, COINBASE; MARK WILLIAMS,
EXECUTIVE-IN-RESIDENCE, MASTER LECTURER, BOSTON UNIVERSITY,
SCHOOL OF MANAGEMENT; L. MICHAEL COUVILLION, ASSOCIATE
PROFESSOR OF ECONOMICS, PLYMOUTH STATE UNIVERSITY, COLLEGE OF
BUSINESS ADMINISTRATION
STATEMENT OF JERRY BRITO
Mr. BRITO. Thank you. Thank you very much, Mr. Chairman,
members of the Committee. Thank you for inviting me here today
to comment on Bitcoin's use for small businesses.
Virtual currencies and electronic payment systems are
nothing new. They have existed for decades. So what is it about
Bitcoin that makes it unique? Bitcoin is the world's first
completely decentralized digital currency, and it is the
decentralized part that makes it unique. Prior to Bitcoin's
invention in 2009, online currencies or payment systems had to
be managed by a central authority, whether it was Facebook
issuing Facebook credits or PayPal ensuring that transactions
between its customers were reconciled. However, by ingeniously
solving some longstanding problems in computer science, Bitcoin
for the first time makes possible electronic transactions that
are person-to-person without the need for an intermediary
between them, just like cash.
This technical breakthrough presents both potential
benefits and risks for consumers and small businesses. For
example, because there is no central intermediary in Bitcoin
transactions, fees associated with those transactions are
relatively small. Small businesses accepting credit card
payments often face fees of around 25 cents for each card swipe
plus 2 to 4 percent of the transaction total. If you are a
small margin business, those fees can really eat into your
bottom-line. In contrast, businesses that use a merchant
processor, like BitPay or Coinbase, pay fees of 1 percent or
less on Bitcoin transactions. If you are a smaller margin
business, that difference could mean doubling your profits.
Another reason small businesses are attracted to Bitcoin is
that, like cash, all transactions are final. And again, because
there is no central intermediary, there is no third party that
can reverse the transaction. This protects small businesses
from chargeback fraud, which often results not just in the loss
of a sale but also in penalty fees. And such friendly fraud
accounts for 41 percent of all claims. And if a merchant has 1
percent of their charges reversed as chargebacks, they can
often be kicked out of the credit card networks, potentially
ending their business.
And finally, because Bitcoin is decentralized, businesses
can now accept international payments that were not previously
possible. There are over 50 countries that traditional payment
processors do not serve, often because of high fraud rates.
Because Bitcoin payments are global and final, doing business
with consumers in those countries, especially in developing
countries is now feasible.
For consumers, the benefit Bitcoin presents is essentially
choice. Wishing to encourage its use, merchants frequently
offer discounts to customers who pay with Bitcoin. This means
consumers will be able to choose to pay a little more and get
the benefits of using a credit card, like fraud insurance and
airline miles, or they can choose to pay a little less by using
Bitcoin. For some price-sensitive consumers, this could be a
very valuable choice.
Of course, there are also risks associated with Bitcoin.
Chief among these is Bitcoin's historic volatility. It has
traded from a low of pennies when it was first introduced in
2009, to a high of $1,200 last December, with wild short-term
swings. However, there is nothing inherent in Bitcoin's design
that naturally makes it so extremely volatile. Its extreme
volatility is likely attributable to the fact that it is a new
currency. Bitcoin is still an experiment, and it is still in
the process of discovering a more stable price.
Additionally, as a nascent currency, it is very thinly
traded, and as a result, a single, large enough trade can
affect the exchange price substantially. If Bitcoin's use
continues to expand, potentially, we could expect to see
extreme volatility subside. Additionally, derivatives that
allow investors to bet against the price of Bitcoin will soon
become available and this should help stabilize the price as
well.
The volatility risk is one that a small business faces if
it accepts Bitcoins directly. It should be noted, however, that
small businesses can use Bitcoin entirely as a payment system
without ever holding Bitcoins. And in fact, this is what most
small businesses do. Using a merchant service company like
BitPay or Coinbase, merchants can denominate prices in dollars,
not in Bitcoin, and denominate their prices in dollars, accept
Bitcoins for payment at the current exchange rate, and then
immediately convert those Bitcoins to dollars, never actually
holding a Bitcoin.
Security is another concern. Because Bitcoin is essentially
digital cash, securing it is vitally important. There is no
intermediary that can replace your Bitcoins if they are stolen.
As we have seen, however, merchants need not hold Bitcoins, and
as interest in Bitcoin expands, we are seeing a great deal of
innovation and investment in secure consumer products. But,
this still means that exchanges, merchant processors, and other
new Bitcoin intermediaries will have to earn consumers' trust
just as Visa and PayPal have.
Like the Internet itself, Bitcoin has the potential to be a
platform for the kind of permissionless innovation that has
driven so much of the growth of our economy. And like all
emerging technologies, Bitcoin also presents risks. The
challenge for policymakers is to address those risks while
doing no harm to the innovative potential of the technology.
Thank you for your time, and I look forward to your
questions.
Mr. TIPTON. Thank you, sir.
Our next witness is Adam White, Director of Business
Development and Sales at Coinbase. Coinbase is a payment
processing company for businesses interested in accepting
Bitcoin. Prior to joining Coinbase, Mr. White served in the
United States Air Force and was a test pilot for NASA before
receiving his MBA from Harvard Business School.
Appreciate you being here with us today, Mr. White, and
look forward to your testimony.
STATEMENT OF ADAM WHITE
Mr. WHITE. Thank you, Mr. Chairman, Ranking Member
Velazquez, and other members of the Committee, for the
opportunity to appear here today.
My name is Adam White. I am the Director of Business
Development and Sales at Coinbase, a company founded in June
2012, with the goal of making it easy for merchants and
consumers to transact with the digital currency, Bitcoin. More
than one million consumers use Coinbase as their digital
wallet, and as of today, there are nearly 28,000 businesses
that entrust Coinbase to accept Bitcoin payments on their
behalf using our payment tools. These merchants include large
enterprise-level businesses, such as Overstock.com and Big Fish
Games, as well as tens of thousands of small businesses like
Tealet, Tuft and Needle, and Mondo Cellars.
Prior to my role at Coinbase, I served as a captain in the
United States Air Force, and am a veteran of Operation Iraqi
Freedom and Operation Enduring Freedom.
I would like to begin today by outlining the inherent
benefits of Bitcoin in commerce, namely the powerful prevention
of fraud, the reduction of transaction fees, and the
monetization of new markets, and how these benefits could be a
positive influence on businesses of all sizes.
Bitcoin enables individuals to push payments to merchants
without having to share personally identifiable information
that can be intercepted by criminals and used for fraudulent
purposes. This irreversible nature of Bitcoin enables the
abstraction of personal information and significantly reduces
the risk of fraud, something that merchants, card processors,
and banks spend billions of dollars per year combatting. With
Bitcoin, for example, the target data breach that compromised
40 million consumers' credit card information would not have
been possible. Moreover, this irreversibility shields merchants
from chargebacks. That is, the forced return of funds from a
merchant to a customer's bank account and the cost associated
with managing, defending, and preventing fraudulent chargeback
claims.
In response, many card issuers and merchants use fraud
detection systems that are overly sensitive to trigger
activities, especially in card-not-present transactions common
online. Initial estimates suggest that some merchants turn away
nearly 8 percent if incoming orders due to issues associated
with suspicious activity. Many of these transactions, however,
are, in fact, legitimate. Bitcoin prevents the need for risk
algorithms and ensures merchants capture 100 percent of their
customers' orders.
Due to the powerful prevention of fraud and the reduction
in the number of intermediaries required to process a payment,
Bitcoin transactions are dramatically less expensive than
traditional card-based payments. Merchants can reduce their
electronic payment acceptance fees to less than 1 percent when
accepting payment in Bitcoin. This is especially important for
small businesses that sacrifice anywhere between 3 and 5
percent of their revenues in card transaction fees. Businesses
can use these savings to reinvest in their company or return
them to consumers in the form of lower prices. Moreover,
merchants are not subject to a fixed fee per transaction,
enabling them to forgo minimum transaction limits and sell
small ticket items profitably.
Finally, Bitcoin provides the opportunity to monetize new
markets by democratizing foreign exchange and enabling
frictionless cross-border transactions that settle immediately.
Many products and services are not available for sale in
foreign countries because the business cannot manage the
payment systems needed to support overseas commerce. Because of
the borderless and global nature of Bitcoin, a Bitcoin payment
made by a customer in New York looks identical to a merchant,
as a Bitcoin payment made by a customer in London, Buenos Aires
or Tokyo. There are no individual currency conversion fees
associated with Bitcoin payments, so merchants can sell low
margin items just as profitably abroad as they do domestically.
The ability to easily begin accepting payments from customers
around the world can open up whole new markets for merchants
and significantly improve topline revenue.
We see Bitcoin as an extremely powerful technology, and it
is our goal to bring these efficiencies created by the Bitcoin
network to the masses. We are encouraged to see the Committee's
proactive examination into the topic of Bitcoin as it relates
to small businesses, and I look forward to engaging in dialogue
and answering any questions you may have.
Mr. TIPTON. Thank you, Mr. White.
Our next witness is Mark Williams, professor of Finance and
Risk at the Boston University School of Management. Before
joining the faculty at Boston University, Mr. Williams worked
as a senior trading floor executive, bank trust officer and as
a bank examiner for the Federal Reserve Bank. Mr. Williams
holds an MBA from Boston University School of Business, and a
B.S. from the University of Delaware.
Welcome, Mr. Williams, and please begin.
STATEMENT OF MARK WILLIAMS
Mr. WILLIAMS. Thank you. I am very happy to be here, and
thank you for inviting me. In particular, I am very interested
in Bitcoin, and the reason for that interest really stems from
classroom discussions going back to 2011. At that point in
time, prices were 35 cents, so it was more of a theoretical
discussion, but very quickly within the classroom it moved from
discussion to by 2012 when Bitcoin prices started to increase
by over a dollar to actually homework assignments, and then
eventually, these homework assignments turned into outright
discussions and debate in the classroom. By 2013, the price of
Bitcoin by January had increased actually to $13 a coin. Very
quickly, in 2013, it escalated from $13 all the way up to
$1,200. It was remarkable.
But what was unusual about this price run-up at the peak in
2013 was the fact that this was a 9,000 percent increase.
Nowhere on this planet or any planet has there been that sort
of price increase. And what that represented to the marketplace
in particular is the fact that this was a unique product and a
unique risk.
So what I would like to do today is I would like to focus
specifically not on the promised benefits of Bitcoin, because
we have heard enough about that, but I would like to take my
discipline in risk management, in particular, working on a
commodity trading floor, and talk specifically about the risks
that are associated with Bitcoin. In particular, I provided a
30-page testimony which outlines 10 of the specific risks, what
I consider to be the top risks associated with Bitcoin. But
what I would like to do for the Committee right now is really
focus on the top six risks. And I will leave this up for the
discussion later.
In particular, the first risk which is very important to
look at for big businesses and for little businesses is that
Bitcoin itself is not legal tender. And what I mean by that is
the fact there is no legal precedence; that is, that
individuals and corporations themselves have to accept Bitcoin.
So as a result, it is a very voluntary commodity. So just as
equally as we can turn a light off today, if the market decides
they do not want to accept Bitcoin anymore, the value could
drop to worthless. What is very interesting about that
statement of worthless, we have seen Bitcoin drop already.
Since its high in December, it has dropped by roughly 60
percent. So clearly, this is not a currency. Currencies do not
behave like this. But what this is is a high risk speculative
commodity.
Since December, what have we seen? We have seen daily price
movements of up to 10 percent. Can you imagine having currency
in your wallet that can move up or down by 10 percent? That
would be hot currency. If you were worried about it dropping by
10 percent, you would be selling it very quickly, getting it
out of your wallet. If you thought it would appreciate, you
would hoard it. And these characteristics are characteristics
that you see in Bitcoin. Over 90 percent of Bitcoin is hoarded.
What that means is only 10 percent of what is available trades.
Increasingly, we have had changes within the marketplace.
Last week, the IRS came out with a formal ruling and said
Bitcoin is not currency. What it is, it is property. And what
that means is it reduces the likelihood of people to use it to
spend. It actually gives a disincentive. What it increases
though is the incentive to hoard. So this is the opposite of
what you want in a currency. Currencies, we collectively use
currencies because currencies themselves provide us with the
ability to buy things. A $100 bill has not value to us to put
on the wall, but that $100 bill has value for us to buy art
that we can then put on the wall. Bitcoin is unusual in that
regard. The fascination, fixation of investors on Bitcoin is
tied directly to it as a commodity, as something to speculate,
not as something to use as a transactional currency.
So what are some of the other risks? There is extreme price
volatility that was discussed earlier as well, and with that
extreme price volatility with daily movements of 10 percent,
what that means to put it in perspective, Bitcoin is seven
times more risky than gold, eight times more risky than the S&P
500. In particular, it is 15 times more risky than the U.S.
dollar. And just for fun I will throw this out. If you look at
the Argentinian peso, Bitcoin is seven times more risky than
the peso.
So as you can see, this is not a currency, but this is a
very risky commodity. But more importantly, when we think about
businesses, businesses, your average business, they actually
have profit margins of maybe 10 percent, 15 to be liberal. If
you have a daily fluctuation of 10 percent, what that means is
that profit margins can be evaporated within a period of days,
and that is of concern.
Two quick more risks that I will bring up to the Committee,
and that is the asset bubble. Many noted economists have
mentioned this asset bubble, and we have seen it actually since
December start to implode. As I mentioned, the price dropped by
60 percent. In addition, the number fifth risk is a growing
concentration risk. We are seeing firms like Coinbase doing a
nice job of trying to mitigate the market risk, but what is
happening is they are moving the risk from let us say 20,000 or
30,000 people to their balance sheet. So they are warehousing
that risk and there is not a mature market for them to offload
that risk. So we have concentrated risk on their books. They
are thinly capitalized. They are a startup. There is no minimum
capital requirement. So what should happen if one of these or
both of these firms were to blow up? Then consumers, U.S.
businesses would be impacted.
And then finally, when we think about Bitcoin, there is
Bitcoin tax which now is a risk. In a sense of using Bitcoin on
a daily basis, deciding whether to pay, for example, employees
or actually accepting it as currency, if you are having daily
fluctuations of 10 percent, you can see capital gains very
quickly.
So I thank you for your patience.
Mr. TIPTON. Gentlemen, if you would not mind, we apologize.
Naturally, when we start, we get a vote called. And we want to
make sure that our last witness has the appropriate amount of
time and our folks are going to be able to listen. So we will
go into recess, run over and vote. I believe it is going to be
a short vote. And should be back in 20 minutes or so. Is that
about right?
So if you do not mind, I apologize, and certainly
appreciate your patience.
[Recess]
Chairman GRAVES. We will go ahead and call the hearing back
to order, and I now yield to Ranking Member Velazquez for her
introduction.
Ms. VELAZQUEZ. Thank you, Mr. Chairman.
It is my pleasure to introduce Professor Michael
Couvillion. Professor Couvillion is an associate professor of
Economics at Plymouth State University's College of Business
Administration. His current research includes asset allocation
modeling and alternative investment vehicles such as Bitcoin.
Additionally, he has worked with the Enterprise Center of
Plymouth to educate local, small business owners in New
Hampshire about the advantages and disadvantages of Bitcoin.
Welcome, Professor.
STATEMENT OF L. MICHAEL COUVILLION
Mr. COUVILLION. Thank you very much. And thank you to
members of the Committee for inviting me.
I thought I would take a slightly different tact this
afternoon and not discuss the nuts and bolts of Bitcoin because
you have heard so many excellent comments about that before.
My interest in Bitcoin started about three semesters ago
when one of my best students wrote a research paper in a class
on Bitcoin. He was a passionate advocate for Bitcoin, and he
liked it so much he actually put $100 into Bitcoin. He would
not tell me how many Bitcoins he bought except that it was well
under $10. So the student has graduate and now I keep getting
emails from him. ``Hey, check out the price of Bitcoin.''
Because he bought it, I think, about $8, and Bitcoin is worth
about $450 right now. So he has got a very nice paper profit
here.
So he got me certainly thinking about Bitcoin in a way I
had never thought about it before. And I began to become
interested in Bitcoin and opened an account with Coinbase in
May of last year. I have some data in my written remarks that
come from that dataset, which is roughly about 10 months, so it
is suggestive, it is recent, but it is by no means definitive.
Some of the things I have learned I would like to share
with the Committee. Coinbase charges a different price if you
buy Bitcoin than they do if you sell Bitcoin. This is known as
the bid-ask spread, very similar to the spreads on a NASDAQ
stock let us say in the stock market. And just for a random
day, which was March 28th--that is last week--the bid-ask
spread for Coinbase was 17 basis points. That is about two-
tenths of one percent. By way of comparison, the Dow Jones
Industrial Average at the same time had a bid-ask spread of
about 45 basis points, twice as high, and the Standard and
Poor's 500 had a bid-ask spread of 32 basis points. So on that
day, compared to the stock markets, Coinbase's bid-ask spread
was lower. In addition, I have taken a look at the trend in the
bid-ask spread. The high is 164 basis points, the minimum is
zero, and the average is 40. So that is where I got that data
you will see on the spreadsheet.
Also, the bid-ask spread has been steadily trending down
over time and it is a significant trend. So that is important
because bid-ask spreads are an excellent measure of the
liquidity of any market. They also have to measure risk because
if a market is very thinly traded, you will see much larger
bid-ask spreads.
Then, I took a look at the statistics for Bitcoin, asking
what kind of distribution does it follow? And my conclusions
are that the Bitcoin price return series, that is the
percentage daily change, is 2P. It has too many small moves and
not enough middling moves. It is also skewed heavily to the
right and that causes a problem for using standard or
traditional statistical analyses.
Sorry, is my time up? No, okay.
Also, I did a comparison of Bitcoin with three other
invesmtents--short-term global interest rates, the dollar
index, and the emerging markets currency index, and
essentially, I found out that none of those models predict
Bitcoin. Its price is in essence unpredictable. You cannot with
any degree of accuracy project the price of Bitcoin more than
just a few days in the future.
Now, that is good if you are a small businessman, and the
reason it is good is that because the average return to Bitcoin
is positive--and remember, the price of Bitcoin has risen from
about $85 last May to about $450 now. It is a bit seductive to
a small business person because if you were to buy Bitcoin, you
would see your Bitcoin increase in value. That is only because
we have a bullish trend lately. The other thing that you will
discover is that the number of daily moves are fewer than they
should be at less than 10 percent.
Now, Bitcoin investors, unfortunately, pay for that because
while the number of 10 percent or more moves is less than it
should be by approximately roughly 2 percent, if you look at
the number of 15 percent moves, there are more than there
should be. There is about 2 percent of the observations there
and huge moves, which we call fat tails, there should be none.
In the dataset there were six. Three were positive. Three were
negative. But there were six price moves that would be
completely unpredictable based on chance. So again, I would
like to corroborate what your other witnesses have already told
you, that Bitcoin is a very volatile currency.
In terms of the other technical features, the problem with
Bitcoin is that we cannot analyze it using the standard tools
of finance because the underlying distributions simply does not
fit our models. And that means it is hard if you are trying to
use sophisticated techniques like value at risk or covariance
matrices. It is hard to reach any conclusions that actually
work. I realize that small businesses probably will not do
that, but even large businesses will have difficulty with
Bitcoin for that reason.
I gave a small example of the cost comparison, and Bitcoin
works at every level from $1 transactions all the way up to
$10,000 transactions. Businesses can save money if they use
Bitcoin, and that I believe is the single fact that is what is
going to drive Bitcoin to a successful integration into the
marketplace. So there is a slight advantage right there.
Offsetting that, it is difficult for businesses to use
Bitcoin because they first have to educate themselves and their
employees, and then they have to educate at least some of their
customers. And exactly how do you do a trade using Bitcoin? So
there is a steep learning curve at first, but once you have
managed to get your employees and your customers educated, then
things go a whole lot more smoothly. That is a good role here
for the government to encourage confident and detailed
education on the part of the companies that do a large business
in Bitcoin. Because it is so new, you have to educate consumers
about that, and because there is so much risk, they also need
to be clearly informed and disclosed that this is not an FDIC-
insured investment. It is not something that you would ever
have invested in before. So I did want to make that point.
Finally, I tried to forecast the price of Bitcoin, and my
model suggests that the best predictor of the price of Bitcoin
tomorrow is 99 percent of the price today plus $4.73. And that
is because there is a positive trend in Bitcoin prices. And I
have a graph that shows that basically in 46 days, the price of
Bitcoin could be as low as zero or as high as $1,000. That is
in 46 days. So it makes it problematic, and I believe that the
market for Bitcoin will remain volatile at least for a while
unless it achieves mainstream acceptance.
So having said that, there are a couple of advantages of
Bitcoin that have not been touched on previously, so I would
like to mention them quickly. One is that somehow you can send
a message using Bitcoin. There is a way where you could say
thank you for your business or some other message like that. I
have no idea technically how that happens. I just know that it
is possible. So it represents a different way for customers and
businesses to communicate with each other. I find that
interesting, particularly if you are communicating across the
ocean with customers who may be in many, many different parts
of the world. That is a benefit there.
The other shoe to drop, so to speak with Bitcoin, is the
IRS and its announcement recently that they are going to begin
to tax Bitcoin. A lot of people are very, very upset by that in
the Bitcoin community because they view it as an announcement
that came late.
Chairman GRAVES. Time is expired.
Mr. COUVILLION. Okay, thank you.
Chairman GRAVES. I am now going to turn to questions, and I
will let Mr. Hanna open them up.
Mr. HANNA. Thank you.
Mr. Couvillion, you undermine your own argument. The
volatility alone proves that it is not a storage of value. Your
conversation about the S&P or say pick a stock that is backed
by a company with real assets that are in some way attachable,
discernible, and measurable because you can go to their
website, you can go to their annual reports, there are a
thousand ways to figure out what it is you are buying when you
buy a company, I find that completely not even relevant. This
is about a storage of value that is reliable for people that
they can use and go back to that is not volatile. As a matter
of fact, any volatility at all that is more than the dollar
depreciating over time or some other currency that fluctuates
mildly is really, for me, a counterargument.
But I want to ask Mr. Williams, why do we need an imaginary
currency? What is there about this that benefits our society or
the world at large? And in terms of the underground economy,
what are the effects of this--why do we need an imaginary
currency in talking about the underground economy?
Mr. WILLIAMS. Great. So let me do it in reverse order, in
regard to the underground economy, in particular. This is a
potential tool which we have seen already because of Silk Road,
to be used in nefarious ways. In essence, there are two aspects
of Bitcoin that make it very dangerous in their wrong hands.
And the one is the fact that it is anonymous. So that means
whoever has it and controls it, owns it. So if you have an
account and someone can hack it and grab that coin, not only
does that criminal own it, but there is no way to trace down
who took it and there is no way from a consumer standpoint to
get it back. So in regard to the underground economy, that is
one reason why it is a designer currency of choice. Now, it is
unfortunate because Silk Road has sort of painted a very
negative picture about virtual currencies.
The second aspect of this sort of underworld of virtual
currencies is the fact that Bitcoin also is not only anonymous
but it is also irreversible. So once that transaction is done,
it cannot be pulled back. So let us just say it is transferred
by mistake to somebody. There is no way to get that back unless
that person is generous and willing to do so. So that is of
concern.
Now, the first question you had, excellent question, and
that really is what is the benefit? It is questionable in a
sense that clearly I view the risks much greater at this point
in time than the benefits. In regard to the price volatility,
the fact that my colleague to my right can say within 46 days
it could be worth zero. Currency is supposed to be used for
transactional purposes to facilitate business. If you cannot
count on currency, business will not be facilitated. What will
happen is that will be hoarded and GDP will drop, employment
will drop, and that is a negative thing for business.
So what business needs is confidence in the currency that
consumers are going to use. And it is not clear to me that
confidence is there with Bitcoin.
Mr. HANNA. Do you want a rebuttal, Mr. Brito?
Mr. BRITO. Thank you. Actually, a couple things.
I think there is a misperception that Bitcoin is completely
anonymous. Bitcoin is not completely anonymous. Cash
transactions on the other hand are completely anonymous. If I
put a bike for sale on Craigslist and I get an email from
somebody I do not know, we meet at a park, I give him cash----
Mr. HANNA. But credit cards are not anonymous. I mean, they
certainly do not have to be. I can trace them. Checks are not
anonymous. And frankly, trading in dollars and not paying your
taxes is actually illegal. So, I mean, there is nothing
different about Bitcoin than me paying somebody in cash and
them not declaring it.
Mr. BRITO. So I was getting to that. Whereas, cash is
completely anonymous, credit cards are completely identified.
Credit card company knows who I am, who the merchant is, the
time, the amount, all of that. Bitcoin is in the middle. It is
between cash and credit cards. Because while there is a record
captured of every transaction, the amount, we do not know who
that is. Now, this is where the Bank Secrecy Act comes in, and
companies like Coinbase are required to keep a record of all of
their customers. And so, for example, I have an account with
Coinbase. They know my name. If there was ever a subpoena
related to a particular Bitcoin transaction, Coinbase could
turn over my name.
Mr. HANNA. But it requires a subpoena.
Mr. BRITO. The same way with a credit card.
Mr. HANNA. Thank you. Well, right, but credit cards are a
lot. I got it.
Thank you, Chairman.
Chairman GRAVES. Ranking Member Velazquez?
Ms. VELAZQUEZ. Thank you, Mr. Chairman.
Professor Couvillion, last week Iceland announced that it
will be releasing a variant of Bitcoin called Auroracoin. This
is just one of many other cryptic currencies that exist in
addition to Bitcoin. What makes these currencies so different
from one another?
Mr. COUVILLION. Thank you for the question.
Bitcoin has what we economists call ``first mover
advantage,'' because it was the first successful digital
currency and because it has an overwhelming market share of, I
believe, more than 90 percent. It will likely succeed simply
because they were there first. There are many, many other
different types of currencies, and most of them are variations
on the same, but some offer a few different features than
Bitcoin does.
Ms. VELAZQUEZ. Do you think that the market can sustain
numerous virtual currencies?
Mr. COUVILLION. No. The parallel I would give is the time
in the United States when banks printed their own currency
before the Civil War and we saw ultimately the government had
to then step in and create a national currency, the dollar. But
that is a historical parallel. How good it is, I am not sure.
Ms. VELAZQUEZ. Okay.
Mr. COUVILLION. However, I do think we will see increasing
use of Bitcoin very, very rapidly. I believe it is in the
growth phase.
Ms. VELAZQUEZ. Thank you.
Mr. Williams, in your testimony, you indicate that the
Bitcoin financial middlemen, who have multiple business lines,
such as Coinbase, have an inherent conflict of interest. Can
you please elaborate why you believe that this is the case?
Mr. WILLIAMS. Sure. And that is a correct statement. The
inherent conflict of interest with financial middlemen like
Coinbase is on one hand they need to mitigate price risks for
customers. So what they are interested in doing is being able
to once they have the coin, is to sell at the highest price.
But Coinbase also has another business line and that is selling
Bitcoin to customers. Customers have an interest to buy at the
lowest price, so just in those two business lines there is an
inherent conflict of interest.
Ms. VELAZQUEZ. What will regulatory oversight do to protect
consumers in these cases?
Mr. WILLIAMS. Right. I would say as regulation seeps into
the industry pretty quickly, regulators will look at this and
say we have to actually put a wall up with this conflict of
interest. It is very significant and it needs to be taken care
of.
Ms. VELAZQUEZ. Mr. White, how would you respond to this
criticism?
Mr. WHITE. Thank you, Ranking Member Velazquez.
First off, I would say at Coinbase we work very hard to
make sure our pricing is completely transparent. So it is
important to realize that we offer two prices. We offer a buy
price and a sell price, and those are identical for both our
merchant services as well as our consumers. So for our
consumers that purchase Bitcoins and want to sell those
Bitcoins, that is the exact same price that we offer to our
merchants. So that bid-ask spread that Mr. Couvillion annotated
was about 17 bps, 17 basis points. So we believe it is very
small and a fair small price.
There is also in the Bitcoin market, pricing is incredibly
transparent. So there are a number of websites out there, one
of which is Bitcoincharts.com where you can look at the price
of Bitcoin across a number of the largest exchanges or
brokerages and determine if whether or not the price you want
to pay for a Bitcoin on Coinbase is fair or not. We are held,
because of arbitrage, to seek that true price as close as
possible.
Ms. VELAZQUEZ. Okay. Mr. Brito, last week the IRS issued
guidance that Bitcoin is to be traded as a property rather than
currency for tax purposes. What effect will this have on the
Bitcoin and the business ability to accept it as payment?
Mr. BRITO. So, I will begin by saying that I am not a tax
professional and you should consult one, but I can say the
following. It is going to introduce some accounting headaches
because every time that you dispose of a Bitcoin in a
transaction, you might be subject to capital gains. What does
this do for the person who is accepting it, which is your
question? Maybe nothing. If they are a merchant accepting
Bitcoins via Coinbase and they choose to never hold Bitcoins,
they just take dollars, they really do not have to do anything
with that. That is something that consumers or the person who
is spending the Bitcoin is going to have to make that
accounting.
Now, it is interesting that the choice that the IRS faced
was should the coin be treated for tax purposes as currency or
as property. And from what I understand, if the choice had been
property, it turns out that foreign currencies--sorry, if it
had been treated as currency, foreign currency transactions
have to account for a gain when you dispose of your foreign
currency, just as if it was property. The only difference is
that there is a de minimums exemption for currency of $200 per
transaction. So in essence, if it had been treated as currency,
any transaction under $200, you really did not have to worry
about that accounting. We might hope to see that kind of de
minimums exemption for property.
Ms. VELAZQUEZ. Mr. Williams, would you care to comment on
that question?
Mr. WILLIAMS. Well, I view the blow last week with the IRS
as devastating, in particular to Bitcoin. As I mentioned
earlier, 90 percent of the coins are hoarded, so in that kind
of economy, very few coins circulate. So that is not very
liquid. We could look at bid-ask spread. That is only one
measurement of liquidity. When we add now the IRS ruling last
week, that increases and encourages consumers to horde more,
not less. And as a result, that reduces liquidity even more. So
it is very concerning. Being the leading financial market in
the world, how we view this is extremely important, and it is
going to set the tone for other nations as they try to regulate
this currency as well.
Ms. VELAZQUEZ. Thank you. Thank you, Mr. Chairman.
Chairman GRAVES. Mr. Chabot?
Mr. CHABOT. Thank you, Mr. Chairman.
Just a couple questions. In February, CNN Money ran an
article regarding the illegal website Silk Road, and it has
come up a couple times already in this hearing, and its
relationships with Bitcoins. In that they wrote, and I quote,
``The Silk Road is primarily used to buy and sell drugs.
Bitcoins are the only kind of currency accepted on the site
because they are traded electronically and are difficult to
trace to individuals,'' as has also been mentioned. That is a
direct quote from the CNN Money Report.
My question is this. If Bitcoin transactions are difficult
to trace and also are irreversible, how do we prevent Bitcoins
from facilitating criminal activity? And I would open that up
to anybody who might like to address it.
Mr. BRITO. So I think, again, by applying the Bank Secrecy
Act and your customer rules to Bitcoin intermediaries, and that
is something that FinCEN at the Treasury Department has already
done and we are seeing these new intermediaries complying with
those regulations.
Second, I think it is a question for law enforcement and
every time I have spoken to law enforcement, I have heard law
enforcement testify, for example, last November's hearing
before the Homeland Security Committee, law enforcement has
said that they are less concerned about virtual currencies
being used for these illicit transactions online than they are
about centralized virtual currencies or about cash, indeed. So
I think it is a matter of law enforcement doing their job, and
they say that they are up to the task, and it is a matter of
enforcing our existing money laundering laws.
Mr. CHABOT. Thank you.
Would any of the other members like to address this? Mr.
Williams?
Mr. WILLIAMS. Well, I view the anonymous part of Bitcoin as
actually being the Achilles heel. The fact it is anonymous, it
makes it very dangerous, not only for criminal use for also for
consumers. If these coins are stolen by criminals, they cannot
be returned.
Mr. CHABOT. Okay. Thank you.
I will go on to another question. Of the number of
businesses who sell their services or sell their products
online, what percentage would you say--and I know it is
difficult to know what it is for sure--but what percentage
would you say of the businesses actually accept in some form
Bitcoins for their items? Mr. White?
Mr. WHITE. I will take that. So at Coinbase, we have
roughly 28,000 merchants that use our payment tools as of
today. What is interesting to note is the vast majority, and it
is difficult to say with any certainty, but by and large
probably 95 percent, if not more, are small businesses. And
these are organizations or individuals that are confronted with
high credit card fees, issues with chargebacks and financial
risk they are just not prepared to handle. And Bitcoin enables
them to bypass or avoid a lot of those issues.
Mr. CHABOT. Let me ask you a question. When you say they
are small businesses, is there a particular type of small
business that they are in general?
Mr. WHITE. Absolutely. So right now what we see is Bitcoin
is an incredibly seamless experience when used online. So in
line with payment options on a website, it is very simple.
Using a Coinbase product, you can click out or you can check
out in as simple as two clicks. The vast majority of these
businesses are ecommerce facing companies where they sell their
products online and accept Bitcoin as a form of payment just
with PayPal or credit cards.
Mr. CHABOT. Okay. Now, if you have 28,000 yourself with
your company, how many others are out there? What percentage
are we talking of the overall businesses on the Internet?
Mr. WHITE. So between Coinbase and our competitors, my best
guess would be there is roughly 50,000 businesses that are
accepting----
Mr. CHABOT. Altogether you mean?
Mr. WHITE. Altogether here in the U.S. Correct.
Mr. CHABOT. And out of how many are we talking about
theoretically? Because I know it is pretty hard to know
exactly. Whether it is 50,000 out of----
Mr. WHITE. The vast majority are going to use a Bitcoin
payment processor, like Coinbase, because they want to shield
themselves.
Mr. CHABOT. I am not asking that. I am asking the 50,000
businesses that are actually utilizing Bitcoin now, out of a
universe of how many businesses on the Internet are we talking
about? If anybody else might know that----
Mr. BRITO. I imagine it is a very small fraction of
businesses, small businesses that accept Bitcoin. I imagine it
is less than 1 percent.
Mr. CHABOT. Would you agree with that, Mr. White?
Mr. WHITE. I would agree.
Mr. CHABOT. Less than 1 percent. And you would assume over
time--I would assume you would hope that that would grow
substantially over time?
Mr. WHITE. We are seeing our merchant services grow at
about 10 percent month over month.
Mr. CHABOT. Okay. Are there online gambling businesses that
are using this now? And are those any of your folks?
Mr. WHITE. To the best of my knowledge there are. At
Coinbase, we do not have the resources to ensure proper
compliance with those online gambling organizations, so we do
not provide Bitcoin payment processing services for them. But
the thing with Bitcoin is you do not necessarily need to use a
payment processor like Coinbase. An individual could create an
online gambling site and accept Bitcoin directly, but that is
not something at Coinbase we support.
Mr. CHABOT. Okay, thank you. I see that my time is ready to
expire so I will yield back. Thank you very much.
Chairman GRAVES. Ms. Clarke?
Ms. CLARKE. Thank you very much, Mr. Chairman. And I thank
our panelists for coming and sharing their expertise with us
today.
My first question is to Mr. Brito. In your written
testimony, you mention there is nothing inherent in Bitcoin's
design that makes it naturally volatile. You attribute the
current volatility to the fact that the currency is new and as
such, thinly traded.
My question is twofold. First, how is it that a currency
backed by nothing more than market forces, and at the very
least, without a central authority to intervene in price
destabilization amongst other regulatory issues, that it is not
inherently volatile. And then secondly, regarding your
explanation on the current volatility, I have gathered from
your written testimony that you believe time and increased
trading and use will alleviate current volatility. A cynic
might suggest that that was an oversimplification at best, or
further, assumes that Bitcoin is an asset that can only
appreciate, thus forcing stability. How is that unlike any of
the previous bubbles we have seen inflate and pop over the
course of the past 20 years?
Mr. BRITO. Okay. I appreciate that question.
So in my testimony, I think what I mentioned was that there
is nothing inherent in Bitcoin's design that makes it extremely
volatile. Extreme volatility. All currencies are volatile, and
Bitcoin is certainly a deflationary currency by design. But
this extreme volatility that we are seeing probably results
from the fact that it is thinly traded. If Bitcoin's economy
were to grow and it was much more widely traded, and if we
began to see derivative products that allowed you to hedge
against Bitcoin's volatility, we should see the volatility
subside. Does that mean there would be no volatility? No. Is
there a central bank that can intervene and basically introduce
more money into the money supply to meet demands? No, there is
none of that. So Bitcoin is still going to have a certain
amount of volatility, but this extreme volatility is, I guess,
what I am addressing.
Does that mean that I see Bitcoin as only ever increasing
in value? No. What I am saying is volatility, if Bitcoin's
acceptance grows and it begins to be traded more, volatility
will subside, but it does not mean that it will subside
necessarily in an increasing fashion. It might just reach
hopefully a stable range.
Ms. CLARKE. Mr. Williams, did you want to comment on that?
Mr. WILLIAMS. Yes, on a few things.
So since Bitcoin was created in 2009 and started trading,
the volatility the first year was 160 percent annualized. That
is just unheard of. Since then it has dropped to 140 percent,
so we are still in nosebleed territory. That is concerning.
Structurally, there are three reasons why Bitcoin itself is
so volatile. The first is the fact that it is hoarded, and that
is, as I mentioned earlier, of concern because hoarding allows
you to manipulate the price.
The second part, which is very important, is the ownership
structure itself is very small. With data that we know so far,
at least looking at addresses, not knowing ownerships per se,
we know that roughly 29 percent of Bitcoin is owned by 47
people. So you can imagine if 47 people get in a room and say,
``Hey, lets not sell,'' then that sets an artificial floor.
A third thing, which is extremely important, is the fact
that when we think about Bitcoin and what is happening here, is
not only do we have sort of this scarcity of this commodity,
and that is the third point, but it is scarce in a sense that
by the year 2140, it maxes at 21 million. So in essence, if you
create anything that has a scarcity and you hype up demand and
you get enough people that think this is the next new, new
thing, then you are going to see prices move and you are going
to see high volatility.
So those are the three structural things that have
happened, specifically, that I view is why we have seen such
extreme volatility. And up until last year, the space rocket
went to the moon. This year it is coming back down to earth.
Ms. CLARKE. So the second part to my question was do we see
this as a bubble? Would you characterize it is such?
Mr. WILLIAMS. Yes, I would. In December of 2013, I came out
very strong adamantly saying that this was a bubble. We have
also seen Alan Greenspan on December 4, 2013, come out and say
it is a bubble. We saw actually Professor Shiller, a very well-
known economist from Yale who came out in January. And it was
very interesting the way he described this bubble. He said,
``It is not only a bubble, it is an amazing bubble.''
More recently, we have also seen additional examples. We
know bubbles have three phases--growth, maturity, and pop. And
we are clearly seeing the pop phase right now.
Ms. CLARKE. I am out of time, but I thank you gentlemen for
your response.
I yield back, Mr. Chairman.
Chairman GRAVES. Mr. Mulvaney?
Mr. MULVANEY. Sure, let us just continue right there.
I guess, Mr. Williams, and this is not where I was going,
but just to follow on your last comment, so what? So what if it
is a bubble? It is a very small--I mean, this is not like it is
the housing bubble. It is not like it is a real estate bubble.
It is a very, very small piece of the economy. Right? So what
if it is a bubble?
Mr. WILLIAMS. Right. So let us go down that road. So if it
is a bubble, then we have these 47 people that are harmed.
There is roughly 1,000 people that own roughly 50 percent, so
they are harmed. But it does not harm a greater population.
Mr. MULVANEY. Okay.
Mr. WILLIAMS. However, the problem with that logic is the
fact that we are talking not about a manufacturer's
manufacturing a good; we are talking about currency, which is
the lifeblood of economies. We have to rely on currency and
trust that currency to have effective business. So in essence,
if the currency is flawed, then it impacts negatively our
economy.
Mr. MULVANEY. Right. But we just established that it is
less than 1 percent of online trade, so, I mean, it is much to
do about nothing in terms of the bubble. Right? It might be, it
might not be, but I guess in my mind I am hard pressed to see
why Congress would care if it is a bubble.
But let us move on to a couple of other things before I get
to my own questions.
I had a chance to listen to some of the questions from Mr.
Chabot, and my question to you, Mr. Brito, for example, would
be Mr. Chabot was clearly concerned about its use, Bitcoin's
use in illicit activity, whether it be drug sales, online
gambling. Is it technologically possible and practically
possible to make Bitcoin say as safe as the dollar when it
comes to those types of transactions?
Mr. BRITO. You are asking me if I was a criminal would I
rather use a dollar or would I rather use a Bitcoin?
Mr. MULVANEY. I guess so.
Mr. BRITO. And the answer would be no. I mean, I have heard
this from numerous law enforcement folks who told me you would
be crazy to use a Bitcoin because there is a permanent record
made of every Bitcoin transaction. And that is a record that
could be accessed years from now to tie you back to a
particular transaction. Is it your name? No, it is not your
name. It is a pseudonym. It is a Bitcoin address. But there is
a permanent record made of that transaction. And what we have
seen with Silk Road, which is the example we all know of an
online marketplace for drugs that use Bitcoins, is that the FBI
successfully took down that website. And today, we are seeing
one after another of the vendors on that website being arrested
by the FBI.
Mr. MULVANEY. Okay. Thank you.
Let us get to my question then, which is the IRS decision,
which Ms. Velazquez asked I thought some excellent questions
about. Start with this, and I will ask everybody to check in on
this very quickly because I really do not know where you folk
stand on this, was it the right decision? Was the IRS decision
to classify this as property and not currency the right
decision? We will just go right down the aisle.
Mr. Couvillion, do you want to start? And I will come back.
Answer yes or no. We will come back and ask each of you why,
but I am trying to get a sense of the panel.
Mr. COUVILLION. No.
Mr. MULVANEY. Okay.
Mr. WILLIAMS. Yes.
Mr. WHITE. I would say no.
Mr. BRITO. Tentative yes.
Mr. MULVANEY. Okay. Here is my question. I guess, because
it looks like--which is a nice thing about having a good panel,
you get different answers from everybody. It strikes me that it
is a way to tax the Internet, is it not? Right now, we do not
have taxes on most of the Internet sales, at least we talk
about some of them. We are dealing with Main Street fairness
and those types of things. It strikes me that this is a way to
tax Internet trade. But if I cannot tax the transaction, I will
tax the currency that is used to do it. So that is where I am
coming from.
Mr. White, you tell me why you think it is no. Mr.
Williams, you tell me why you think it is yes.
Mr. WHITE. Yes. So I think what was surprising was the
misalignment between the regulators. Right? Because we had
FinCEN come out last year and basically describe Bitcoin as a
currency. They said companies like Coinbase that operate and
provide Bitcoin services, please register as a money service
business under FinCEN, and we followed that guidance.
Mr. MULVANEY. You are doing that, right?
Mr. WHITE. We are doing that. Absolutely.
With the IRS's recent guidance that now Bitcoin is a
property, there is a mismatch there between how do you exactly
describe this asset class? How do you describe Bitcoin? At
Coinbase, obviously, we are working with our counsel and
working closely with the IRS to seek additional guidance
because what we want to do is enable as burdenless as a process
as possible for our users to be able to transact in Bitcoin.
And right now with this guidance it makes buying a $2 cup of
coffee nearly impossible without additional products and
services to track that cost basis.
Mr. MULVANEY. Mr. Williams, and maybe the chairman will let
you go a little bit more, but if you could give us your answer
as to why you think it was the right decision.
Mr. WILLIAMS. Sure. Well, when we look at Bitcoin itself,
it is not a currency. To be a currency, it has to be of store
value, and see it is not of store value at all. It actually
destroys value. Second, we know it is not stable.
Mr. MULVANEY. I am sorry. I have to cut you off. Destroys
value? If I bought it at a penny and it is worth $450, does
that not create value? I am sorry, what do you mean it destroys
value?
Mr. WILLIAMS. Right, so with currency, for example, you
want stability. So you want to be able to put it in your wallet
and not think about it and then next week use it, not worry
about the daily price moving.
Mr. MULVANEY. I have no idea what the name of the currency
is in Argentina or in Venezuela. Is it still a currency?
Mr. WILLIAMS. Yes, it is. And earlier I referred to it.
Bitcoin is seven times more risky than Argentinian peso.
Mr. MULVANEY. And Venezuela is still a currency? I think
you see my point is currency, you go through different phases.
But go ahead. Finish your thought.
Mr. WILLIAMS. Okay. So we will move on.
So in regard to another measurement of a strong currency,
and that is that it is stable, and we are seeing that there is
volatility. So there is not stability in this currency. But
most importantly, when we think about a currency, it needs to
be liquid, and that is that you can get in and get out. And it
is not very clear that you can get in and out at good
execution.
But let us move it over. So if it is not currency, what is
it? And that is what the IRS is really helping with. In
essence, the IRS is saying, okay, well, if it is not currency,
what does it look like? Well, if we think about a commodity,
right. A commodity is something that is mined. That is Bitcoin.
A commodity is something in particular that actually is stored.
It is something that is processed. It is something that is
resold in the market, and it is something that actually has
scarcity. Well, that sounds a lot like Bitcoin. So in essence,
I see the IRS ruling as moving more towards commodity. At least
it is calling it a product. So I think we are getting closer to
the discussion we need to have about what is this.
Mr. MULVANEY. Does Mr. White have a valid point about the
misalignment? Why would he have to know his customer if he is
dealing in a commodity and not a currency? To you, Mr.
Williams. No, does Mr. White have a point? Is he right about
the misalignment? One part of this government is treating it as
currency and the other is not. He should not have to know his
customer if he is only dealing in commodities; right?
Mr. WILLIAMS. Right. So there is a lot of uncertainty about
what it is.
Mr. MULVANEY. Right.
Mr. WILLIAMS. And so we saw that with the Treasury
Department as it came in last year with this announcement with
FinCEN, for example, and how they are working with money
transmitters, and we are seeing with the IRS. The picture is
getting clearer, but yet there is still a lot of uncertainty
out there.
Mr. MULVANEY. Thank you, gentlemen. I appreciate the time.
I appreciate the chairman's indulgence in going over a little
bit.
Mr. LUETKEMEYER. There we go. Okay, Mr. Payne, five
minutes.
Mr. PAYNE. Thank you, Mr. Chairman.
Mr. Mulvaney, the gentleman from South Carolina, was so
thorough in his questions, he asked all of mine, so the
indulgence for additional time probably cost me my questions.
So I yield back.
Mr. LUETKEMEYER. Mr. Payne, if you can think of anything in
the meantime, let us know. I will be happy to get back to you.
As we go through the discussions, a lot of times questions
pop up and we want to make sure you have an opportunity to ask
anything that may come up. But I understand. I was sitting here
and I checked off all my questions. They were being asked as
well.
With that, Mr. Schweikert, you are up next. You have five
minutes.
Mr. SCHWEIKERT. Thank you, Mr. Chairman. And Mr. Payne just
proved he is actually the smartest member of the Committee
because brevity I think is a sign of being brilliant. And now I
am going to break that.
Okay. I want to actually sort of back up a little bit and
have a conversation that is a little less transactional. And I
do not mean to move almost ethereal. I sat on actually Monetary
Policy a couple years ago, and I think we were one of the first
meeting where part of it went off and we had the discussion of
alternative currencies. And I almost am uncomfortable using the
term alternative currency and more alternative units of value
or acceptance and trade.
What else is on the horizon? You know, Bitcoin appeared,
what 2009? What else is out there? What other alternative
exchanges of value do you see coming that are going to take
advantage of the Internet universe? Because you and I can is
there and come up if we really think it through, you know,
tokens in a babysitting exchange are ultimately units of value
in exchange. I mean, this is not--conceptually, it is not new.
But with technology, what is next on the horizon?
Mr. BRITO. So I think one thing that we have been doing
here is focusing so much about Bitcoin being currency or being
money, and I think that misses the point. Currency or money has
three properties. Right? It is a medium of exchange, a store
value, and it is a unit of account. Now, Bitcoin probably is
not good at all of those three, certainly not right now. As Mr.
Williams so eloquently put forth, it is not a good unit of
account. I certainly would not want my mortgage or my salary
denominated in Bitcoin, and it is not a good store value
because of its volatility. But what about medium of exchange?
Is it a good medium of exchange? And I think with the 50,000
merchants, usually all small businesses that are accepting
Bitcoin today, are telling us that this is a very good medium
of exchange.
Mr. SCHWEIKERT. My question was what is next on the
horizon?
Mr. BRITO. Okay. So jumping from there.
Mr. SCHWEIKERT. Is there Bitcoin 2? Is there someone that
is going to take a million bucks of gold and say I am going to
produce an electronic currency that has a gold peg? What else
is next?
Mr. BRITO. So I think the next thing we are going to see is
that because Bitcoin at base is simply a ledger that keeps
track of value being transacted, there is no reason why a
Bitcoin has to represent only a dollar. A Bitcoin could also
represent anything else. An ounce of gold, a share of stock, a
car.
Mr. SCHWEIKERT. So you could see a generation----
Mr. BRITO. Commodities markets based on Bitcoins.
Mr. SCHWEIKERT. I want to bounce to Mr. White. The
question, what is next on the horizon?
Mr. WHITE. That is a great question. We see Bitcoin as more
than just a payment network in digital currency. This is the
first application of Bitcoin as the protocol. The core
technological problem that was solved here has never been
solved before, and that is the ability to prove and transfer
ownership without the need of a trusted third party.
Mr. SCHWEIKERT. Okay. So is there the next generation on
the horizon?
Mr. WHITE. Exactly. So Mr. Brito said that you can attach
this one satoshi, the smallest amount of a Bitcoin worth much
less than a fraction of a penny to an asset or a stock. So in
essence, you could provide this ability to trade assets. You
could also use it as a date timestamp to prove ownership of an
idea using the blockchain, which is this universally
distributed ledger that no one central body controls.
Mr. SCHWEIKERT. Okay. Mr. Williams, that sort of concept,
what is next on the horizon in this concept?
Mr. WILLIAMS. Well, if you open the door and you call it a
currency, then that is a real slippery slope.
Mr. SCHWEIKERT. You know of my preference of value of
exchange.
Mr. WILLIAMS. Okay. So if we slam that door shut, then it
is not a nationless currency. Then you have more control. And
then what is it? Well, it is a payment system. How is it
different than ACH? And the question is, well, it is definitely
much more sophisticated. ACH happened. This payment system in
the 1970s, the Fed had a lot of influence over that system, but
it still remains to be an efficient system. So all of a sudden
you have focus now on the payment benefits of Bitcoin, and then
you have competition within that payment system. And we have a
discussion no longer about currency.
Mr. SCHWEIKERT. Do you see something else on the horizon
that takes this technology that goes to the next level?
Mr. WILLIAMS. Right. So then----
Mr. SCHWEIKERT. Or a commodity pegged to such electronic
currency or something else?
Mr. WILLIAMS. Right. So yes, I do. What we will see is more
asset classes that can be pushed through this payment system.
Mr. SCHWEIKERT. Okay. And Mr. Couvillion, and my mother's
maiden name, please, the same question. What else is next on
the horizon?
Mr. COUVILLION. In terms of the next thing on the horizon
that I think the Committee might be interested in taking a look
at, there are at least three serious proposals to get approval
to launch Bitcoin-based exchange traded funds, commonly called
ETFs, such as the diamonds, the spiders, the NASDAQ cubes.
There are more than 400 others. If they do get approval to
launch these Bitcoin ETFs, it may be possible by the end of
this year, if you have a self-directed IRA, to put in effect
Bitcoin into your individual retirement.
Mr. SCHWEIKERT. Or hold a Bitcoin denominated?
Mr. COUVILLION. Exactly.
Mr. SCHWEIKERT. In other words, you would look at it just
in the reverse.
Mr. COUVILLION. Exactly. And I am not sure that that is a
wise idea.
Mr. SCHWEIKERT. Mr. Chairman, I know I am a little over
time, but there is a fascinating philosophical debate
underlying here for those of you who are followers of sort of
monetary policy. Mr. Williams just spoke, a nationless currency
or value of exchange. I am not sure that is a bad thing. And in
many ways we have had it forever. I mean, a gold peg contract.
But also something of Bitcoin, yes, it is a challenge to being
a reserve currency but the benefits we gain as a country being
the reserve currency is we have minimal transaction costs;
correct?
Mr. COUVILLION. Yes.
Mr. SCHWEIKERT. And if all of a sudden there is another
medium of exchange that no longer has that transaction cost
spiff benefit, it also becomes a threat to becoming the reserve
currency.
Let us start with Mr. Williams, just because you and I seem
to be the farthest outliers from each other. Tell me where I am
wrong on both those premises.
Mr. WILLIAMS. Well, you say what is wrong with a nationless
currency. So we are back--you opened that door that we shut I
thought earlier, and that was it cannot be a currency.
Mr. SCHWEIKERT. Then that is why we were--Mr. Williams,
that is why we were reusing the term ``value of exchange'';
correct?
Mr. WILLIAMS. All right. So now if this is a value of
exchange, then it will not compete with nation currency, such
as the U.S. dollar.
E: Well, the fact of the matter is any type of exchange,
whether I am willing to exchange diamonds or gold or anything
else, ultimately is--has inflationary, disinflationary effects
on exchanges of value and commodities and other things.
So, and first, let us go through my couple of questions.
Let us try these.
Threat to reserve currency if it becomes an efficient means
of avoiding the exchange cost. Yes? No?
Mr. WILLIAMS. I do not view it as a threat because of this
high volatility that we see.
Mr. SCHWEIKERT. Okay. But if you and I are sitting here a
decade from now and there is ETFs and others, assuming this
concept even survives that long, that volatility would
ultimately be squeezed away because of the amount of
participation. Because would you agree that much of the
volatility today is because of how thin the market is?
Mr. WILLIAMS. Right. So I would disagree with that. There
is structural problems and it has less to do with the fact of
how thinly it is traded. It is actually how it is structured.
So good question though in regard to looking forward what
could happen. A competition within currencies. That is what we
have in the global financial markets. Sometimes the dollar is
stronger, sometimes it is weaker against other currencies. So
if this could ever gain that status, then it would be in the
mix and be competitive.
Mr. SCHWEIKERT. But what becomes fascinating there in
monetary policy is all of a sudden you would have a currency
without intervention from a central bank which becomes a
fascinating--you actually have an honest peg of value compared
to--let us be completely honest--pegs of value of currency,
nation currency that do have a certain level of intervention,
and therefore, manipulation.
Mr. WILLIAMS. So I am going to stir it up a little bit. I
have made this statement before. So with the U.S. dollar, we
have central bankers in the monetary policy you have spoken
about and they determine how much of the money supply increases
or decreases to spur economic growth for our businesses. If we
go to a Bitcoin-type currency, then the new central bankers is
the computer program itself and those miners that mine it. So
the question is not that central bankers go away but they just
are different people.
Mr. SCHWEIKERT. Yeah. And now you are heading in the
direction I was hoping to have the conversation. I am sorry. I
told you it was going to get slightly ethereal.
Do we let--Mr. Brito----
Mr. BRITO. Yes.
Mr. SCHWEIKERT.--had one comment and then I thank you. You
have been very patient with my ramblings.
Mr. BRITO. I will simply say that this is something that
Milton Friedman proposed that we should replace humans at a
board determining the money supply with a computer that had a
set of rules and simply determined the money supply based on
the algorithm. The thing about Milton Friedman's proposal is
that the computer, you can always go in and reprogram it. A
human could always go in and reprogram it with a currency like
Bitcoin or another currency. Once you set the algorithm in
place and you have a wide diversity of miners and others
running that program, it becomes virtually impossible to
change. That algorithm change the money supply.
Mr. SCHWEIKERT. Mr. Chairman, I am one that believes by the
end of this decade I will see another type of alternative value
of exchange here, but will we have some collective or others
that attach some reserve value or a peg of value or something
of that which may deal with the stability issue, but it does
actually start to become both a threat to a country like ours
where we carry a large deficit and we use certain monetary
policy, inflationary policies and others to be able to value
back those future payments. But in many ways you are seeing I
think the tip of an iceberg of a fascinating discussion.
Thank you, Mr. Chairman.
Mr. TIPTON. As you can see, Mr. Schweikert is a very, very
thoughtful member of our Committee.
Let us go for round two. If anybody has any extra
questions, we will go through those. We will start with Ms.
Clarke.
Ms. CLARKE. Thank you, Mr. Chairman. I do have one final
question for Mr. Brito.
Mr. Brito, you mentioned that one-quarter of Americans who
are unbanked and underbanked could look to Bitcoin as an
important new option, and a good number of these unbanked and
underbanked individuals are one step away from absolute
financial calamity. How would Bitcoin be an effective buttress
against the calamity given its valuation swings?
Mr. BRITO. So I said it could potentially be seen as a new
option for the unbanked and the underbanked. So the unbanked
and the underbanked traditionally, they do not have bank
accounts. They do not have credit cards. They use Payday loans.
They have to buy prepaid cards. With something like Bitcoin, it
allows for them to have electronic transactions and perhaps at
a much cheaper cost. Right? So if you are going to a merchant
that is giving you a discount because you are using Bitcoin,
you can do that.
Is that going to happen tomorrow? No, I do not think that
is going to happen tomorrow. But the beauty of Bitcoin is it is
an experiment and its potential is huge. So I think what we
need to do is allow the experiment to go on. Today, state
regulators are coming up with regulations that are consumer
protection regulations and make sure the Bitcoin businesses are
well capitalized, comply with disclosure, et cetera, et cetera.
We need to make sure that those rules are consistent and clear
so that we can have these products potentially become available
to these consumers. Is it available today? No. But if we take
the view that the risks just outweigh the benefits at all
points, and we should not even think about this thing, then we
are going to--in order to avoid the risks, you are going to
give up all the potential benefits, and that would be a real
shame.
Ms. CLARKE. Thank you, Mr. Brito. Thank you, Mr. Chairman.
Thank the panelists today. I yield back.
Mr. TIPTON. Thank you.
Mr. Mulvaney, do you have any second questions?
Mr. MULVANEY. Sure, real briefly.
Continue there, Mr. Brito. In terms of allowing this
experiment to run its course, how damaging is the IRS decision?
Mr. BRITO. So earlier you asked me if I thought the IRS
decision was right or wrong, and I said tentatively yes. Let me
tell you why. The IRS only had a choice between designating it
a currency or property. Those were its two choices given to it
by Congress. And so between those two, I think Mr. Williams is
right, technically it looked at the thing and it looks more
like property. So technically, they probably made the correct
decision that was available to it.
Now, it does create this problem that Mr. White was
alluding to, where potentially now if you want to buy a cup of
coffee you have to calculate your capital gains. Some folks
think it should have been treated as a currency because if it
were currency, then there is a $200 de minimums exemption.
Right? So if you are buying something under $200, you do not
have to worry about capital gains. Perhaps it is something that
Congress should consider having that kind of exemption for
property or perhaps creating a new category for virtual
currencies to allow the kind of entrepreneurship and
development that might get these products out to the world.
Mr. MULVANEY. My staffers mentioned something, again, I
know a little bit about Bitcoin, mostly on account of the
presentation you made to the Monetary Policy and Trade
Subcommittee on Financial Services. But I do not know that much
about it. My staffers are telling that Germany has classified
it in a very special way as a private currency. Is that an
option that might be available to us? Is that something that
makes sense?
Mr. BRITO. So I am not a tax expert, as I mentioned before,
so I am not 100 percent on that. I could look into that.
Mr. MULVANEY. Mr. Williams, are you familiar with that at
all? No?
Mr. WILLIAMS. No. I am not a tax expert either.
Mr. MULVANEY. Gotcha. And again, Mr. Chairman, so what I am
hearing is it is classified as something else in other
countries, so maybe Mr. Brito is onto something that it is not
currency and it is not property. It is something new. Perhaps
not too surprising in this 21st century that we have new types
of things. So it is something we will take a look at.
Thank you, gentlemen, very much. It is very enlightening.
Mr. LUETKEMEYER. Yes, Mr. Couvillion, you have a comment?
Mr. COUVILLION. Yes, I do. I would like to read a very
short statement from Alistair Nevius, who is the Journal of
Accountancy's editor-in-chief for tax matters.
``The IRS warns that taxpayers who treated virtual
currencies inconsistently with the notice before the date the
notice was issued will not get penalty relief unless they can
establish that their underpayment or failure to properly file
information returns was due to reasonable cause. Many people
believe that because the IRS announcement came out three weeks
before income tax forms are due and because many taxpayers have
already filed their income tax returns, everyone, at least for
this year, should be able to use the reasonable cause.''
Mr. MULVANEY. Mr. Chairman, if I may, Mr. Couvillion, if I
may interrupt, there is no way to do that, is there? What you
have just read to us says the IRS expects you to treat it--to
have been treating it as property from the beginning of time
and that if you filed, I guess, last year or if you have
already filed this year, they expect you to pay taxes on it as
if it was property. Does small business have the ability to do
that? Have they been tracking it as property this whole time or
have they been treating it as currency?
Mr. COUVILLION. It can be done. You can go back and audit,
but it is not something anybody thought we would ever have to
do two years ago, three years ago, and so it creates a huge
paperwork burden. Technology can help, but especially this
year, many people think it is simply unfair to expect taxpayers
to amend their returns at this late date because the IRS just
issued this ruling.
Mr. LUETKEMEYER. Mr. Brito, not to interrupt, did you not
mention a while ago that every single Bitcoin transaction is
documented so that there would be the ability then, even to buy
a cup of coffee, be able to go back and recreate a record for
an individual's transactions over the course of a year to see
whether they gained or lost or whatever?
Mr. BRITO. Sure. And I also think that the tax consequences
for this year for consumers, or at least I should say the
compliance costs are not going to be huge simply because most--
the folks who are today holding and spending Bitcoins, it is
not your grandma. It is not your average Joe. It is people who
know what they are investing in, what they are doing. And they
have known that there was going to be a tax--an IRS guidance
coming out soon. And so they have probably filed for
extensions, so they are not filing on April 15th. They are
probably doing that in September. And even if that is the case,
the IRS is probably not going to audit you for very small
transactions. It is going to be if you have--if you are not
declaring capital gains on $20,000 worth of Bitcoin.
Mr. TIPTON. The rules document the database of
transactions.
Mr. BRITO. The transactions, it is available to anyone. It
is online. You can download it. Anybody can download it at any
moment.
Mr. TIPTON. So the IRS has full access to this document or
this database?
Mr. BRITO. This database. Yes.
Mr. TIPTON. Okay.
Mr. Mulvaney, do you have any other follow ups?
Ms. Herrera, would you like to ask any questions?
Okay. I do not have very many. I just have one or two. With
regards to hedging Bitcoins, you mentioned a while ago, Mr.
Brito, they do not do that yet. Is that correct?
Mr. BRITO. So there are no--to my knowledge, there are no
options or exchange traded futures or options available on
Bitcoin. There are some companies today, some exchanges today
that are looking to get CFTC approval to offer those. But I
think Mr. White probably could speak more to how Coinbase might
be hedging.
Mr. LUETKEMEYER. So if they are looking to start hedging,
would that make it a currency then or would that make it a
commodity?
Mr. BRITO. I do not think the fact that you are hedging
against a value of something, that alone does not speak to
whether it is a commodity or currency.
Mr. LUETKEMEYER. Okay. Very good. I have no other further
questions. I certainly enjoyed the conversation here. It is
certainly thought-provoking to see something like this. I think
Mr. Schweikert is kind of also on the cusp here of some things.
Is this today's currency and 10 years from now there is going
to be another Bitcoin 2 or some other entity out there,
whatever it is called, that will be a new method of transfer of
payment. You know, who knows? I think as our economies continue
to evolve and trade continues to take place, people are going
to find ways to trade. From the beginning of time we have been
bartering and trading. And so today's world is no different. We
just use currency right now as a traditional way of transacting
trades, but that being said, I come from rural Missouri. There
is still a lot of bartering that goes on where I live. You
trade this for that and the IRS never knows anything about it.
So with that, as we close the hearing, I would like to
again thank all the witnesses for being here and thank you for
sharing your expertise, both with the members of this Committee
and the small business community. I believe that today's
discussion provides valuable information about the benefits and
risks associated with Bitcoin and other virtual currencies as
the government further examines this alternative payment
system.
With that, I ask unanimous consent that members have five
legislative days to submit statements and supporting materials
for the record.
Without objection, so ordered.
This hearing is now adjourned. Thank you very much.
[Whereupon, at 3:08 p.m., the Committee was adjourned.]
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Written Statement to U.S. House of Representatives Committee on
Small Business
Thank you Chairman Graves and members of the House
Committee on Small Business for the opportunity to appear here
today.
My name is Adam White and I'm the Director of Business
Development and Sales at Coinbase, a company founded in June
2012 with the goal of making it easy for merchants and
consumers to transact with the digital currency, bitcoin. More
than 1 million consumers use Coinbase as their bitcoin wallet,
and as of today, there are more than 27,000 businesses that
entrust Coinbase to accept bitcoin payments on their behalf
using our payment tools. These merchants include large,
enterprise-level businesses such as Overstock.com and Big Fish
Games, as well as a myriad of small businesses like Tealet,
Tuft & Needle, and Mondo Cellars.
Prior to my role at Coinbase, I served as a Captain in the
United States Air Force and am a veteran of Operation Iraqi
Freedom and Operation Enduring Freedom. I also worked briefly
as a consultant at Bain & Company and a product manager at
Activision Blizzard after completing my MBA at Harvard Business
School.
I'd like to begin today by outlining the inherent benefits
of Bitcoin in commerce--namely the elimination of fraud,
reduction of transaction fees, and monetization of new
markets--and how these benefits can be a positive influence on
businesses of all sizes.
Bitcoin enables individuals to push payments to merchants
without having to share personally identifiable information
that can be intercepted by criminals and used for fraudulent
purposes. This push functionality gives Bitcoin a unique
characteristic that eliminates the risk of fraud, something
that merchants, card processors, and banks spend billions of
dollars per year combatting. With Bitcoin, for example, the
Target data breach that comprised over 70 million consumers'
credit card information would not have been possible.
Additionally, many card issuers use fraud detection systems
that are overly sensitive to trigger activities for card-not-
present transactions. Initial estimates suggest that some
merchants turn away nearly eight percent of incoming orders due
to suspicious activity, many of which could, in fact, be
legitimate. Bitcoin payments are irreversible, so fraudulent
charges are prevented from occurring, and as a result,
merchants do not bear the risk and cost associated with these
false declines.
Due to the elimination of fraud, Bitcoin transactions are
dramatically less expensive than traditional card based
payments. Merchants can reduce their electronic payments
acceptance fees to less than 1% when accepting payment in
bitcoin. This is especially important for small businesses that
sacrifice anywhere between 3-5% of their revenues in card
transaction fees. Businesses can use these savings to reinvest
in their company or pass them on to consumers in the form of
lower prices. Moreover, merchants are not faced with a fixed
fee per transaction, enabling them to forgo minimum transaction
limits and sell small ticket items profitability.
Finally, Bitcoin democratizes foreign exchange and enables
frictionless, cross-border transactions that settle
immediately. Many products and services are not available for
sale in foreign countries solely because the business cannot
manage the payments systems needed to support overseas
commerce. 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. Moreover, 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. The ability to
easily begin accepting payments from customers around the world
can open up whole new markets for merchants, and significantly
improve top-line revenue.
We see Bitcoin as an extremely powerful technology, and it
is our goal to bring the efficiencies created by the Bitcoin
network to the masses. We are encouraged to see the Committee's
proactive examination into the topic of bitcoin as it relates
to small businesses, and I look forward to engaging in dialogue
and answering any questions you may have.
Testimony of Mark T. Williams \1\
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\1\ Mark T. Williams has only a de minimis financial interest in
Bitcoin and no direct investment in Bitcoin-related startups.
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Banking Specialist, Commodities and Risk Management Expert
Boston University Finance Department
To U.S. House of Representatives
Committee on Small Business
April 2, 2014
Hearing
Bitcoin: Examining the Benefits and Risks for Small Business
Rayburn House Office Building,
Washington, DC 20515
Introduction
Good afternoon Chairman Sam Graves and other distinguished
committee members. My name is Mark Williams and for the last 12
years I have been on the Finance faculty of Boston University
where I have specialized in banking, capital markets and risk
management related matters. In 2010, I wrote Uncontrolled Risk,
a book about the fall of Lehman Brothers and what caused the
2008 real estate asset bubble www.uncontrolledrisk.com. Prior
to my academic career, I was a senior executive for a Boston-
based commodity-trading firm and have worked as a field
examiner for the Federal Reserve Bank in San Francisco and
Boston. On occasion, I have also been a consultant to small
businesses.
Through my academic and work experiences I have gained a
strong understanding of how the capital markets function, the
role of currency, how businesses operate and how unaddressed
risks can result in financial harm. For the last 18 months, I
have closely studied, researched, and more recently written on
Bitcoin, its structure and its highly-risky nature.
I appreciate the opportunity to testify today and I view
this committee room as an extension of the Boston University
classroom. My interest and fascination with Bitcoin started in
2011. Initially it was part of an in-class lecture, later a
homework assignment, and ultimately, morphed into a full
classroom debate. At that time, Bitcoin was trading for 32
cents. Over the last three years, this pseudo currency has
taken on a life of its own. In 2013 its speculative value
increased from $13 to a market high of $1,200.
Most Recent Events
One month or even one week in the Bitcoin world can be
equivalent to a decade in other markets. The price risk
associated with Bitcoin is extreme and unlike any other
volatile community. Despite the dramatic rise in 2013, prices
have not been a one-way space rocket to the moon. Since
November 2013, Bitcoin has slid by over 60 percent to $462.\2\
China's decision on December 5, 2013 to prohibit its banks and
money transmitters from accepting Bitcoin was the pin that has
begun to prick the Bitcoin Bubble.\3\ On this date, the world's
second largest economy warned that virtual currencies carry
substantial risk.\4\ Other market disruptions have occurred. On
January 19, 2014 Alibaba, the Chinese equivalent of Amazon
stopped accepting Bitcoin. Two weeks later, Charlie Shrem, the
Vice Chairman of the Bitcoin Foundation, located a stone throw
from these Chambers, was indicted by the FBI for money
laundering. Then on February 6, 2014, Russia declared the use
of Bitcoin illegal stating that the Ruble was the sole official
currency. That same week, Mt Gox of Japan, formerly the world's
largest Bitcoin exchange, accounting for 80 percent of trading
volume, announced it had been hacked, and later disclosed
customer losses of more than $400 million. The other two major
exchanges, Bitstamp, located in Slovenia and BTCe, located in
Bulgaria, were also impacted by this attack. The scale and
scope of the Mt Gox virtual-bank heist further rattled market
confidence, raising new questions about safety and the need for
basic consumer protection standards. In February, cyber hackers
broke into Silk Road, the defunct deep-web purveyor of illegal
goods and services, stealing over $2.7 million worth of e-
coins, proving that criminals can also steal from criminals.
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\2\ Market price of $462 on March 30, 2014 ($738/$1,200) = 62
percent.
\3\ On December 4, 2013, former Federal Reserve Bank Chairman Alan
Greenspan indicated publically that Bitcoin was a bubble.
\4\ China on December 5, 2013 declared that Bitcoin was not a
virtual currency but a virtual commodity.
On March 11, 2014, the U.S. Financial Industry Regulatory
Authority released a stern warning to investors about the
dangers of buying and using virtual currencies. Shortly after,
on March 24, 2014, the Internal Revenue Service dealt a further
blow to Bitcoin, ruling it is not a foreign currency but should
be taxed as property. This IRS ruling gives investors with a
low-cost basis an added incentive to hoard coins instead of
using them for transactional purposes. This further diminishes
the already low level of market liquidity. Casting more doubt
on the prospects of Bitcoin, on March 14, 2014, famed investor
Warren Buffett stated ``Stay away. Bitcoin is a mirage.'' His
comments supported remarks made by Charlie Munger, Vice
Chairman of Bershire Hathaway a year earlier, when Munger
declared Bitcoin ``rat poison.'' \5\ Despite these significant
market disruptions, scandals and pessimistic comments made by
well-respected investors, Bitcoin promoters continue to trumpet
the virtues of this volatile, nationless and anonymous
currency. Some advocates have declared this period as the
Bitcoin Revolution (2000s), equivalent to the early stages of
the internet (1990s). Although I do not view Bitcoin as ``rat
poison,'' this virtual currency does pose significant risks to
small business owners. These risks need to be carefully
evaluated before deciding whether or not to venture into these
new, uncharted waters.
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\5\ Stated on Fox Business May 6, 2013.
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U.S. Small Business - Market Innovation
Small businesses fuel growth. Decisions by owners have
broad impact. Presently, U.S. small business accounts for over
half of private sector gross domestic product and employment.
Since the 1970s, small businesses provide 55 percent of all
jobs and 66 percent of all net new jobs. Businesses that are
willing to adopt and utilize new technology, such as virtual
currencies, may gain a distinct competitive advantage (e.g.,
cost savings, increased sales) over their competitors. However,
blindly adopting technology without understanding the full risk
implications can be hazardous to a company's financial health.
Bitcoin is an example of new technology that has clear promise,
but also poses a multitude of risks for both businesses and
consumers.
In my testimony today I will not focus on the promise of
virtual currencies as I will leave that to the other hearing
witnesses. Instead my focus will be on the significant and
currently unaddressed risks associated with Bitcoin. Sound
business and regulatory decisions can only be made when these
identified risks and promised benefits are examined, and
weighed against each other in the light of day.
Once the facts are fully laid out, my hope is to leave this
Committee with one simple question to ponder: what net
benefits, if any, does Bitcoin actually provide to legitimate
U.S. small businesses?
How Risky is Bitcoin to Small Businesses?
This question is best summarized by looking at the
disclosure statement provided by Coinbase, a San Francisco
based money transmitter who is servicing an increasing number
of the nation's small businesses. As part of the new account
set-up process, Coinbase describes Bitcoin as a virtual
currency that could drop to the price of zero. In order to
fully assess the risks of Bitcoin, small business owners should
take note of this particularly revealing disclosure prior to
deciding whether or not to accept Bitcoin. Indeed, if the U.S.
dollar carried a similar risk disclaimer, how many small
business owners would be willing to use the greenback to
conduct commerce?
The 10 Major Risks for U.S. Small Businesses
In determining whether to accept Bitcoin when selling goods
and services or for meeting payroll or paying vendors, small
business owners need to first assess these 10 major risks. If
this panoply of risk is not fully understood or controlled, it
has the potential of exposing a business to greater earnings
uncertainty, losses and fraud.
These 10 major risks are discussed below.
1. Bitcoin Is Not Legal Tender
Small businesses need to clearly understand that Bitcoin is
not legal tender. It is not created or supported by a
sovereign--it is nationless. Unlike the U.S. dollar, there are
no laws that require businesses or individuals to accept
Bitcoin to settle private or public debts. Bitcoin is also not
backed by taxing power, ability to assemble an army, assets or
other natural resources customarily owned or controlled by
nation states. In contrast to legal tender, the use of Bitcoin
is limited to those willing to accept it. Presently the group
of Bitcoin users is minuscule relative to the U.S. population
(1 million out of 317 million). Globally, these numbers are
even smaller. If businesses or individuals suddenly decide not
to accept it, Bitcoin will become worthless.
Extreme Price Risk
Since inception, Bitcoin has experienced extreme annual
price volatility topping 140 percent.\6\ Bitcoin is 7 times
more risky than gold and 8 times more risky than the S&P 500.
Compared to currencies it is 7 times more risky than the
unstable Argentinian Peso and 15 times more risky than the U.S.
dollar. As a result, 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. In contrast
to small businesses, a Wall Street trading company might be
willing to assume the triple-digit price risk posed by Bitcoin
but only with experienced staff, sophisticated systems, strong
controls and a large balance sheet to buffer against daily
price swings.
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\6\ In 2009, annual volatility was approximately 160 percent. Using
price data from 2010 forward from Mt Gox, Bitstamp and BTCe, annual
volatility through 2014 was approximately 140 percent.
[GRAPHIC] [TIFF OMITTED] T7403.027
In a single day, it is not uncommon for Bitcoin prices to
move by 10 percent. At current price levels, Bitcoin can drop
by $50 or more in a single day. In December 2013, in a 48-hour
period, Bitcoin plummeted by 50 percent. Since the November
2013 market peak, Bitcoin prices have dropped by over 60
percent. On February 14, 2014, during a flash crash, one block
of 6,000 coins fell, in seconds, by over 80 percent to $102
before rebounding.\7\
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\7\ Prices plunged on the BTCe to $102 before rebounding to over
$600.
3. Extreme Price Movements Can Quickly Erase Company Profit
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Margins
The profit margins of U.S. small businesses are dependent
on numerous factors including the nature of the industry,
competition, location, number of employees, technology
employed, cost of capital and level of management skill and
experience. Although net profit margins can be 10 percent or
less, more profitable companies earn margins in the 15 to 20
percent range. Examples of higher profit margin professions
include CPAs, chiropractors, and dentists, lawyers, portfolio
managers and optometrists.\8\
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\8\ Nelson, Brett, The Most Profitable Small Businesses, Forbes,
February 10, 2011.
Given that the daily price movement of Bitcoin can be as
high as 10 percent, a small business owner who accepts this
form of payment could see profit margins reduced or completely
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erased in a matter of days.
4. Bitcoin is an Asset Bubble in the Process of Deflating
Small business owners need to be cognizant of the fact that
Bitcoin prices were only $13 at the start of 2013 and could
easily drop to the same low level in the near future. In an
efficient capital market, capital flows to its highest and best
use as investors seek a tradeoff between desired risk and
desired return. When investors receive timely, accurate and
transparent information, the likelihood of an asset bubble is
diminished. However, even in efficient and well-developed
financial market, it is not uncommon to experience bubbles
(e.g., Dotcom 2000, Real Estate 2007).
[GRAPHIC] [TIFF OMITTED] T7403.028
All asset bubbles are similar in that they have three
phases: growth, maturity and pop. However, not all asset
bubbles see prices collapse during the final phase; sometimes
prices deflate over an extended period allowing investors to
experience lower losses and softer landings. Bitcoin entered
the growth stage in 2011, the maturity stage in 2013 and now is
in the pop stage. Since December 2013 rapid price swings
continue to demand that owners watch prices on a daily and even
hourly basis. If small business owners are willing to accept
Bitcoin they need to stay vigilant in monitoring the high
probability of a pronounced price collapse.
In December 2013, when prices were still over $1,000, I
indicated that Bitcoin could drop to $10 or below (http://
cognoscenti.wbur.org/2013/12/05/bitcoin-currency-mark-t-
williams). This prediction was based on several observations
including the underlying option value of this new and uncertain
technology, price level at the start of 2013 and the percentage
price drop associated with the 1637 Tulip Mania Bubble \9\. On
January 24, 2014, Nobel prize-winner economist Robert Shiller
stated ``it is a bubble, there is no question about it... it's
just an amazing example of a bubble.'' As articulated by
Coinbase, as part of its new customer disclosure statement,
business owners have to be prepared for the chance that Bitcoin
prices could drop to zero.
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\9\ The price dropped once the bubble burst was 99 percent.
5. Growing Concentration and Bankruptcy Risk to Financial
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Middlemen
Increasingly, small businesses, in an effort to avoid the
extreme price risk of Bitcoin, are using the risk-mitigation
services of Coinbase and BitPay. However, in relying on these
startups, there is a growing exposure to concentration and
bankruptcy risk.
Both Coinbase and BitPay, as financial middlemen, accept
price risk for a fee and allow businesses to receive their most
preferred currency. Merchants are given a fixed Bitcoin
conversion rate linked to a window of time. For example, BitPay
provides a locked price quote for only 15 minutes. The fee for
basic entry level service is 1 percent of transaction
value.\10\ Customers pay in Bitcoin but merchants can elect to
receive U.S. dollars. Extreme daily price swings have created a
niche for Coinbase and BitPay but also have created a
potentially dangerous level of industry concentration risk. It
is important to note that Coinbase and BitPay do not eliminate
overall Bitcoin price risk but simply warehouse this risk on
their books. This is of particular concern given that these two
fledgling firms are lightly regulated, thinly capitalized, and
not required to operate with minimum capital requirements.
Without these important safeguards, it is uncertain what this
price mitigation guarantee is really worth? Adding to this
concentration risk, no derivatives market exists to off-load
this significant risk.
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\10\ BitPay has a four tier customer structure with fees ranging as
low as 1 percent of transaction value to monthly fees of up to $3,000
for extremely large transactions.
As the number of small business customers increases, the
amount of Bitcoin price-risk retained by these financial
middlemen will also grow. For Coinbase or BitPay, a single-day
price drop of 20 percent or a prolonged price decline on a
large enough Bitcoin position could be financially
devastating.\11\
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\11\ Since December 2013, there have been several days where daily
intra and inter-day price movements have exceeded 10 percent,
increasing to 15, 20 percent or more.
Coinbase also has multiple business lines that present an
inherent conflict of interest. In offering price-risk
mitigation and Bitcoin-for-sale services, Coinbase has an
economic incentive to sell Bitcoin at the highest market price
while customers have an economic incentive to buy Bitcoin at
the lowest market price. Without strong regulatory oversight it
is unclear how Coinbase effectively balances this duel and
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conflicted loyalty.
If these financial middlemen were to declare bankruptcy, no
longer able to honor their obligations, and accounts receivable
owed to merchants were not paid, such a scenario could be
extremely costly.
6. Bitcoin Exchange Bankruptcy Risk
Business owners can also sell coins and open e-wallets
through Bitcoin exchanges. Since Mt Gox trading was halted on
February 7, 2014, and its subsequent bankruptcy two weeks
later, the bulk of Bitcoin trading has been concentrated in the
hands of two exchanges: Bitstamp and BTCe. To sell on these
exchanges, U.S. small businesses must send instructions and
trust that their requests will be honored. These exchanges
operate under no regulation and are outside of the reach of
U.S. regulators. With no regulatory oversight, it is not
unusual for certain well connected buyers and sellers to gain
preferential treatment in terms of price execution. Front-
running is not uncommon.\12\ In a weak corporate governance
environment are customer funds adequately protected from
internal or external fraud? In this ``wild-west'' atmosphere
many exchanges have failed. It is estimated that of the 40
Bitcoin exchanges that have been started since the inception of
Bitcoin, almost half (18) have failed.\13\ When exchanges
close, customers tend to lose everything. In November 2013,
GBL, based in Hong Kong, closed its doors, costing investors
over $4 million. In December 2013, the European Banking
Authority also warned of the dangers of other exchanges failing
and of the lack of investor protection laws. Should one or both
of these exchanges go into bankruptcy, small businesses that
store e-coins on either of these exchanges could experience
substantial financial exposure.
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\12\ Practice of a self-interested firm executing trades in its own
account after having advanced market information, sometimes trading at
the detriment of the customer positions.
\13\ Moore, Tyler, Christin, Nicolas, Beware the Middleman:
Empirical Analysis of Bitcoin-Exchange Risk, 2013.
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7. Bitcoin Use Can Trigger Significant Tax Risk
Unlike legal tender, Bitcoin has been designated for tax
purposes as property. This distinction is significant. Unlike
legal tender, when accepting Bitcoin, business owners can be
subject to additional taxes associated with the gains--the
difference in value on date received versus value on date sold.
On March 25, 2014, IRS issued a ruling that clarified the
tax treatment of Bitcoin but, in doing so, created greater
uncertainty about the e-coin's future. Bitcoin is now taxed as
property and not as foreign currency. Any gains in Bitcoin
value is taxed as ordinary income (as high as 39.6 percent) or
at the capital gains (20 percent) tax rate. Given the high
price run-up of Bitcoin during 2013, there are significant tax
considerations which also influence the level of hoarding
versus spending. If an e-coin was purchased for $250 and it now
trades for $500, the owner is going to be less motivated to use
it for transactional currency purposes, especially if doing so
would trigger an additional tax event. For holders of Bitcoin,
this IRS ruling reduces the incentive to use e-coins for
transactional purposes, reducing transaction flow, market
liquidity and price stability. Prior to this ruling, over 90
percent of e-coins were hoarded. It is highly plausible this
tax ruling will encourage even more hoarding.
Small business owners are now confronted with several other
tax risks. If they decide to accept and retain Bitcoin, they
will need to keep records of the market price on the day
received and sold. Any increase in value from that date forward
would be subject to income tax. If a merchant decided to pay
its employees in Bitcoin, the firm also needs to withhold the
required employment tax in U.S. dollars. Companies that pay
employees in Bitcoin are also subjecting staff to increased tax
risk should coins appreciate in value or if prices drop. Such a
policy, given Bitcoin's extreme daily price volatility, would
unfairly penalize employees.
8. Transaction Fraud Risk - Double Spending
Under Bitcoin protocol all new transactions are validated
through the blockchain, a public ledger that is independently
verified every 10 minutes. Validation is done to avoid a
situation where a customer is able to fraudulently double-spend
this e-coin. However, this 10 minute window poses potential
risk should two businesses be paid with the same Bitcoin. If a
double-spending incident occurred during this time gap, the
last merchant to report the transaction would have little
recourse to collect on this payment.\14\ That merchant would
then lose the value of the product or services sold. If the
customer had used a credit card and not Bitcoin to commit the
fraud, the business would have had recourse through the credit
card company. One way merchants can attempt to mitigate this
risk is by waiting until a full validation is completed before
permitting customers to receive goods or services.
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\14\ Although the Bitcoin community has indicated that double-
spending events are rare, and controls against it are strong, merchants
still need to be prepared should such fraud be committed.
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9. Bitcoin Slow Transaction Speed Increases Credit Risk
Credit cards such as Visa and MasterCard have higher
upfront charges for small businesses; however, the transaction
speed of the credit card network is superior to the existing
transaction speed of Bitcoin. At point-of-sale, it still
remains faster and more convenient for customers to swipe a
card or input the card number on an internet e-commerce site
than it is to use Bitcoin. The process of copying and pasting
an e-coin alphanumeric string into another program and waiting
for the confirmation is cumbersome and time-consuming.
Merchants are also much more accustomed to receiving a point-
of-sale credit card authorization and receipt within seconds of
sale. With Bitcoin, merchants remain exposed if they deliver
product or services before payment confirmation is fully
verified.
On the existing Bitcoin network, only 7 transactions per
second can be processed compared to 2,000 transactions on the
credit card network.\15\ If the number of Bitcoin transactions
on the existing network continues to grow, and if the network
is not accordingly scaled up, small businesses accepting
Bitcoin could see transaction time lengthened and payment
verification slowed. Although inconvenient for customers, to
mitigate this risk, merchants may need to have customers wait
until a transaction can be completely verified.
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\15\ Bitcoin advocates claim that in the future the Bitcoin payment
network will be much quicker than the existing credit card network.
However in 2014, transaction processing time for Bitcoin remains much
slower as measured in time to confirmation.
BitPay, a virtual currency payment facilitator provides
small businesses with three speed setting to help manage the
Bitcoin payment confirmation process. At the fastest speed,
merchants assume total credit risk if they deliver the product
in advance of receiving a completely verified payment
confirmation. For small transactions like candy, coffee and
newspapers this concern may be minimal. For larger
transactions, the concern for credit risk may take precedence
over customer inconvenience. This is especially true before
retail customers are allowed to take possession of merchandise
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or a product is shipped from an internet-based enterprise.
10. Risk of E-Wallet Theft Remains High
Small business owners that decide to accept Bitcoin have to
create an e-wallet, and determine whether to store it on one's
own personal computer hard drive or relying on a third-party
vendor such as Blockchain or Coinbase. Third-party vendors that
create and hold e-wallets perform a deposit-type function.
However, unlike banks, these vendors lack regulatory oversight,
minimum capital standards and don't provide consumer protection
against loss or theft. Once created, e-wallets generate a
public and private key. Small businesses need to have strong
controls in place around the storage of e-wallets and of the
private key.\16\ This is particularly important given that
Bitcoin is an anonymous currency that is irreversible once
transferred.\17\ Bitcoin features make it an ideal target for
cyber criminals. If an e-wallet is hacked and coins stolen or
transferred by mistake, they are lost forever. If a computer is
infected with a virus, it could wipe out the hard drive and the
stored value of all e-coins.
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\16\ Some businesses to gain maximum control have taken paper
copies of private keys and placed then in locked boxes, E-wallets can
also be taken off line. This control technique is called storage.
\17\ These secrecy features also raise the question of what
business need these benefits unless they have something they want to
hide.
Relying on third-party vendors also has it drawbacks, as it
requires confidence that adequate controls are in place to
minimize the likelihood of cyber-attacks or internal employee
fraud. It is not uncommon for e-wallet service providers to go
out of business. This was evidenced by the dramatic and costly
Mt Gox bankruptcy in February 2014. Last month, Flexcoin, a
Bitcoin e-wallet bank, based in Canada also folded after being
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hit by a devastating cyber-attack.
Background
a) Forms of Payment
Forms of payment in commerce have evolved over many
centuries including barter, shells, crude metal coins, precious
metal coins, leather money, paper money, wampum, gold, gold-
backed dollars, charge plates, checks, wires, credit cards,
debit cards and prepaid cards. Each manifestation has occurred
in response to consumer demand for more convenient ways to
conduct commerce. In the process, businesses have expanded and
financially benefited.
Virtual currencies, Bitcoin in particular, are being
presented as the newest attempt at payment innovation. Bitcoin
promoters claim it is a safer, faster and cheaper form of
payment than existing forms including credit cards. These
claims have yet to be fully proven.
b) Facilitating Commerce
It is widely known that businesses can increase sales by
expanding the availability of customer payment options. Credit
cards remain the primary form of payment used by consumers when
entering brick and mortar businesses or when shopping online.
Unlike cash or debit cards, credit cards facilitate greater
purchasing by delivering a fast, short-term loan to consumers.
In a cash only economy, businesses would not sell as many
products or services, and profits would fall. Credit cards also
increase impulse buying. To encourage even greater purchasing,
some credit card companies establish reward programs, enhance
product warranties and provide free loss/damage insurance on
products purchased. In addition to credit cards, PayPal makes
it convenient for customers by providing the option of quickly
transferring money from either personal bank accounts or credit
cards.\18\ PayPal has made significant inroads into e-commerce,
now representing 18 percent of the market or $315.3 million in
daily payment activity.
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\18\ The predecessor company to PayPal was founded in December
1999. On October 3, 2002, PayPal became a wholly owned subsidiary of
eBay.
The cost of processing plastic is higher and small
businesses attempt to manage higher fees especially on smaller
purchased items by imposing credit card minimums or by
establishing a cash or credit card price. The average cost of
credit card transactions to merchants ranges from 2 to 3
percent. In the last year, small businesses have also gained
greater relief from credit card fees. Since January 27, 2013,
U.S. merchants have been permitted to pass on to consumers a
surcharge when using a credit card. Presently, few merchants
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have exercised this right.
Small businesses have also received meaningful fee relief
when accepting debit cards. Since the Dodd Frank Act and with
the adoption of the Durbin Amendment, per-swipe fees have
dropped by about 50 percent to 21 cents. This cost savings of
an estimated $8 billion per year has been advantageous to small
business.
c) Credit Cards Fees Come With Merchant Benefits
Credit cards have fees but with these fees come services
and benefits to both merchants and customers. Consumers using
credit cards are more likely to spend than those who only have
cash. Business owners at point-of-sale receive instantaneous
assurance that a card is valid and its owner has sufficient
funds available to make a purchase. Credit card companies also
work with merchants to reduce the change of fraudulent
purchases. Consumer sales are increased through the use of
loyalty program, enhanced guarantees and damage insurance. As a
financial middleman, credit card companies also handle dispute
resolution, gathering facts from merchants and customers. The
chargeback protection (disputed purchases) also increases the
likelihood of credit card use and thus a greater number of
purchases.
d) Evolving Payment Landscape - Business Transactions
Currently, two-thirds of all point-of-sales transactions in
the U.S. are completed either with credit, debit or gift cards.
A little over twenty-five percent of sales are completed with
cash and this rate is projected to decline to only 23 percent
by 2017.\19\ Technology continues to make it easier for
merchants to accept credit card transactions as older swipe
machines and dedicated phone lines continue to disappear.
Innovative firms such as Square, WePay and PayPal are making it
more convenient to accept plastic or to make bank account
direct transfers.
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\19\ Javelin Strategy & Research 2012.
There is also significant growth in the use of prepaid
cards. In 2013, Starbucks reported that one-third of the
company's U.S. sales or $2.5 billion was conducted through this
payment method. Annually, over $65 billion in U.S. sales is
conducted through prepaid cards. This convenient and
inexpensive payment method is projected to double in consumer
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use in the next two years.
Most Small Businesses Don't Accept Credit Cards
Internet commerce continues to grow rapidly where the
preferred payment methods are either credit card or the use of
PayPal-type services. In 2013, U.S. E-commerce sales increased
by 17.22 percent to $380.6 billion accounting for 6 percent of
total sales. Despite this market trend, more than half (55%) of
the nation's 27 million small businesses do not accept credit
cards.\20\ Some businesses argue that credit card-related fees
(2 to 3%) or PayPal fees (2.2. to 2.9%) remain too high, while
other small companies prefer cash over the transparency and
reporting requirements associated with the use of credit cards.
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\20\ McClue, TJ., Why Don't More Small Businesses Accept Credit
Cards, Forbes, August 16, 2013.
Cash-only businesses also increase the chance for tax
under-reporting. The Internal Revenue Service estimated that
under-reporting by small businesses represents about $140
billion in annual uncollected taxes. It is also estimated that
56 percent of sole proprietors' cash receipts are not disclosed
for tax purposes. Since 2012, the IRS has devoted more
resources to address tax under-reporting by small
businesses.\21\
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\21\ IRS requires payment processors to annually file form 1099-k,
a record of system transaction history.
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Why Small Businesses Might Utilize Bitcoin?
There are two major reasons why U.S. small businesses might
either accept Bitcoin as payment and/or use it for paying
employees, and vendors:
1. Illegitimate Purposes - Silk Road, the deep web purveyor
of drugs, guns and prostitution, accepted payment only in
Bitcoin. The FBI shutdown Silk Road in October of 2013. The
Silk Road Case elevated public awareness of Bitcoin as the
designer currency of choice for the criminally-inclined. The
anonymous nature of Bitcoin and the fact that transactions are
irreversible, make it an ideal way for criminals to launder
money, buy illicit goods and avoid taxation with little chance
of detection.
Legitimate Purposes
a. Gain Marketing Exposure - Bitcoin has gained
increased media attention. As a result, more small
businesses view accepting Bitcoin as a way to gain
market exposure. Posting a sign on a door front, on a
website or gaining local media coverage increases free
advertising and brand awareness. For example, Grass
Hill Alpacas, a Massachusetts lama farm and purveyor of
wool socks, has gained considerable visibility being an
early acceptor of Bitcoin.
b. Reduce Transaction Costs and Gain New Customers -
Bitcoin represents a new possibly less expensive,
private payment form to sell goods and services and
possibly expanding sales by reaching new customers.
How do Small Businesses Obtain Bitcoin?
There are four legitimate ways businesses can obtain
Bitcoin:
1. Buying through an exchange (BTCe) or money transmitter
(e.g., Coinbase)
2. Accepting as a form of payment for goods and services
3. Receiving as a gift
4. Mining coins
To obtain Bitcoin, assuming there is no interest in mining
coins, businesses first have to setup e-wallets, either through
third-party vendors (e.g., Blockchain) or by storing them on
the hard drive of a personal computer, which then allows for
the receiving and sending of coins.
Additional Background
There are over 190 virtual currencies traded in the
marketplace totaling $6.5 billion in stated value. http://
coinmarketcap.com/mineable.html. Of these traded e-currencies,
Bitcoin, is the dominant player representing about $6 billion
or 92 percent of this total stated value.
In 2009, a programmer by the pseudonym Satoushi Nakamoto
\22\ supposedly designed Bitcoin, a computer generated
``virtual currency'' produced by solving progressively complex
mathematical equations.\23\ The code-protocol for Bitcoin is
open source, allowing it to be easily viewed, commented on and
if a majority of programmers agree, changes are adopted. In
this regard, Bitcoin is very transparent.\24\ Bitcoin, the
pseudo currency and Bitcoin, the low-cost payment system, are
dependent on each other and are inseparable. Bitcoin is the
locomotive while the payment system is the track that allows it
to move back and forth. The Bitcoin infrastructure is
decentralized and based on a peer-to-peer structure.
Individuals in a multitude of locations, using powerful
computers to solve pre-determined equations, authenticate e-
coins and help keep a general ledger of ongoing transactions. A
continuous blockchain is used and maintained to record Bitcoin
ownership. New transactions are authenticated every ten
minutes. Unlike in credit card transactions, the peer-to-peer
network was designed to eliminate the need for the financial
middleman or the associated fees. These individuals verify
transactions and provide the backbone control to ensure that e-
coins are authentic and are not double-spent. As a reward for
their efforts, they earn blocks of e-coins. This process is
referred to as mining and those that do it are called miners.
Interestingly, using such terminology also gives the false
impression that something of tangible value is being created
such as gold being mined out of the ground. Some enthusiasts
have claimed that Bitcoin is gold for geeks. Initially, the
entry-level barrier to become a miner was low. Overtime, this
barrier has risen and those who are already mining have a
competitive advantage and greater market power.
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\22\ In March, Newsweek presented facts in an attempt to prove the
founder in Dorian S. Nakamoto who currently lives east of Los Angeles.
When confronted by reporters, Mr. Nakamoto denied having any connection
with the creation of Bitcoin.
\23\ Bitcoin has not been recognized by any of the G20 countries as
meeting the definition of currency as it lacks price stability and does
not provide a stable store of value. As a result it is a speculative
virtual commodity with no tangible value.
\24\ The Bitcoin community has argued that this open source
unregulated peer-to-peer approach is a strong control as it allows a
large community of computer scientists, software engineers and
cryptologists to watch over the system and insure its integrity.
At first miners were rewarded with 50 coins per block.
Initially Bitcoin prices were in pennies. More recently, a
block is equal to 25 coins. The block/coin ratio will continue
to halve as time goes on. It takes approximately 10 minutes to
mine a block and approximately 4,000 new e-coins are generated
globally per day. Currently over 12.3 million Bitcoins have
been minted and by year 2140, the 21 million limit will be
reached. A preset quantity limitation creates scarcity which
puts upward pressure on price. This is especially true as long
as new investors can be recruited to buy newly minted e-coins.
Although commodity scarcity is dictated by predetermined rules,
it is unclear what mechanism or controls are in place to
guarantee that rules will be followed and that incentives to
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cheat the system will be eliminated.
Theoretically, the Bitcoin mining and authenticity process
is decentralized, keeping collusion between miners to a
minimum.\25\ As new e-coins are minted they are added to the
blockchain and when trades occur, existing e-coins are
authenticated against this blockchain. As more Bitcoins are
mined, the blockchain grows longer in complexity and the
verification time increases. In February 2014, a series of
cyber-attacks occurred on the Bitcoin infrastructure, targeting
three of the largest exchanges, resulting in significant
trading disruption. While the integrity of the blockchain
remained intact, several third-party vendors were significantly
impacted. Mt Gox eventually filed bankruptcy and the other two
largest exchanges, Bitstamp and BTCe were immobilized for a
week. During this attack, markets and Bitcoin prices suffered.
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\25\ However, in practice, as prices have skyrocketed, there has
been a greater economic incentive for miners to band together in
pursuit of increased profits. As a result, this remains a clear
weakness in the Bitcoin infrastructure.
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