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Boston Fed: Bitcoin Could Be Reducing Online Shopping Costs

(@mpmcsweeney) | Published on September 16, 2014 at 23:20 BST

Boston Fed

The Federal Reserve Bank of Boston has released a new report that suggests the technology underlying digital currency could reshape global payments.

Authors Stephanie Lo and J. Christina Wang note in their September policy perspective, Bitcoin as Money?, that while it's not certain that bitcoin will supplant traditional currencies or payment systems, bitcoin’s "lasting legacy" will be the innovations it brings to payments technology.

In the full paper, the regional branch of the US Federal Reserve, examines whether digital currency as it exists today is a viable form of money, looking at it as a medium of exchange and a store of value. The paper echoes sentiments shared by many central banks worldwide – that bitcoin’s price volatility and lack of a central authority make it a risky form of money, though its underlying technology holds great promise.

Yet, the authors say that bitcoin could become a solution for online commerce, particularly as more e-tailers begin accepting digital currency. In the long term, bitcoin could be a viable candidate system to replace an existing financial infrastructure that the Boston Fed deems “fragmented” and “inefficient”.

The authors note:

“In principle, any of the functionality or services related to payment and transfer offered in the existing financial system should be, and likely will be, a candidate for reform if such reform can result in greater efficiency by using technology developed in the open-source distributed network framework that is at the foundation of bitcoin.”

Risky money

Overall, the report suggests that bitcoin can meet the primary functions of money, but not without potential risk to those who use and invest in it.

The paper examines one of bitcoin’s chief use cases – online commerce – and compared this utilization to how dollars are spent online. The data presented shows that bitcoin users, within the Fed’s sample of price changes across online retailers like Overstock and TigerDirect, experienced slight discounts when using bitcoin.

These indications, while tenuous, suggest that merchants are in fact being drawn to the idea that using digital currency is more attractive than accepting payment methods like credit cards.

As the authors state:

“Caveats notwithstanding, our finding that these retailers do not charge a premium and may in fact offer a discount, albeit slight, on purchases made with bitcoin suggests that retailers consider that payments made with bitcoin are on net at least as profitable as payments made with standard means. The most likely reason is that accepting bitcoin lowers merchants’ costs by reducing payment processing costs, chief among which are the credit card interchange fees, typically on the order of 2–4%.”

The report goes on to say that online bitcoin payments may serve as the technology's primary use case, given its increasing acceptance by retailers.

This behavior, the authors suggest, may be attributed to the fact that payments processors in the bitcoin space assist merchants by insulating them against wide price fluctuations.

Mining process flawed

The Fed explored the role of bitcoin's miners, assessing the network's strengths compared to how the broader financial system establishes and settles transactions.

Overall, the report views the industry critically, suggesting that its pre-determined increase in mining difficulty and the trend toward consolidation constitutes a long-term risk.

Specifically, the paper notes, the competitive nature of bitcoin mining – wherein miners race to solve the complex cryptographic equations and discover new blocks – is self-defeating from the standpoint of a stable network. Noting its “social inefficiency”, the authors suggest that the rising cost of mining could one day outweigh the broader benefits of cheaper transactions.

The report highlights how the composition of the mining network itself is shifting from a cluster of small entities to fewer, more powerful operations. As mining power consolidates under a few centralized mining pools, the Boston Fed suggests, the risk of collusion between parties rises.

Consolidation or outright monopolization in the mining network may require greater oversight, the paper states. Yet even if the network maintains a level of distribution consistent with where it is today, the Boston Fed posits that regulation should be explored.

The paper stated:

“Regardless of the exact future structure of the mining operation, the inevitable increase in concentration suggests the need for enhanced oversight, either by the players themselves or by an independent third party, to guard against the likelihood of collusion or other non-competitive behavior.”

Such a process would not be easy. As a global industry, mining would require the oversight of supragovernmental organizations, as well as agreement among nations with significant mining industries, including China, Europe and the US. Regulating sources of hashing power that are more difficult to track would also complicate the matter.

Too early for remittances

The authors briefly touch on the subject of remittances, described by many as a potential catalyst for bitcoin use expansion worldwide. In the Boston Fed’s view, however, it’s still too early for digital currency in its current form to be a viable vehicle for cheap global payments.

At the same time, the report says, the prevalence of mobile devices in developing economies could make digital currency-based remittances more popular should information about how to use the technology become more widespread.

The report states:

“To the extent that a mobile application for international remittances using the Bitcoin network can be developed and accepted by a broad range of providers around the world, it can be possible for Bitcoin to capture a nontrivial share of this market.”

The global remittance marketplace is worth an estimated $500bn, and companies in the bitcoin space are already targeting this application. The Boston Fed says that the deciding factor will be the willingness of businesses that offer payments processing in developing countries to integrate bitcoin.

Bitcoin's future

The Boston Fed says whether or not bitcoin succeeds depends on many factors, the evolution of digital currency technology itself notwithstanding. Any outcome rests in the hands of the broader currency-using public, who may or may not see bitcoin as worth using compared to existing methods.

The report’s authors also highlight the fact that information about bitcoin is still disseminating among consumers, business and regulators.

They write that questions exist that need to be answered before any conclusions can be drawn about bitcoin’s future, saying:

“For example, what are the fundamental needs satisfied by digital currencies such as bitcoin? How, if at all, should bitcoin intermediaries be regulated? What are the main drivers of bitcoin price movements?"

The paper concludes: "Many interesting questions remain to be explored.”

Image via Wikimedia


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