Goldman Sachs: Bitcoin Isn't a Currency But Underlying Tech Holds Promise
A new Goldman Sachs report on digital currencies has found that while bitcoin is not a practical currency, its underlying ledger technology could hold promise.
The top-of-mind report, entitled 'All About Bitcoin', appears to have been compiled recently and it is possible Goldman Sachs commissioned it following the highly publicised Mt. Gox collapse.
The report outlines the basics, citing bitcoin's advantages and shortcomings, backed by statements from critics and supporters.
The main difficulties facing bitcoin, according to Goldman's Dominic Wilson and Jose Ursua, include the notion that it is not a very good store of value, a fact which will present a major roadblock to its adoption as a medium of exchange.
In addition, Head of Goldman Sachs commodities research Jeff Curie believes bitcoin's attributes make it a commodity rather than a currency.
Bitcoin could reduce costs but ...
However, Goldman Sachs' IT Services equity analyst Roman Leal, estimates that the use of bitcoin could save up to $200bn a year, based on current trading volumes.
He also cautions that direct comparisons of different costs might be misleading, as bitcoin's cost advantage could be diminished if "conventional players" are forced to compete.
His concerns are echoed by those of security specialists and scholars. Improving security will add more expenses and simply maintaining the block chain could become a lot more expensive and demanding. Currie points out that the size of the block chain has increased to 15GB from 10GB in six months.
More regulation, more security and more hardware is needed – and none of it comes cheap.
The Libertarian model doesn't work
Eric Posner, Professor of Law at the University of Chicago, believes bitcoin would not work as a substitute for fiat currency, as governments need to control the money supply.
"One of the most appealing aspects of a decentralized currency for some people – and even perhaps a motivation for its creation - seems to be freedom from government or central bank control, as reflected in the libertarian mindset," Posner points out.
"But it is wrong to think that people would be better off if we lived in a world in which the government did not control the money supply. Control over the money supply is an extremely valuable attribute of government that allows it to navigate and minimize or avoid economic problems like recessions or, maybe, asset bubbles."
Posner argues that monetary policy can be misused, but then again governments can misuse the military too. It is a simple argument - if a government is planning to harm its own people, it may as well use physical repression to do so, not money.
He also points out that bitcoin is not completely autonomous, as it relies on the Bitcoin network. People who operate the network can change the money supply. Most of them are not economists or monetary experts.
"I find that unsettling and I think most people would feel the same way," Posner adds.
Posner also points out that a single world currency simply wouldn't work, as it would prevent governments from using monetary policies at their own discretion. He cites the Eurozone as a good example – what works for Germany doesn't exactly help Greece and vice versa.
Bitcoin isn't a currency, but it has plenty of potential uses
Goldman Sachs market researcher Dominic Wilson and Jose Ursua pointed out the main ways bitcoin differs from standard fiat currencies, and why they don't consider bitcoin a 'currency' in the true sense of the word.
However, Wilson and Ursua also point out that bitcoin shows more promise in terms of its payments technology than as a stable store of value, which is what many bitcoin entrepreneurs have been saying all along.
The researchers concluded that bitcoin could have a significant impact in terms of innovation on payments technology and it might force existing players to adapt to it or co-opt it.
"The fundamental obstacles to bitcoin being used more broadly in the payments system are arguably not insurmountable, though connections with the conventional banking system are ultimately essential to its functioning," the researchers argue.
"The absence of derivative markets makes it harder to manage and hedge risk around bitcoin’s value, but it is possible to imagine how those could ultimately develop."
Volatility remains the biggest concern, as the volatility of bitcoin exceeds that of other currencies by an order of magnitude. Goldman Sachs found that the volatility of bitcoin stands at 108.1%, roughly 20 times higher than major national currencies like the dollar and euro. Interestingly, Goldman Sachs researchers used CoinDesk data to gauge bitcoin volatility.
Imact on payments industry, potential savings
Goldman Sachs IT Services analyst Roman Leal also believes existing payment providers will have to adapt or co-opt bitcoin, in what he describes as "co-opetition."
Leal points out that the bitcoin network could solve some of the pain points involved in the current payments system, but only in theory. Bitcoin could make money transfers as seamless as email, businesses could have the same fees regardless of purchase amount and travellers would not have to pay cross-border fees.
Leal also looked into hypothetical savings and came up with very encouraging numbers. Based on 2013 volumes, up to $200m could be saved in remittances, retail and e-commerce. The biggest savings would come to remittances, with an average fee of 8.9%.
"Bitcoin gateway service providers such as BitPay and Coinbase, which enable merchants to accept bitcoin payments, typically charge a fee of about 1%. At face value, the annual net savings if all electronic payments were conducted in Bitcoin could potentially add up to over $150 bn in retail point of sale and $12bn in e-commerce fees per annum based on global 2013 purchase volume.”
"Using this math, merchants generating $1 million in annual purchase volume would save at least half in payment processing fees by accepting bitcoin, with small merchants even better off," Leal concluded.
Consumers could also see plenty of savings. Money transfer networks like Western Union tend to charge high fees of up to 10%, so bitcoin transactions could reduce fees tenfold. In addition, reducing fees could allow merchants to transfer part of their savings to consumers.
However, Leal also cautions that the bitcoin cost advantage might not last. Just as merchants could pass their savings on to consumers, bitcoin providers might be forced to pass the expenses of more regulation and security down to their users.
Balanced and mostly positive
In addition to its own researchers and scholars, Goldman Sachs also tapped a number of bitcoin advocates and critics, as well as industry veterans. Coinbase's Fred Ehrsam outlined how bitcoin payments operate and how bitcoin operators make their money.
IT specialist Ken Hess criticised the "pie-in-the-sky" ideology pushed by some bitcoin advocates, but even he admitted bitcoin could be a decent payments platform.
On the whole, the report is quite extensive and it merely reiterates the argument that bitcoin could complement fiat currencies rather than replace them. It also promotes the idea that Bitcoin could be a viable and cost-effective payments platform.
Turning the hypothetical 'could' into reality is something else entirely. Goldman Sachs envisions a future with more regulation and more security, but more regulation is not something that many in the bitcoin community desire at this point.
However, institutional investors will not get on board without a bulletproof regulatory framework and the collapse of Mt. Gox is bound to silence many critics.
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