“Cryptocurrency” is a term that is becoming increasingly more important in eCommerce. Cryptocurrencies are a kind of fiat money; money that is not backed by a physical commodity, like gold or silver. At the moment there are more than 800 different types of digital currency, and new cryptocurrencies are always being created – this process is also called the “initial coin offering” (ICO). The most notable currency of this kind is, without a doubt, bitcoin.
Every bitcoin user is a part of the bank of bitcoin
The idea behind bitcoin came about in 1998, but the first documented proof of concept took place in 2008 by an anonymous user that famously went under the synonym Satoshi Nakamoto.
In short, bitcoin is a digital currency that is used to mainly make online transactions. The unique aspect of bitcoin is that it can be transferred between users within 10 minutes without having to first go through a credit institute or bank. The transaction is instead based on a peer-to-peer network, making every bitcoin user a part of the bank of bitcoin.
Bitcoin is not controlled by any person, government or bank – even the founder has absolutely no influence on the currency. This is made possible by the fact that the code is open source. Anyone can therefore view the code and “mine” bitcoins; a process that entails using your computer to solve math problems and verify transactions in exchange for bitcoins.
Every process is recorded in a what’s called a “blockchain”, which is a database that stores an ever-expanding list of transaction data and the whereabouts of every bitcoin. This ensures that a bitcoin cannot be issued several times or counterfeit. The algorithm also specifies that there cannot be more than 21 million bitcoins in circulation at any given time. It is a global accounting system that has the special feature of being completely transparent, as it can be viewed by anyone.
Demand determines the price
Bitcoin’s success depends on the confidence of its users. In short, bitcoin has value because people think it has value. Since there are a finite number of bitcoins in circulation, demand determines the price. Since demand has risen significantly in recent years, the current value of a bitcoin is around 3,700€ (as of 2 October, 2017).
Small fun fact: The first bitcoin transaction took place on May 21, 2010, when a user named Laszlo Hanyecz from Florida offered 10,000 bitcoins for anyone who bought him two pizzas. Those bitcoins would be valued around 37M€ today.
However, the value of a bitcoin fluctuates by the second. Bitcoin’s unpredictable nature creates many sceptics, who see the currency heading for a “bubble” that could burst at any moment. Before anything, bitcoin is somewhat of a gamble and should not be considered a safe investment.
Ethereum attracts more attention
So much for the basics – how do you get your hands on bitcoins? There are a number of possibilities. You can offer goods in exchange for bitcoins, purchase them in digital exchange bureaus, or earn them through the mining process described above.
When you finally get bitcoins, they will be stored in a digital wallet. The exact wallet you choose is up to you, but you have to consider how you’ll be using your bitcoins in advance. For instance, will you use your bitcoins on your smartphone for everyday use or will you be exchanging bitcoins strictly from your desktop where your transactions are a bit more secure? It is possible to create your own wallet, but wallets from existing service providers are more recommended, as they often offer more security.
Aside from bitcoin, Ethereum is gaining more and more attention. At the end of 2013, a young Russian-Canadian programmer named Vitalik Buterin published a whitepaper for his idea of Ethereum, a platform where developers have tools to build decentralised blockchain applications, which, in the end, could end replace third-party services that control the centralised design of the internet.
The dark side of cryptocurrencies
Cryptocurrency is regarded by many as the currency of the darknet and is often referred to as the “currency of cybercrime”. Transactions do not require bank control and it is not possible to reverse a payment. Sceptics see this as a security vulnerability and do not trust blockchain technology.
German politician Dr Jens Zimmermann said about cryptocurrency security: “Virtual currencies could be a good alternative to existing means of payment, but at the moment they are primarily objects of speculation. The strong price fluctuations aren’t the only problem; there are also difficulties with data protection, money laundering and tax treatment. Unless these issues are resolved, cryptocurrencies will not be suitable for everyday use.”
Dr Konstantin von Notz, a member of Germany’s Green Party, justifies the use of blockchain technology: “The approach of a decentralised coordination system that promises transaction security at low costs by means of cryptographic chains is attractive for a wide variety of applications. During these times of big data and cashless databases, financial data protection is an increasingly critical issue – but it is not solved per se by cryptographic currencies.”
Concerning the question of taxes, Dr Zimmermann answers: “In principle, income and profits from exchanging cryptocurrencies fall within the scope of the respective tax laws in individual countries. At least for Europe, the aim should be to achieve a uniform regulation. In 2015, the European Court of Justice already dealt with the VAT treatment of services when exchanging bitcoin for state currencies and vice versa."
These statements suggest that policy on cryptographic currencies is still highly sceptical. However, Dr von Notz believes that there is still room to experiment with innovative new technologies. Doing so would follow recent events in Estonia, where they are currently considering a state cryptocurrency: the Estcoin.
Cryptocurrencies are proving to be an interesting new payment method that have a clear impact in eCommerce. Bitcoin is a strong indication that trading virtual currencies could pose as an alternative in times when the “cashless payment” trend continues to grow. However, since the number of bitcoins in circulation at any given time is capped at 21 million, this could ultimately create an issue: as they become more and more coveted, the fear of deflation could rise.
Numerous third-party providers already offer services so that online shops can start accept bitcoins as a form of payment. In our second part of this series, Lucas Pulkert, the owner of the online shop Jungfeld, reports on his personal experiences using bitcoins.