Essec Business School

E-commerce is booming, growing at around 20% per year according to a recent report. But despite these changes in our consumption behavior, most online payments are still made with the good-old credit card, a technology that hasn’t much evolved in decades. Consumers are familiar to this technology and tend to forget some of the drawbacks to the credit card, not least the fees and privacy issues. So is it time to explore new payment options?

Enter the digital currency. Although they’re not entirely new, digital currencies have been on the rise in recent years – and in particular since the arrival of the Bitcoin in 2009. Indeed, Bitcoins and other digital currencies resolve some of the drawbacks of using traditional currencies or credit cards.

In the wake of financial and economic crises, many have put forward that the Bitcoin could revolutionize the financial landscape or even one day replace the dollar. That said, ProfessorAshwin Malshe believes that while signs are encouraging, their time to “take over the world” hasn’t quite yet arrived. So what are some of the benefits of using a digital currency and what’s holding them back?

The up side: Saving on transaction fees

“One of the clear benefits of digital currencies it that they help both companies and clients save money,” he explains. “For companies using virtual currency, they take out the credit card company middleman: they no longer need to pay a fee every time a customer uses a credit card and they can easily pass this savings onto the customer.”

“Currency exchanges can also cost companies – pay an employee in a virtual currency and they won’t need to worry about losing a cut every time a check changes hands. Facebook is already using its digital currency to pay its developers.”

Closed corporate ecosystem currencies, like Facebook Credits – whose value is decided by the company – are starting multiply. After Facebook’s success with the technology, Amazon launched the Amazon Coin just last month, to positive reviews. And according to professor Malshe, adoption is easier in this environment because clients are already fairly familiar with the system: similar systems like air miles and loyalty points have already been around for years.

And the Bitcoin – the most popular, floating cryptocurrency, which acts much like a traditional currency - is also growing in popularity, particularly amongst small businesses: saving on transaction costs can make a big difference to their bottom line. So if digital currencies are helping everyone save money, what’s holding them back? “Above all, traditional monetary entities like credit card companies and banks are going to be major obstacles to the scaling up of digital currencies,” says professor Malshe. “They’re standing in the way of change and they won’t be easy to convince.”

The down side: Volatility

With corporate virtual currencies, corporations control the value, while in the case of Bitcoins, it’s all a question of algorithms. Professor Malshe says that is a plus in some ways – as companies and governments can’t flood the market and cause inflation. But, in other ways, it leaves still-fragile digital currencies at the mercy of volatility.

“Some had speculated that bit coins would take off in the wake of the Cyprus crisis,” he adds. “The Bitcoin value did go up for a time, but it quickly became volatile: because they are relatively new, investors were very sensitive the smallest pieces of information.” “The thing is, no one knows for sure yet if virtual currencies will be inherently volatile. In fact, signs point towards a fairly robust system. While statistics show that people still have relatively little faith in this kind of system, this may change in the future.”

And the jury is still out on Privacy

The controversy over National Security Agency (NSA) data mining has put the subject of online privacy back in the headlines, boosted sales of Orwell’s 1984 (up 112% on Amazon) and made whistleblower Edward Snowden an overnight celebrity. As it turns out, not only have NSA been tracking social media and mobile activity, they’ve most likely been tracking credit card activity. Bitcoins offer an answer to this kind of privacy dilemma because they are completely untraceable. However, herein lies the debate.

The NSA’s surveillance program has upset a lot of people – not least Europeans who fear data has left American soil and been shared with the UK. But many others – and a majority of Americans – feel that giving up their online privacy is worth it if it means catching a criminal and keeping society safer.

“This is a classic example of Type 1 and Type 2 error trade-off,” says professor Malshe. “Without surveillance, you could potentially miss information about terrorist activity – the type 1 error – and with surveillance, you could be using information against an innocent – the type 2 error. By picking one option, you’re making a trade-off and accepting a certain amount of error. And this is the very same debate that runs rampant amongst critics and supporters of virtual currencies.”

As professor Malshe goes onto explain, many have criticized Bitcoin technology because of its untraceability. While it can ensure privacy, it could make virtual currencies a target for money launderers, terrorist and others intent on criminal activity. And because Bitcoins are an open sourced technology, many believe this leaves them open to the risk of hacking.

“On the other hand, privacy isn’t the issue with corporate digital currencies because they make it easier than ever for companies to gather data on the real purchasing behavior of their clients,” he adds. “Facebook in particular is benefiting from this information in terms of marketing because they already know so much about their users. With middlemen, there are almost always legal perimeters limiting access to data.”

So are we at the cusp of a currency revolution? “Digital currencies probably won’t replace the dollar any time soon, but usage does look ready to expand,” he concludes, “particularly within closed ecosystems. And if Bitcoins aren’t here in ten years, some other virtual currency certainly will take it’s place.”