“The future of money,” “drug dealer’s dream,” “transformative,” “disruptive”– Bitcoin has been called many things. Beyond its anonymous nature, bitcoin has the potential to change the way we bank, make transactions, and view money. Let’s examine bitcoin’s potential and its challenges.

A Quick Primer

One can earn money (dollars/pounds/euros) by working, selling things, or exchanging other currencies. Similarly, one can earn bitcoins by mining (working in a virtual world), getting paid in bitcoins for selling goods, or purchasing bitcoins by exchanging existing currencies (like US dollars). Earned or purchased bitcoins reside in safe wallets, which are online secure bitcoin storage provided by bitcoin service providers. Wallet owners can use bitcoins for any transactions where the counterparty accepts bitcoins. Every transaction gets recorded onto the bitcoin network (through blockchains), which authenticates the transaction.

The Speculative Nature

Any currency's primary usage is for transaction-based trades, i.e., buying and selling things. Bitcoin is not yet widely accepted by buyers or sellers, and its valuation has been a speculative game. The use of bitcoins for illegitimate purchases (like drugs and gambling) can make buyers pay a premium due to the nature of goods or services involved. Moreover, anyone purchasing legitimate goods or services through bitcoins would make a comparison with the dollar equivalent, and opt for the cheaper option. In the last quarter of 2013, bitcoin was trading above $1200. Since then, it has seen a steady decline. From around $800 in January 2014 to $330 in December 2014 and to yet another low of $170 in early 2015, bitcoin has lost significant ground.

The dotcom bubble may have burst in 2000, but overall Internet use has grown exponentially, making it a mandatory framework for the present-day economy. Recent valuations of bitcoin may be perceived as a similar bubble burst. In 2014, bitcoin saw some significant developments, which indicate the long-term positives and adoption potential of the currency:

  1. The largest increase in bitcoin trading volume.
  2. The number of bitcoin wallets grew from 3 million to 8 million.
  3. Large corporations, such as Microsoft, Dell, Expedia, and Dish Network, have joined the list of merchants accepting bitcoin.
  4. The number of merchants accepting bitcoins grew from 36,000 to 82,000.
  5. The number of bitcoin ATMs grew from just 4 to 340 worldwide.
  6. Venture capital investment in bitcoin shot up significantly, from $98 million in 2013 to $335 million in 2014.

Yes, bitcoin valuations are at rock bottom, but these recent developments demonstrate the strong future potential of the currency. And venture capitalists, pouring in large amounts of capital into the currency, are in it to reap great returns from long-term potential.

A rare combination of technology and finance with global reach, bitcoin’s framework is impressive. Its real potential is not in its high exchange rate valuation or in providing an additional virtual currency that is free from governmental or political interference. Bitcoin’s potential lies in its underlying technology, a secure system with built-in authentication of transactions and record-keeping, which could change the global financial ecosystem.

Future of Bitcoin Adoption

To transfer money to a friend, one's bank takes a cut for providing services. To purchase a house, one pays significant fees for registration and stamp duty charges to register one's ownership in multiple books and records. Through digital labeling, the indelible record of a bitcoin transaction has the potential to eliminate such third parties (and their costs). 

Zerohedge cites findings by a Goldman Sachs analyst, “in 2013 money transfer fees would have fallen by 90% if bitcoin had been used...Global transaction fees at a retail point of sale, meanwhile, were $260 billion on over $10 trillion of sales. Using bitcoin, those fees fall by almost $150 billion to $104 billion.” In addition, currently, credit card companies charge 2%-4% to retail merchants. Using charge-free bitcoins would be a game-changer for small businesses running on thin margins, as these are businesses with low sales volumes.

A World Bank report estimates that by 2016 international remittances will be worth over $700 billion. Banks and money transfer services take significant cuts ranging from 4% to 10% on the transferred amount. This charge may be direct (such as a standard quoted percentage) or indirect (such as a less favorable forex rate). Bitcoins allow free transactions beyond geographical boundaries (or for a simple 1% charge if using bitcoin service providers like Coinbase or Bitpay). A mere 3% savings on such transactional costs on the projected figure of $700 billion would result in a savings of $21 billion, leaving more money for the end consumers.

The potential of bitcoin is not limited to transactional cost savings. A Bloomberg report from 2012 noted that more than half of the world’s population does not have a bank account, although mobile penetration is above 75%. Imagine bitcoin payments through mobile apps that could enable money transactions over remote distances at no extra costs.

The secret of bitcoin lies in the underlying "blockchain" – a secure digital ledger on bitcoin networks that keeps track of bitcoins by recording every single transaction. It facilitates agreement by all parties as to who owns how many bitcoins. A bitcoin wallet holder will have an exact replica of the blockchain on the secure public bitcoin network, which virtually overrules any attempts of counterfeit.

This blockchain currently tracks and records money movements – buyer A paid x bitcoins to seller B. However, the same blockchain can be utilized to record transaction details to include title deeds and transaction details, which can act as public records. It could nullify the costs of title registration, ownership, and record keeping.

Firms like ColoredCoins.org are adding attributes like coloring to bitcoins, which represent other assets like 100 shares of a company, an ounce of gold, or $5,000. Similar to bitcoins, colored coins can be used to trade the underlying assets. As long as the market participants agree on a standard and honor the conversion of the colored coin to something in the real world (stock, bond, car, or a house), a colored coin can be used to represent the ownership of that real-world thing. Without paying a broker commission, one can sell one's green-colored bitcoin to you that may represent 100 shares of Apple Inc. (AAPL), which would give you dividend payments and voting rights. Effectively, an extra layer has been built into bitcoins, enabling the transfer of ownership of real-world commodities.

Beyond the Business of Bitcoins

This cryptocurrency concept has enabled many new digital currencies and structures to float in the virtual world, including Ethereum, a platform that will allow multiple cryptocurrencies to be exchanged. Ethereum will also allow creating and hosting apps (like file storage or instant messaging apps). Users can pay for usage in cryptocurrencies (like $1 per 100 MB file storage or $2 per year for using IM app beyond a year) or can earn equivalents by contributing to the platform (like developing a new app).

Today, Facebook (FB) allows advertisers to target its users specifically. eBay (EBAY) offers a secure marketplace to enable buyer-seller interaction. Today both Facebook and eBay are able to bank on (and profit from) such privately held restricted networks, accessible to and controlled only by them. Such companies are valuable because of their registered user bases (and associated information), which are held privately by them.

Imagine if a similar generic network opens up based on block chains, offering secure yet decentralized control. On such a network, a Facebook user can easily connect to an eBay seller to buy the desired good. Effectively, both users are on the same blockchain network and are using Facebook and eBay like apps on this network for their requirements. In this new world, sellers will no longer have supreme control based on their individual user bases. Such a decentralized protocol enables peer-to-peer transactions, secured by bitcoin and its underlying technology.

Companies Without Directors?

Any cryptocurrency is a company without directors, including bitcoin. It offers financial services and pays its employees (or miners), and those who hold bitcoins are the shareholders. It is theoretically possible to run a company without a director as a blockchain can be pre-programmed with a specific set of business models to run and operate the business. The blockchain acts as a public record to store financial information, record shareholder votes, and run the business accordingly. 

A new platform, BitSharesX, is in development to replicate bank operations, including lending other currencies to clients against BitShares as collateral. More offerings include election services and online lotteries running on their own with transparent rules. The idea is based on decentralized autonomous operations, not controlled by any single person, authority, or organization.

The Challenges

Bitcoin has evolved as a great cryptocurrency, built on the backbone of a robust and resilient network. However, its scripting language is considered to be vulnerable to attacks. Third-party applications and systems built on top of the bitcoin protocol can be insecure and vulnerable and can lead to bitcoin thefts. However, technological advancements could make the system more robust, particularly if bitcoin gets into the mainstream.

A global cryptocurrency will come with its own set of challenges, including decentralized autonomous control and a lack of geographical and regulatory oversight. How efficiently can rules be created and adopted in the autonomous network will be an area of concern.

The Bottom Line

All in all, bitcoin and its underlying technology have great potential. Applications based on blockchains will present technical, legal, economic, and social problems that may be similar to the ones raised by similar peer-to-peer applications like Torrent, Napster, or Freenet. The alternatives offered by bitcoin will have to pass the test of time and trust before it gets accepted in the mainstream. Nonetheless, while bitcoin might not last, the technology underpinning it will be a game-changer and continue to evolve in the coming years.