Why Cryptocurrencies are not yet Making a Big Impact in Payment Processing
Bitcoins have been around for nearly a decade. Billed as a currency, and introducing blockchain technology with its advent, many expected it to eat away at the functions that traditional currencies perform. In several measures as a currency, the use of cryptocurrencies have grown a bit. However, their adoption or use in payment processing, has been underwhelming by some measures. Noting that bitcoins currently accounts for over 72% of all cryptocurrency use, it is instructive to examine some of the reasons behind this observation focusing on bitcoins.
In general, online payments or other forms of remotely made payments have been growing annually the past few years. The share of that growth that is being completed using cryptocurrencies has not grown by much. Table 1 shows trends in online payments the past three years, comparing the growth in the use of cryptocurrencies with overall online payments. The table includes data showing the adoption of bitcoins as a payment processor by merchants, overall trends in remote payments, online payments per day, as well as the number of bitcoin transactions per day. The data reveals that the adoption of bitcoins is not growing exponentially as we observe for instance in other metrics of its growth such as the number of bitcoin wallets (accounts), number of media mentions, and its price. The data also shows that while the number of transactions per day is growing, it will likely take a few centuries at its current pace to become comparable with online payments made in the US alone today. The gap is much wider when it is noted that a substantial portion of those daily bitcoin transactions is due to investments in and speculative transactions in cryptocurrencies, and several non-value added transactions (the top 10 bitcoin addresses in transaction volume is dominated by such names as Satoshi-dice and Luckybit) rather than payments made for bills, goods or services.
Transaction Speed and Capacity is too Limiting
One reason why bitcoins have not grown much in use in payment processing is its performance in transactions. It takes too long to process. About ten minutes on average per transaction currently, as shown in Figure 1 from blockchain.info. If a large portion of online payment suddenly switched to using bitcoins, this would result in a world-wide wait (www). It is unlikely that customers would enjoy routinely waiting 10 minutes at checkouts or online for their payments to clear.
The number of transactions that can be handled per seconds is also limiting. This is due intrinsically to the formulation within the technology itself. Firstly, the ledger is published and public and is maintained severally by thousands of nodes. All nodes maintain essentially the same copy of the ledger which makes it difficult for any one entity to alter any part of the ledger maliciously or erroneously as their copy would no longer be in sync with the rest of the nodes, and will thus be excluded. Because there is no trusted entity verifying transactions, the grand scheme used in maintaining integrity of transactions is one where each block of new transactions is encoded with a computational seal that is very difficult to derive but easy to verify. If the block is verified as accurate by all other nodes of the network, by consensus it is accepted and added to the ledger. Once added, it is virtually impossible to reverse it as it would take too long to do so, since sealing a block requires a time consuming computational seal, and more blocks would have been added by other nodes in the time it would take to do so. This of course makes a potentially reversed or altered block out of sync and behind the public ledger, and thus excluded. That computational seal derived for each block is termed the proof-of-work done on the block.
The trust mechanism as described above results in lots of needless computation that consumes lots of energy, and results in high transaction costs, Figure 2. Although the transaction costs are not yet passed to the consumer directly, and is thus likely not yet a reason behind the slow growth of cryptocurrencies as a payment tool, it would likely be an issue long term if not resolved. The same can be said for the high energy costs per transaction, where it was noted in some studies that the electricity consumed by 1 bitcoin transaction could power a 3.95 U.S. households for 1 day. Even half this level of energy consumption will not be environmentally sustainable long term if cryptocurrencies continue to grow in use.
More limiting for its adoption as a major payment processing instrument is it transaction capacity. The proof of work algorithm is set with a degree of difficulty necessary to keep the network synchronized and working in such a way as to maintain the integrity of the block. That degree of difficulty ensures that new blocks can only be written about once every 10 minutes. Each block has a size limit of 1MB and can hold roughly about 2,000 transactions. This effectively limits the entire network to about 200 transactions per minute.
Too Valuable to be Spent
As noted in the epochal release of the global cryptocurrency benchmarking study from the University of Cambridge, there is evidence that the main use case for cryptocurrencies is speculation. Their conjecture was based on a 2016 Joint report from Coinbase and ARK Invest that surveyed cryptocurrency users of the Coinbase platform and obtained responses indicating that over half collected the currency as an investment. The allure of bitcoins, for instance as an investment rather than as a transactional medium can be illustrated using its price chart shown in Figure 3.
It can be shown based on a review of the variables that govern its limited supply that the demand side of bitcoins would likely grow as a function of its current level of adoption. In other words, if x is the demand for bitcoin as an asset at a time t, the rates at which that demand would increase in time would be proportional to its current level of adoption. If k is the yet undetermined rate at which the demand multiplies in time based on its current level at the time, this can be written in equation form as.
That equation has solutions in the form:
Filtering the historic bitcoin price data, excluding the bubbles, and solving that equation subject to selected filtered data points results in the above trend curve that yielded a value of k = 0.003 and C ≈ 0, starting from an x0 value of 2. While the curve has shown deviations from this exponential slope in small bubbles and a major bubble and snap back through 2014, it has tended to revert back to the curve roughly over the past eight years. This means that effectively, the price of bitcoins has on net been doubling every 231 days (loge(2)/k). We see an even faster rise for the ethereum, which is currently about the second most prevalent cryptocurrency.
With that kind of rate of appreciation, it should not be unexpected that most of the adopters of bitcoins and some of the other cryptocurrencies have done so as an investment vehicle, and may not be using it for transactional purposes.
For merchants, the volatility in value might also be an issue, as much as the lack of customers spending the currency. It is still too common to see fluctuations in price of up to 20% a day in bitcoin prices. It is possible to sell a good or service only to find that it was sold at a loss by day’s end, or pleasantly at a greater profit than expected. Most merchants usually prefer to work with more stability in the transactional currency in which, they denominate their goods or services.
The likelihood of seeing the current prevalent cryptocurrencies play a bigger role as a transactional medium in online payments will continue to be low as long as the issues discussed here are not resolved. There is some work currently being done to address some of these issues, and some of the more recent privately maintained ledger systems might be able to overcome some of the highlighted issues based the fact that their consensus mechanisms simply do not have some of the same trust complexities. Looks like trusted entities might still have some significant role to play in any eventual cryptocurrency ecosystem in future.
1. Hileman, G. & Rauchs, M. (2017) Global Cryptocurrency Benchmarking Study, University of Cambridge, JJudge Business School. Accessed May 20 2017.
2. Most Popular Bitcoin Addresses by Output. Blockchain.info. Accessed May 20 2017.
3. Median Bitcoin Confirmation Time. Blockchain.info. Accessed May 20 2017.
4. Bitcoin Cost Per Transaction. Blockchain.info. Accessed May 20 2017.
5. Bitcoin Energy Consumption Index. Accessed May 20 2017.
6 Burniske, C. & White, A. (2016) Bitcoin: Ringing the Bell for a New Asset Class. Available at http://research.ark-invest.com/ bitcoin-asset-class (Accessed: 20 March 2017)
7 Claire Greene, (2016) Virtual Currency: User Points of View, Survey of Consumer Payment Choice (SCPC), Consumer Payments Research Center, Federal Reserve Bank of Boston, Accessed May 20 2017