Do Bitcoins Pose A Threat To PayPal, Visa And Mastercard?

Includes: EBAY, MA, V
by: Michael Fitzsimmons

Back in September, The Economist magazine printed an article on a fascinating development: the Bitcoin. The Bitcoin (BTC) is a distributed digital currency created by the pseudonymous entity Satoshi Nakamoto. It is subdivided into 100-million smaller units called "satoshis".

Does this new digital currency pose a threat to companies like Ebay(NASDAQ:EBAY), VISA(NYSE:V), and Mastercard(NYSE:MA)? Before we can make an educated assessment of the potential threat the Bitcoin may or may not pose to these online transaction heavyweights, we must first understand what it is and how it works.

What Exactly is a Bitcoin?

Bitcoins are digital coins you can send through the internet. Bitcoins are not controlled by a single organization or government. It is the first decentralized digital currency that is completely distributed. The decentralization of the Bitcoin system is the basis for its security and freedom. There is no credit-card company or banker acting as a middle man between you and the person you want to send or receive money from. You can learn more here and there is an informative video here.

How Are Bitcoins Created?

Bitcoins are generated all over the internet by anyone running an application called "Bitcoin Miner". This software is available free for Windows, Linux, and the Mac OS and can be downloaded here. The software is released under the MIT license and is part of the Open Source Initiative (OSI). The OSI insures anyone can review Bitcoin code at any time.

Minting a Bitcoin requires solving very difficult mathematical problems. The problems and the amount of computer power needed to solve them are automatically adjusted by the network such that BTCs are always created at a predictable and limited rate such that the overall supply of Bitcoins cannot grow too fast. The Bitcoins are then stored in a digital wallet. When you transfer Bitcoins, a cryptographic electronic signature is added, and after a few minutes the transfer is verified by a miner and permanently and anonymously stored on the network.

How many Bitcoins Will Be Created?

According to Wiki, the Bitcoin network is programmed to increase the supply until the total number of Bitcoins reaches 21 million BTC. As of October 2012 slightly over 10 million had been created. The current total number of Bitcoins created is available here.

The total number of BTC in circulation over time are estimated in the following graph. The total number of Bitcoins will never be more than the asymptotic limit of 21 million coins.

Advantages Over Other Currencies

Bitcoin enthusiasts site several benefits of using Bitcoins over other traditional currencies:

  • Transaction are peer-to-peer - no central bank or clearing house
  • Fees are lower
  • You can use them in any country, or between any countries
  • Your account cannot be frozen
  • There are no pre-requisites or arbitrary limits
  • Transactions are more anonymous

Advantages for Small Business Owners

The claim is that Bitcoins are changing finance the same way the web changed publishing. For small businesses, Bitcoins have some substantial advantages:

  • Accepting is free
  • No charge back or fees
  • Additional business from the Bitcoin economy.

Do Physical Bitcoins Exists?

Yes, and you can buy BTCs (using Bitcoins) at Casascius.

You can buy Bitbills at

Exchange Rate

The value of a Bitcoin is subject to supply and demand and prices fluctuate widely as compared to traditional currencies. In August 2012, 1 BTC traded around $10 U.S. dollars. Today, Bitcoins are trading around $13. Taking into account the total number of Bitcoins in circulation today, the total monetary base is roughly $130 million U.S. dollars. Several exchanges exists where you can trade your BTCs for US$, Euros, GBP, Japanese Yen and more. Wiki reports as of July 2011, the Mt. Gox exchange handled over 80% of all Bitcoin trade. The website has a banner which lists the last price, high, low, volume, and weight average in a currency of your choice. Here is a chart of the Bitcoin's value since its introduction.

Click to enlarge

Is The Bitcoin Being Adopted?

The volatility of the Bitcoin's value is settling down and an increasing number of online retailers are excepting the currency. New smartphone apps are enabling Bitcoins to be used as easily as cash. From The Economist article:

Tony Gallippi, the boss of Bitpay, which processes Bitcoin payments for retailers, says that his client list has increased from around 100 in March to 1,100 now. These are mostly e-commerce businesses, selling things like domain names and web hosting. But the list also includes a taxi-driver in Chicago and a dentist in Finland. "Credit cards weren't designed for the internet," he says. Bitcoin transactions cost less and cannot be reversed in the way credit-card transactions can be. This is important for firms selling to customers in countries known for credit-card fraud, such as Russia or Belarus.

The article also points out another reason for the currency's success: its role in shady online markets. The currency's relative anonymity makes it a natural choice for criminal activity.

So now back to the original question: is the Bitcoin a threat to EBAY and it's Paypal segment, VISA, and Mastercard? Short-term the answer is obviously no. The currency's $130 million monetary base pales in comparison to the amount of business conducted by PayPal and by major credit card companies. That said, since the maximum number of total Bitcoins is fixed, and since their value is set by marketplace supply and demand, there is nothing preventing the currency's monetary base to grow and become competitive. Since the currency offers small business owners significant costs savings over traditional credit card fees, the incentive is there for those willing to take on the volatility of the currency. That risk is counter-balanced not only by the potential for new business, but also the potential the currency may indeed appreciate. After all, note that a business accepting a BTC for payment in May of 2011 for the equivalent of $5 now has a BTC worth ~$13 - not too bad! Since the BTC can be subdivided into 100-million smaller units ("satoshis"), there is much room for BTC price appreciation yet still have smaller granularity transactions.

This is a fascinating development enabled by the vast distributed nature of the internet. While the Bitcoin might not directly affect a company like VISA today, it may in the not too distant future cut into the company's profit margin. After all, what small business would chose to pay a 5% charge back fee when it could accept a Bitcoin and pay none at all?

However, it must be noted that powerful interests are, or soon will be, aligned against the Bitcoin. Government central bankers, commercial banks, and of course transaction oriented businesses like American Express, VISA, PayPal, and Mastercard would all be against adoption of the Bitcoin. However, if the Bitcoin continues to advance and become a big success it would be great for the average man-on-the-steet. A the same time, many of the above mentioned businesses would become irrelevant. It is therefore quite certain these companies will use their political and financial power to try and put a stop to the Bitcoin. But will they be able to?

If not, EBAY may well be the company with the most to lose. If they begin to support Bitcoins, they could lose out on Paypal transaction fees - Bitcoin users would certainly object to such fees. If they don't accept BTCs, that opens the door for a Bitcoin centric competitor.

EBAY Chart

From Ebay's latest earnings report (available here):

PayPal delivered a strong third quarter performance. It ended the quarter with 117.4 million active registered accounts, a 14% increase over the third quarter of 2011. Revenue increased 23% year over year and net total payment volume (TPV) grew 20% year over year to $35.2 billion. PayPal continues to innovate on a global scale while expanding its addressable market to offline. PayPal's offline initiative is following a three-pronged approach: soliciting direct merchant relationships; partnering with Discover to access its 7 million retail locations in the United States; and using a direct and indirect approach to distribute its small business payment solution, PayPal Here, both domestically and internationally.

With a total payment value (TPV) of over $35.2 billion growing at 20%, it is clear Paypal is a huge growth business for EBAY. In the future, large adoption of Bitcoins could put a big dent in EBAY's financial performance. While today the threat is small, very small, we have seen in the past how fast internet-based initiatives can change business fundamentals. It's certainly something for EBAY stockholders to monitor going forward.

Bitcoins As A Diversified Currency Investment Vehicle

Those looking to diversify their currency bets should consider purchasing BTCs for their appreciation potential. Central banks around the world seem to be printing money as quickly as possible. We see this not only in the U.S., but in Japan and Europe. Other than gold and silver, what better currency to have than one that is limited to 21 million coins, total, forever? Currently, roughly half of the total limit of Bitcoins have been issued. From the curve presented earlier in the article, the growth rate in Bitcoin issuance is still rather step. But notice in 2017 the issuance growth rate begins to slow dramatically as total number of Bitcoins begins to reach its 21 million limit. The time to invest in Bitcoins would be prior to this flattening out of the issuance curve as its value will be more dependent on supply demand and less dependent on issuance.

After all, if one looks at the U.S. dollar value figure shown earlier in this article, Bitcoins have gone from $0 to $13 in about 2 years. No other currency investment can come close to this performance.

I don't know what the future holds for BTCs, but I find it a fascinating subject. And that is exactly why I will be periodically checking Bitcoin related websites to track its progress. That is also why I am considering investing in this new digital currency.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am an engineer, not a CFA. The opinions expressed in my articles are my own. Please do your own research. I cannot be held responsible for investment decisions you make. Thanks for reading and good luck!NOTE: I may initiate a position in Bitcoins over the next 72 hours.