An Alternate Way To Profit Off Bitcoin

Jun. 2.14 | About: Winklevoss Bitcoin (COIN)

Summary

Bitcoin will grow in popularity since it has advantages over fiat currencies.

The winners of the Bitcoin revolution are Amazon and Overstock.

The losers of the Bitcoin revolution are Visa, PayPal, MasterCard, MoneyGram, and Western Union.

Bitcoin is a currency and a payment system. Bitcoin is a peer to peer currency that eliminates the need for a middle man. Bitcoin has been described as the "internet of money." These are all apt descriptions, but in my opinion probably the best way to describe Bitcoin is that it is a disruptor. Disruptors are companies or products that revolutionize an industry because they are more efficient and drive cost savings to businesses and/or provide more value to the consumer. Netflix (NASDAQ:NFLX) is an example of a disruptor as it is giving consumers more value at a much lower price than the cable companies offer. Industry disruptors can wipe out huge profits from the powerhouses of an industry. Another example of an industry disruption is how Apple's (NASDAQ:AAPL) iTunes is starting to lose business to firms such as Pandora (NYSE:P) and Spotify because those companies have introduced new ways to listen to music that are cheaper and also provide better ways to discover new artists.

Bitcoin has the potential to disrupt two important industries. The first one is the government's monopoly on money creation. This is especially important to countries that do not have a stable currency such as the dollar. The second industry, which is the one that this article will focus on, is the payment system industry. Credit cards are simply not a payment system that works with the internet. It simply does not make sense that customers must give a merchant access to their credit card number which has access to all of their credit, when they are using only part of their credit to make the payment. This sets up companies such as Target (NYSE:TGT) to be extremely vulnerable to a cyber-attack because it holds such valuable information. Bitcoin allows for security by having consumers only give up their private key to merchants which only hold the information for the amount of currency that is needed for the transaction to take place.

The two companies that I'm highlighting in this article that will be helped by this revolution are Amazon.com (NASDAQ:AMZN) and Overstock.com (NASDAQ:OSTK). Overstock has already begun to accept Bitcoin this January, while Amazon has not. Overstock's CEO Patrick Byrne made the following statement on whether Amazon will accept Bitcoin in the future:

"Yes, I actually think that this forces the hand of Amazon and some other big players. They have to follow suit. You will see them follow suit, I'll be stunned if you don't, because they can't just cede that part of the market to us."

To further back up the claim that Amazon will definitely accept Bitcoin in the medium term is the recent announcement that Dish Network (NASDAQ:DISH) will begin the acceptance of Bitcoin starting in July. With a market cap of $27 Billion, it will be the largest company to accept the crypto-currency. If this occurs then Amazon will reap some the rewards that Overstock.com has had. Coinbase is the company that Overstock has gone through to begin accepting Bitcoins as a form of payments without having any currency risk or risk that the value of Bitcoins will decline. According to Coinbase, when it analyzed the first 50 days of purchases with Bitcoin, it found that the average order size using Bitcoin was 34% higher ($226 vs. $168). It also found that 58% of customers using Bitcoin at Overstock were new customers. These are fantastic numbers that helped Overstock's revenues. With regards to an adoption by Amazon these effects may be more muted because Amazon wouldn't have the first mover advantage that Overstock had and because Amazon is a larger company. Even though the effects may be less than at Overstock, the use of Bitcoin will still open up the use of Amazon to a new subset of buyers, so it will raise demand for goods at Amazon.

There are three main benefits to using Bitcoin that Overstock is experiencing and Amazon will experience once it accepts Bitcoin in the next few quarters. They are the following: 1) there is no chargeback fraud, 2) it is a faster method of payment to the merchant, 3) it has lower fees.

According to Visa's (NYSE:V) website a chargeback is the reversal of the dollar value (financial liability), in whole or in part, of a particular transaction by the card issuer to the acquirer, and usually by the merchant bank to the merchant. A chargeback occurs when there are customer disputes, frauds, processing errors, authorization issues, and non fulfillment copy of requests. There are no chargebacks with Bitcoin. Once a person sends a payment in Bitcoin to a merchant such as Overstock, customers cannot get their Bitcoin back without Overstock giving them permission to do so. Preventing this chargeback fraud clearly helps the profitability of the merchants.

The second reason why Bitcoin is advantageous to Amazon and Overstock is that it provides faster payments to merchants. Credit card companies typically delay their payments. On Visa's website it says that merchants typically get paid in 24-48 hours. According to Coindesk, if a merchant requires that the block chain confirm the transaction, it takes about 10 minutes.

The third reason why Bitcoin is better for Amazon and Overstock is that it is cheaper than credit cards. This is the reason why I highlighted these particular companies. It will definitely benefit Dish when it starts accepting Bitcoin, but the lower fees will help these two companies more because both operate in a low margin business. Overstock's net margins averaged out to be 1.8675% from Q4-2012 to Q3-2013. I used margins from one fiscal year to remove seasonality. The fact that this is a low margin business means there will be a huge increase in profitability based on the 1-2% difference in fees between Bitcoin and credit cards. Credit cards typically have about a 2.2% fee plus $.20, while Bitcoin's fees are less than 1%. The revenues that come from Bitcoin are currently relatively small for Overstock, but they are growing rapidly. According to Overstock's CEO the sales in Bitcoin will be from $10 to $15 million in 2014, which is about 1% of the company's $1.3 billion in sales for the year. The original projection was for $5 million, so this is a huge change in projections. If sales continue with the same growth rate throughout the year, they could reach $20 million. Byrne stated that the Bitcoin part of Overstock's business was growing 30% per month.

The companies that will be hindered by this disruption that Bitcoin is creating are the payments processors. This includes the credit card companies such as Visa and MasterCard (NYSE:MA); the money transfer company PayPal (owned by eBay (NASDAQ:EBAY)); and the international money transfer companies such as Western Union (NYSE:WU) and MoneyGram (NASDAQ:MGI). As I have mentioned previously the benefits of Bitcoin lie in its lower fees. Fees are how these companies make money. If Bitcoin takes some of the market for these services, these companies will be hurt. PayPal, for example, charges 2.9% of the purchase plus $.30 per transaction. The fees will have to be lowered in order to compete with Bitcoin. MoneyGram charges 4.9% to send to wire money to Africa from another country. This service will not be able to compete with the low fees Bitcoin offers. Bitcoins are not widely accepted in Africa, but once Bitcoin expands in reach this will be the alternative people turn to instead of using Western Union and MoneyGram. As I have stated earlier, once Bitcoin is accepted by a critical mass of retailers who are motivated by increasing profit margins, it will make sense for consumers to switch to using Bitcoin instead of Visa and MasterCard because Bitcoin is more secure.

Complex current Authorization Process

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Now that I have explained the reasons why Amazon and Overstock will be helped by Bitcoin and why PayPal, Visa, MasterCard, Western Union, and MoneyGram will be hurt by Bitcoin, I will go over ways to make investments based on this thesis. This is an alternative way to try to make money on Bitcoin that probably has much less risk than investing in a Bitcoin startup or speculating on the currency outright. I have not evaluated the entire businesses of all of these companies, so if you believe, for example, that Western Union is overvalued compared to MoneyGram, then you can make adjustments to this investment. What I am proposing is going long the basket of stocks that are helped by Bitcoin and going short the basket of stocks that are going to be hurt by Bitcoin. I am going set up an index for each of the two groups and check on their performance monthly. Keep in mind that this is a long term thesis. I am betting that Amazon's stock will go up based on the news that it is accepting Bitcoin, so this is why it is included in the index.

There are two main risk factors to this investment's profitability. The first is that Bitcoin's effect on some of these companies may not be enough to move the stocks. The two companies I am referring to are eBay and Amazon. 43% of eBay's revenues come from PayPal as of 2014. Therefore, it is possible that other parts of eBay's business do well and cover for the losses that PayPal suffers. I couldn't find a breakdown of how much revenues Amazon gets from retail items that it doesn't produce (retail revenues excluding Kindle products), but I did find that in Q1 2014, 28% of their revenues came from media. A huge part of Amazon's profitability may, in the future, come from the smartphone it is developing and its cloud services, so it is possible that Bitcoin doesn't help them as much as I am projecting it will. In the near term, the effect on all of these stocks will be muted. The fact that only 1% of Overstock's revenues will come from Bitcoin purchases in 2014 proves this point. However, this is a long term thesis that will take at least 2 years to play out.

The second risk is clear. If Bitcoin does not end up revolutionizing the payment processes in the next few years, then this investment may not be profitable. In my opinion, it is a less risky way to bet on the advances in Bitcoin. If Bitcoin doesn't prove to be the payment system of the future, the value of it will go down almost 100% and the startups surrounding it will go out of business. In fact, even if Bitcoin is a success, some of the Bitcoin startups may not do well. This trade is unlikely to lose that much even if Bitcoin is a bust. If Bitcoin does do well there is also an opportunity risk to this investment because Bitcoin will rise more than any profits you will make on this investment. Even if you used options (which would be a good idea) to play this thesis, Bitcoin will surge way more than you can make, if you bet that Western Union will go down and Amazon will go up. In the Bitcoin literature, it states that if Bitcoin becomes the reserve currency of the world, it will go up to $500,000. That is clearly a huge increase from the $645 that it is at today.

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 do not currently own any Bitcoin, but I may buy some in the coming weeks.