Bitcoin, often touted as a sophisticated digital alternative to traditional currencies, must address several fundamental issues outside cryptographers’ realm before financial institutions embrace it, according to Aite Group.
The primary use of the Bitcoin network today is the exchange of the bitcoin currency—a unit of value that only exists in the digital environment.
In its latest report, "Bitcoin: The Good, the Bad, and the Ugly," Aite Group discusses its understanding of Bitcoin and the ways that traditional financial services companies might engage with it. Aite Group spoke with a wide variety of stakeholders, including merchants, banks, regulators, and Bitcoin enablers.
The research looks at the good, the bad, and the ugly aspects of the cryptocurrency and begins by defining the landscape and examining use cases where Bitcoin is seeing traction. It also examines the abuses that are drawing regulator attention and the obstacles that Bitcoin needs to overcome for further financial success.
Bitcoin relies on a peer-to-peer network of computers, called "miners," for production and processing of bitcoins, harnessing the computational power of the network connected machines to execute the complex calculations required to facilitate bitcoin transactions. As a reward for lending computer power to the network, participating machines are paid in bitcoins; these payments comprise a portion of new bitcoins minted as well as network transaction fees.
Even if Bitcoin doesn’t stand the test of time, its business model is predicted to be successful, though Aite Group sees that some fundamental weaknesses in the original Bitcoin model need to be addressed.
These weaknesses include the self-imposed programmatic limit of 21 million bitcoins in circulation, which leads to deflation by discouraging spending in favor of saving as bitcoin users expect the bitcoins’ value to appreciate over time. There’s also processing overhead, as the computational firepower required to process and produce bitcoins is expensive.
Meanwhile, as bitcoin production slows, transaction fees will theoretically have to make up an increasing proportion of the compensation that bitcoin miners expect, but this is by no means a certain outcome. Lastly, the anonymity inherent in Bitcoin and many of its brethren is a boon to cybercriminals and a significant cause for concern among regulators.
Although Bitcoin has proposed solutions to some of these issues, Aite Group feels that most financial institutions are still sitting on the sidelines at present, keeping tabs on Bitcoin and its brethren but not actively engaging with them.
“How and whether to engage with Bitcoin is not the only question that players in the legacy payment industry should be contemplating,” says Julie Conroy, research director in Retail Banking at Aite Group. “How to address the challenges of Bitcoin 1.0 and capitalize on the platform’s promise represents opportunity for all.”