What You Should Know Before You Use Cryptocurrency for Payments

What-You-Should-Know-Before-You-Use-Cryptocurrency-for-Payments

With more and more companies enabling cryptocurrency payments, should businesses and consumers buy into the new trend?

When Satoshi Nakamoto first created Bitcoin, the aim was to provide the world with a decentralized payment system that was not controlled by financial institutions. The blockchain system was designed to eliminate banks and financial authorities from the payments equation. In simple words, Nakamoto wanted people to be able to freely send payments to each other without having to depend on a bank.

But the real use of Bitcoin has deviated far from Nakamoto’s original vision. Instead of being used as a currency, Bitcoin and other similar digital currencies are largely used as a speculative investment instrument, i.e., securities.

Companies and retail traders alike are rushing to invest in Bitcoin to milk its phenomenal rise over the past six months. The intention is mostly to profit by selling it at a higher price later, not to buy goods with it. Some are even using Bitcoin as a hedge against inflation. This means that Bitcoin is being used as a store of value similar to gold – the only difference is that it is digital.

Of late, there has been significant interest and efforts to further the use of cryptocurrencies as a medium of exchange, per Nakamoto’s original vision.

Last month, for instance, PayPal launched ‘Checkout with Crypto,’ a feature that allows users to pay millions of merchants with Bitcoin, Litecoin, Bitcoin Cash, and Ethereum. It is to be noted, however, that the merchants do not receive cryptocurrencies as payment. Instead, PayPal converts the cryptocurrencies into fiat currencies, which is what the merchants receive.

To the question of using cryptocurrencies as a medium of exchange, there are two perspectives to consider – those of the payer and the payee. Let’s look at the advantages and disadvantages of using cryptocurrencies as actual currencies from both perspectives.

Using cryptocurrencies as a medium of exchange

There are several advantages of using cryptocurrency as a medium of exchange. While some benefit either the payer or the payee, others benefit both parties to the transaction. Here are some key considerations to cryptocurrencies as a medium of exchange:

1. Using cryptocurrency for international payments is faster than traditional cross-border payment methods. For instance, if you’re paying someone living in a different country in Bitcoin, they will receive the payment almost instantly, although the transaction confirmation on the blockchain takes up to 10 minutes.

2. For businesses, using cryptocurrency for payments reduces credit risk since cryptocurrency wallets need to have balance in order to carry out transactions.

3. Transaction fees for cryptocurrency payments can be lower than traditional payment methods, especially in case of cross-border payments.

According to World Bank data, the global average cost of international payments is 6.51% (Q4 2020). Comparatively, cryptocurrency transaction fees are minuscule. Therefore, using cryptocurrency for international remittances can substantially benefit businesses that have to send payments to multiple vendors or employees abroad.

It is to be noted however, that the transaction fee of cryptocurrencies is skyrocketing amid the growing crypto craze. For instance, the average Bitcoin transaction fee is roughly US$59 at present — an all time high. Similarly, Ethereum’s transaction fee shot up to $24 in late March, from $2-$4 at the end of 2020.

While the transaction fee generally settles down in the long term, in the short term, the high transaction fee can negate the advantages of using cryptocurrency for payments.

4. Since cryptocurrencies operate on a blockchain, crypto payments are secure and confidential. It may not be impossible to track down crypto payer or payee information, but it certainly is difficult.

This is because cryptocurrency transactions are recorded with anonymous wallet addresses, which are comprised of a string of letters and numbers. For people and businesses looking to keep their identity confidential and ensure a secure transaction, cryptocurrencies are a good bet.

5. Businesses that operate in several countries can use cryptocurrency transactions to eliminate the hassle of maintaining multiple currency accounts. But this advantage only applies if the company solely uses cryptocurrency for all transactions. Otherwise, cryptocurrency wallets just add to the list of different currency accounts that the business needs to maintain.

6. Payers can also hedge themselves against the volatility of fiat currencies by using cryptocurrencies for cross-border payments. This is especially beneficial when the businesses regularly send payments to countries that have highly volatile fiat currencies.

7. For small businesses, using cryptocurrency can offer protection against chargeback frauds. No third-party can reverse a cryptocurrency transaction and the ability to return any money rests solely with the business.

8. Since cryptocurrencies are a popular investment tool, businesses can choose to hold them for capital gains. Tesla earned a hefty profit by selling 10% of its Bitcoin holdings. (But the company recently made a U-turn on its decision to accept Bitcoin for payment over environmental concerns.)

Therefore, transacting in cryptocurrencies can open a gateway for businesses to earn profits from cryptocurrency trading. However, it is a double-edged sword. Consumers choosing to pay with cryptocurrencies lose out on the opportunity to earn capital gains from them.

This essentially means that over the long term, customers may be paying more than the stipulated price for goods or services, since the value of the cryptocurrencies can appreciate. In 2010, programmer Laszlo Hanyecz paid 10,000 bitcoins for two pizzas. At the time of writing, the value of those bitcoins is more than $448 million.

9. Millennials are more enthusiastic about cryptocurrencies than any other generation, and also represent a significant size of the global population. Therefore, accepting crypto payments can help businesses attract more millennials. And the more businesses accept cryptocurrency payments, the more cryptocurrency adoption will increase.

Disadvantages of using cryptocurrency for payments

The realm of cryptocurrencies as a medium of exchange is not entirely a bed of roses. Here are some key pitfalls to watch out for:

1. Cryptocurrencies are notorious for their volatility. The value of Bitcoin surged over 200% in 2020, from a little over $5,000 in March 2020 to over $28,000 by December that year. Moreover, the price rallied to an all-time-high of over $60,000 last month.

Interestingly, despite the unprecedented bull run which has pushed Bitcoin prices sky-high, its volatility has reduced. Fluctuation in Bitcoin prices have been found to be less severe compared to its earlier bull runs during the last six months.

At the time of writing, Bitcoin is trading at a low of mid $44,000.

Although price fluctuations have reduced, potential profits or losses can still impact users significantly.

For instance, if a business does not immediately convert cryptocurrency payments into fiat currency, they stand to make a loss if the crypto prices drop. However, the price of cryptocurrencies may also appreciate during the same time, and result in a profit.

Either way, cryptocurrencies have been avoided in payments for a long time because of their volatility, which is why stablecoins have gained prominence of late.

2. Recent crypto regulations introduced by some countries can hinder the adoption of cryptocurrency for payments. For instance, Turkey recently banned cryptocurrency transactions, while India is currently mulling a sweeping cryptocurrency ban. For businesses operating in regions that either have anti-cryptocurrency regulations, or lack a clear crypto regulatory framework, cryptocurrency payments may be a dicey bet.

Despite these drawbacks, cryptocurrency payments are likely to grow in the future. But they have a long way to go before turning mainstream, and coming close to replacing fiat currency. Not only do cryptocurrency prices need to dial down the volatility, but businesses and consumers need clear regulatory frameworks that enable effective cryptocurrency transactions in the future.

Header image by Executium on Unsplash

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