The CFO’s Guide to Bitcoin, Part 1: The Basics

80,000 businesses already accept bitcoin. And to echo a recent Entrepreneur article, “Why not yours?”

It’s no longer an idle question.

If the bitcoin question hasn’t landed on your doorstep, it will soon. The Wall Street Journal op-eds are already here. So are eyebrow-raising headlines announcing things like PayPal’s embrace of bitcoin.

Customers will want to know. Business partners will mention it. Soon, the boss will ask. And, accountants and financial executives will be among the first required to weigh in.

Should your business accept bitcoin?

It’s a complicated question.

After all, even former U.S. Treasury Secretary Tim Geithner says he doesn’t quite understand Bitcoin.

The bitcoin decision may not have an obvious answer. In fact, we won’t have real data on bitcoin’s long-term acceptance, price stability, and potential viability versus cryptocurrency competition for years.

But a couple things are sure to happen before those results get tallied. Consumers are going to continue to spend bitcoins. And, someone’s going to ask for your opinion on whether your company should accept them.

Time to get up to speed!

How Does Bitcoin Work?

There are many great articles that go into depth on the nitty-gritty of the bitcoin protocol. This is not one of those articles. There’s just too much to get to from the bitcoin business and accounting angle.

But if you want to understand how the techy stuff works, I won’t leave you hanging, either. If you don’t know bitcoin from bitly, check out:

• Bitcoin.org on “How does Bitcoin Work?”,
• The Bitcoin wiki introduction,
• CoinDesk.com’s “What is Bitcoin?”,
• And (the compellingly titled) “Explain Bitcoin Like I’m Five.”

To start thinking about the bitcoin business case, though, there’s just a few basics you need to know about the bitcoin technology:

• Bitcoin is a peer-to-peer system for the exchange of digital cash.
• It is a protocol, a network, and a currency.
• It’s both anonymous and transparent. All transactions are public, you just don’t know whose they are.
• The currency is not backed by any government or commodity.
• There can only ever be 21 million bitcoins. But they are divisible into one hundred millionths.
• The bitcoin system derives its integrity from mathematics and cryptography. “Miners” create bitcoins by solving complex computations. Each solution proves the spender of a bitcoin is its owner.

How Can Bitcoin Reduce the Cost of Doing Business?

Or, to translate the question into accounting-ese, “Why should I care?”

Bitcoin enables a number of cost-savings opportunities. None are more significant than minimizing credit card processing fees.

A 3% credit card processing rate is common. Processing $1,000,000 in credit card transactions at that rate, therefore yields fees of $30,000. Using bitcoins for a similar transaction volume would likely cost somewhere between $0 and $10,000.

Sometimes it’s misreported that bitcoin is totally free. But the bitcoin network does require a fee in certain circumstances. It’s a small, variable amount. The technical details of each transaction determine the sum. And, yes, in some cases, there is no fee at all. Bitcoin merchant software provider Coinbase estimates the cost of this fee at between .0001 and .0005 BTC. (This is under $.20 based on current Bitcoin exchange values.)

Remember, bitcoin is peer-to-peer. So you don’t need to work with a 3rd party to receive bitcoin payments. But many companies offer to handle these nominal fees as part of their standard service pricing. (The aforementioned Coinbase doesn’t charge on transaction processing, but charges 1% to cash out bitcoins to dollars.)

Are There Any Other Potential Cost-Savings?

Using a digital currency like bitcoin enables some other cost-saving drivers as well.

Bitcoin transactions are non-reputable. There is no such thing as a chargeback. There are no overdrawn accounts and bounced checks. Consumer chargebacks cost retailers up to $11.8B annually. But the distributed consensus system bitcoin relies on disallows the possibility of chargebacks by verifying bitcoin ownership before making the transfer. (Want to know more about how bitcoin prevents chargebacks? There’s a great article at BTCTheory.com on the subject worth checking out.)

The news cycle has also been loaded with instances of high profile credit card data breaches. The recent Home Depot breach alone compromised some 56 million credit cards. And the December 2013 Target breach reportedly cost the company $100M. (VentureBeat.com) When customers pay with bitcoins, however, they are not turning over any sensitive data. As such, there is no cost related to stewarding confidential info. And, consequently, there is no liability for its compromise.

There’s also another burgeoning opportunity for cost savings on the buy-side. Think back to the difference in processing fees for credit card and bitcoin transactions. That delta gives retailers and suppliers a strong reason to incentivize bitcoin spending. And, some are doing just that. Computer giant Dell recently ran a pilot promotion discounting computers for consumers purchasing with bitcoins.

Are There Other Business Benefits?

There’s a popular vision of the accounting department as organizational naysayer. You know, the same stereotype where the CFO is the red-pen wielding curmudgeon.

I’m not naive enough to say that model is totally passe. But it’s also too limiting a viewpoint of the role of most modern financial executives. A more expansive view is coming into focus. Deloitte’s “Four Faces of the CFO” description put it this way: “CFO’s take a seat at the strategy planning table… They are vital in providing financial leadership and aligning business and finance strategy to grow the business.” Bitcoin acceptance offers not only tactical cost-cutting, but additional revenue-generating opportunities.

What kind of revenue opportunity does bitcoin acceptance present for strategic growth? The market capitalization of all bitcoins based on current market exchange rates is $5.5B in USD. (Blockchain.info) Sure, that pales in comparison to the $1.2T of US currency currently in circulation. (NewYorkFed.org) But it would have placed bitcoin ahead of the market capitalization of all but 24 nations’ M0 (cash) currency supplies as of 2007. (MarketOracle.co.uk)

The bottom line is that there’s a lot of bitcoin out there. It has value. And, people want to spend it. For many companies, that will smell an awful lot like opportunity.

From the customer-satisfaction perspective: It’s a win to tell your bitcoin toting customer that you (and not your competitor) can accommodate their spending preference.

Over on the marketing side: There’s no shortage of news organizations and bitcoin evangelists hunting down early adopter stories to share with their audience.

What Are the Risks?

Bitcoin offers some unique business opportunities. But it doesn’t come without risk.

There are three main areas of risk to consider: long term viability/valuation concerns, security threats, and ongoing operation costs.

The $64,000 questions are: Will bitcoins hold their value? And, is the currency here to stay?

It’s not hard to understand why the questions persist. In October 2013 a bitcoin had a value of around $125 USD. In December of the same year rose to over $1,100. Currently, a bitcoin is worth about $400. 10% daily fluctuations in value are not uncommon.

It’s a level of volatility that could make any financial executive queasy. Depending on the timing of a transaction relative to the moment of accounting, a given transaction action could easily go from nice profit to failing to cover costs. Or, the profitability could double or triple.

Barry Silbert, the founder of Bitcoin Investment Trust summed it up this way: “It is pretty much the highest-risk, highest return investment that you can possibly make.”

But it is possible to do business in bitcoin without taking on the investment risk. It’s an important fact that many business leaders may not yet realize. The two leading providers of bitcoin merchant solutions, BitPay and Coinbase, both offer instantaneous conversion of transactions into USD. Eliminating bitcoin holding time negates the possibility for unfavorable exchanges.

The security threat is tougher to parse. The Consumer Financial Protection Bureau released the following warning earlier this year:

Virtual currencies may have potential benefits, but consumers need to be cautious and they need to be asking the right questions. Virtual currencies are not backed by any government or central bank, and at this point consumers are stepping into the Wild West when they engage in the market.

Thefts, fraud, and scandals related to bitcoin companies have been in the news frequently, of course. An article in Wired estimated the amount of the loss on the infamous Mt. Gox debacle at over $460M. (A forum entry at BitcoinTalk.org maintains an updated list of bitcoin heists worth checking out.)

An important distinction should be made though when it comes to bitcoin and bitcoin companies. All bitcoin thefts so far have involved the transfer of end-users’ private encryption keys to 3rd party bad actors. The bitcoin wiki maintains:

In the history of bitcoin, there has never been an attack on the block chain that resulted in stolen money from a confirmed output. Neither has there ever been a reported theft resulting directly from a vulnerability in the original bitcoin client, or a vulnerability in the protocol. Bitcoin is secured by standard cryptographic functions. These functions have been peer reviewed by cryptography experts and are considered unlikely to be breakable in the foreseeable future.

The final major risk to consider in terms of business bitcoin adoption involves supporting costs. While bitcoin payment acceptance opens a revenue channel and offers efficiencies, there are program costs. Key decision makers will need to spend time analyzing which service providers (if any) should be chosen. There are accounting and taxation ramifications tied to bitcoin acceptance that require special attention. And, employees will require training to execute transactions.

For more on bitcoin issues relating to the accounting department, make sure to stay tuned for “The CFO’s Guide to Bitcoin, Part 2: Accounting and Taxes.” Part 3 of the series will follow and focus on business issues related to bitcoin invoicing and payment acceptance.