Fitch: Regulation Could Rob Bitcoin of its Low-Cost Appeal

Global credit rating agency Fitch Ratings believes bitcoin is still too small to affect traditional payment systems and national currencies. The agency's Why Forum published its findings in a report on bitcoin, dubbed 'Sizing up Bitcoin’.

The report points out that bitcoin transactions in February 2014 averaged a meagre $68m per day. Despite a tenfold increase year-on-year, bitcoin's average daily transaction volume pales in comparison to Western Union and PayPal. The two payment processors averaged $225m and $492m per day in 2013.

Fitch examined bitcoin's potential role in the financial markets from three different perspectives: as a payment system, an asset and a currency.

Credit Card comparison

Fitch also found bitcoin's transaction volumes to be practically negligible when compared to major credit card companies.

Visa and MasterCard averaged $19bn and $11bn per day in 2013 respectively. In contrast, bitcoin is simply off the chart.

What's more, Fitch points out that bitcoin's transaction volume also has to be put into perspective, due to its huge price appreciation last year. The price went up, along with the overall volume, but the actual number of transactions did not grow at nearly the same pace.

"In other words, the average size of a bitcoin transaction (in dollar terms) rose significantly, while the amount of transactions per day remained much more stable. From February 2013 to February 2014, the average size of each transaction rose from about $100 to roughly $1,000," Fitch said.

Risky investment

Looking at bitcoin from an investment perspective, Fitch found that bitcoin's price volatility resembles an investment rather than a currency.

"There is no asset class the same as bitcoin, but comparing its price swings to other currencies and commodities can put the volatility in context," Fitch concluded.

"From a trading perspective, bitcoin transaction volumes relative to the stock of outstanding bitcoins resemble those of equity securities."

Regulatory ambiguity is another risk brought up by Fitch. The firm points out that regulatory attitudes vary from country to country, but authorities in most countries have issued warnings and informed consumers and investors of the risks posed by digital currencies.

In addition to the standard list of warnings which includes money laundering, tax fraud and illegal transactions, bitcoin's tax status appears to be a much bigger concern. Taxation, in addition to regulation could quickly render bitcoin unappealing.

Fitch came to an ominous and rather obvious conclusion:

"The future of digital currencies will partially depend on the way public concerns are addressed. It is possible that, if the use of bitcoin were to be regulated as tightly as the use of conventional currency, bitcoin’s appeal as a low-cost means of exchange would decrease significantly."

Bitcoin as a currency

Bitcoin's market cap, or its size as a currency measured by M1 is insignificant compared to national currencies. Bitcoin is smaller than Guatemala's Quetzal, with a capitalization of $6.75bn in late February. Bitcoin is even smaller today, with a market cap of just $5.6bn.

"So far bitcoin is mainly used between private individuals. There are, however, a number of companies that have begun to accept bitcoin as a form of payment. The majority of these companies immediately transfer their bitcoin into local conventional currency in order to avoid significant currency risk due to the price instability of bitcoin. The current price instability is a shortcoming of bitcoin as a standalone currency," the firm pointed out.

Fitch concluded that much of bitcoin's appeal stems from its pseudo anonymity, including people interested in illicit activities and privacy-minded individuals. Another factor is bitcoin's ease of use and it independent nature.

The firm also touched on some altcoins such as litecoin and peercoin, but it concluded that most of them are based on the same principle and technology as bitcoin, but they tend to offer different features.

Curiously, 'Sizing up Bitcoin' ends with next to no conclusion. The report outlines the basics and brings up numerous challenges, which are debated by bitcoin advocates and detractors on a daily basis.

The takeaway appears to be simple: it all depends on regulators. If bitcoin operators are forced to undergo tight regulatory oversight, the regulatory burden could render bitcoin's low-friction network less competitive compared to traditional payment systems. Bitcoin faces the same challenge when it comes to low-cost remittances.

On the other hand, the added cost would to some extent be offset by more stability and long-term security which is necessary for mainstream adoption. As is the norm in the world of bitcoin, regulation it is a catch-22 and a delicate balancing act.

Bitcoin charts courtesy of Fitch Ratings Why Forum.