Cryptocurrency As A Means Of Payment Of The Future?

Cryptocurrencies are at least partly responsible for the upheaval currently taking place on the international financial markets. Assessments of the potential of digital currencies vary widely. While some see them as the future of payment, others believe they represent a gigantic speculative bubble.

The Marshall Islands are the first (and at the same time almost the smallest) state in the world to plan to introduce cryptocurrencies as legal tender. Other states, such as South Korea or Japan, only accept Bitcoin as a means of payment. But what is the difference between an accepted and a legal tender? And do cryptocurrencies really have the potential to be accepted as a means of payment online and offline in the future?

General Information about Cryptocurrencies

Cryptocurrencies are digital currencies that are not issued by a central bank. Instead, the basis of these currencies is a peer-to-peer network. Characteristic of cryptocurrencies is therefore the absence of a regulating organization (e.g. central bank). Accordingly, there is no possibility of intervention by a higher-level organization.

The value of cryptocurrencies is determined solely by supply and demand, as they have no official equivalent value. The first digital coins were created with Bitcoin in 2009, and today there are several thousand cryptocurrencies. In addition to Bitcoin, Ethereum, Ripple and Litecoin are now particularly popular.

As a rule, cryptocurrencies use the so-called blockchain technology. This is a kind of logbook where it is recorded who owns the respective digital coin. The cryptocurrencies are created by calculating very complex mathematical processes (so-called mining).

Requirements for a Legal Tender

Meanwhile several countries have introduced Bitcoin as legal tender. For instance Japan and El Salvador. Even the Marshall Islands had already announced in July 2018 that they plan to do just that. But what is legal tender anyway? According to the German Bundesbank, legal tender refers to “the means of payment that no one can refuse to use to satisfy a monetary claim without suffering legal disadvantages.”

This means that every private person and every merchant must accept a legally recognized means of payment. In the euro area, euro cash is the only legal tender. Only the central banks are authorized to put this means of payment into circulation. While euro coins have only limited legal tender status (no one is required to accept more than 50 coins), euro banknotes are the only unrestricted legal tender.

At the current time, therefore, the introduction of cryptocurrencies such as bitcoin as legal tender in the euro area remains a distant vision. After all, this step would mean that everyone would have to accept Bitcoin as a means of payment without restrictions. And so far this is rather realistic for digital services bought online.

Distinction between Legal and Accepted Means of Payment

In addition to legal tender, there is also the concept of accepted means of payment. For example, Bitcoin is considered a legal, i.e. accepted, means of payment in South Korea, Japan and also in the Philippines. However, this only means that it is permitted to use the digital currency Bitcoin for payment transactions.

However, since this is not a legal tender, no merchant has to accept Bitcoin payment. But there are more and more industries online, especially in the field of software and privacy related services, where crypto payments get more and more common use.

digital service onlineMany people like to use cryptocurrencies to pay for their VPN service or their Smart DNS service, also if they just use it to watch Hulu when they are abroad or to get access to XBOX contents from other jurisdictions, just to name some concrete use cases for crypto payments online.

The status as an accepted means of payment results in particular in strict official regulation. In this case, for example, exchanges and financial service providers must adhere to government regulations, just as they do with other currencies. In Japan, for example, Bitcoin has been considered an accepted means of payment since April 1, 2017.

Since then, however, it has also had to comply with regulations on cyber security, share capital, as well as anti-money laundering laws and the “Know Your Customer” (KYC) principle.

However, there are also some countries where cryptocurrencies are illegal. These include Bangladesh, Ecuador, Bolivia, Qatar, and Kyrgyzstan.

Marshall Islands to Introduced Cryptocurrency as Legal Tender

The Republic of Marshall Islands is an island nation in central Oceania. With a population of just over 50,000, the Marshall Islands is one of the smallest states in the world. The island nation recently revealed that it plans to become the first state to grant legal tender status to a cryptocurrency – as early as the third quarter of 2018. Called “SOV,” it plans to release its own cryptocurrency via a so-called Initial Coin Offering (ICO). To prevent inflation, government officials have said that a maximum of 24 million virtual SOV coins will be brought to market.

The digital currency of the island nation, which is located between Australia and the USA, is to use the well-known blockchain technology, similar to the Bitcoin model. In order to acquire the tokens of the Marshall Islands, the investor has to legitimize himself to the government. The wallets will also be linked to an identity token. This is intended to prevent the misuse of cryptocurrencies, for example for tax evasion, money laundering or terrorist financing.

The Marshall Islands is not the first country to raise money from international investors with a state-owned cryptocurrency. Just recently, economically struggling Venezuela attempted to acquire funds with its own digital currency, “Petro.” According to the government there, the cryptocurrency is backed by one barrel each, or 159 liters of crude oil reserves.

However, since the Marshall Islands are insignificant in macroeconomic terms, there can be no talk of a major breakthrough of cryptocurrencies as (legal) tender here yet.

Transaction Costs and Speed as Arguments against?

In order for cryptocurrencies to establish themselves as a means of payment across the board, a high transaction speed is of great importance, among other things. Unfortunately, this seems to be (still) a major weakness of many cryptocurrencies. Bitcoin, for example, currently allows only 7 transactions per second (according to Segwit2x: 9.6 per second). Other digital currencies such as Ethereum or Bitcoin Cash also currently only manage 20 and 92 transactions per second, respectively.

By comparison, the e-wallet provider PayPal manages up to 450 transactions per second; the VISA credit card even up to 56,000 transactions per second. The transfer of cryptocurrency only takes so long because each transaction must be checked by the network (blockchain) and the payment validated accordingly. This process can take several minutes or even several hours – so it is certainly still too long for a retail payment. However, it should be noted that the transaction speed for cryptocurrencies is being optimized more and more.

Another decisive factor for whether cryptocurrencies are accepted as a means of payment is the transaction costs incurred. These differ depending on the digital currency chosen. For a Bitcoin transaction, 30 satoshis per byte are currently charged as a fee. On average, 225 bytes are required for an average transaction. This means that the transaction fee is about 6,750 Satoshi on average. Currently, 1 Satoshi = 0.00000001 BTC. Accordingly, the transaction fee is 0.0000675 BTC. The transaction fees are levied, among other things, to prevent the pointless transfer of very small amounts and thus overloading (so-called denial-of-service attacks). Of course, charging transaction fees is not attractive if cryptocurrencies like bitcoin want to make it as a means of payment in the future.