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Abstract and Figures

The peer-to-peer virtual currencies market is one of the most exciting markets of our time, driven by an ocean of innovation which is changing its shape every day. In this ocean there is Bitcoin, which is a superlative of what a community together can do. Every day new features and services are added to Bitcoin and there are hundreds of people making sure that the Bitcoin network and its ecosystem is always updated and with improving quality.
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Semester: Spring 2014
Title: Distributed Virtual Currencies The Bitcoin Case
Project Period: February 2014-June 2014
Semester Theme: Design and Markets
Supervisor(s): Iwona Maria Windekilde
Project group no.: 1-2.2
Members: Md. Kamrul Islam
Vasiliki Ntarzanou
Miguel Portela
Fernandes de Almeida Pereira
Copies: 2
Pages: 90
Finished: 27/5/2014
The peer-to-peer virtual currencies market is
one of the most exciting markets of our time, driven
by an ocean of innovation which is changing its
shape every day. In this ocean there is Bitcoin, which
is a superlative of what a community together can
do. Every day new features and services are added to
Bitcoin and there are hundreds of people making
sure that the Bitcoin network and its ecosystem is
always updated and with improving quality.
In this project Bitcoin is being studied in
detail and the authors will introduce a new tool that
will be used to analyze many of the different aspects
related to Bitcoin. This framework will be called
BitPIN Framework and will include several
theoretical frameworks that are crucial to the
understanding of the ecosystem of Bitcoin, in an
attempt to find out the reasons for the development
and growth of virtual currencies the last few years as
well as what the near future holds for them.
Aalborg University Copenhagen
A.C. Meyers Vænge 15
2450 København SV
Semester Coordinator: Henning
Secretary: Maiken Keller
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Table of Contents
............................................................................................................................................... 1
1 Introduction ....................................................................................................................... 4
1.1 Motivation ................................................................................................................. 6
1.2 Problem Definition .................................................................................................... 8
1.3 Methodology ............................................................................................................. 8
1.4 Delimitations ........................................................................................................... 10
2 State of the Art ................................................................................................................ 12
2.1 Background .............................................................................................................. 12
2.2 Categories of virtual currencies ............................................................................... 14
2.3 Regulatory issues ..................................................................................................... 17
2.3.1 Germany: ......................................................................................................... 18
2.3.2 Scandinavia: ..................................................................................................... 19
2.3.3 China: ............................................................................................................... 20
2.3.4 USA: ................................................................................................................. 20
2.3.5 Iceland ............................................................................................................. 20
2.4 The Bitcoin Ecosystem ............................................................................................. 20
2.5 The Bitcoin Algorithm .............................................................................................. 21
2.6 Privacy ..................................................................................................................... 22
2.6.1 Voluntary Disclosures ...................................................................................... 23
2.6.2 TCP/IP Layer Information ................................................................................ 23
2.7 Security .................................................................................................................... 23
3 Theoretical frameworks .................................................................................................. 26
3.1 Convergence ............................................................................................................ 26
3.1.1 Definition ......................................................................................................... 26
3.1.2 Historic Perspective ......................................................................................... 26
3.1.3 Types of Convergence ..................................................................................... 27
3.1.4 Drivers of convergence .................................................................................... 27
3.2 Innovation................................................................................................................ 28
3.2.1 Diffusion of innovation .................................................................................... 29
3.3 Network Economics ................................................................................................. 31
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3.4 Lock-in Effect ........................................................................................................... 33
3.5 Demand & Supply .................................................................................................... 34
3.5.1 Demand ........................................................................................................... 34
3.5.2 Supply .............................................................................................................. 35
3.5.3 Supply and Demand ......................................................................................... 36
4 Analysis ............................................................................................................................ 38
4.1 Analytical Framework .............................................................................................. 38
4.1.1 The Bitcoin Network-Services and Users ......................................................... 39
4.1.2 Demand & Supply in the Bitcoin Network ....................................................... 43
4.1.3 The need for Innovation in the Bitcoin Network ............................................. 46
4.1.4 The role of Network Effects and Lock-in in Bitcoin ......................................... 53
4.1.5 The role of Convergence in the Bitcoin Network ............................................ 55
4.2 Analytical overview ................................................................................................. 60
5 Discussion ........................................................................................................................ 63
5.1 Peer-to-peer currencies popularity - Front runner discussion ................................ 63
5.2 Future trends ........................................................................................................... 66
5.2.1 Virtual Currencies and regulation .................................................................... 67
5.3 Bitcoin: A Standard of virtual currencies? ............................................................... 68
6 Conclusion ....................................................................................................................... 70
6.1 What are the main reasons for the monetized peer-to-peer virtual currencies’
growing popularity? ............................................................................................................ 70
6.1.1 What are the reasons behind Bitcoin’s supremacy to other peer-to-peer
currencies (economic and technological perspective)? .................................................. 71
6.2 What are the possible future trends regarding peer-to-peer virtual currencies? .. 71
6.2.1 What are most important regulatory trends related to virtual currencies? ... 72
6.2.2 Is a standard being formed (Bitcoin), or is there a growing spread of virtual
currencies being used? ................................................................................................... 72
7 References ....................................................................................................................... 74
7.1 Internet references .................................................................................................. 77
8 Appendix .......................................................................................................................... 81
8.1 Timetable ................................................................................................................. 81
8.2 Bitcoin Survey Results ............................................................................................. 81
8.3 Interview .................................................................................................................. 88
8.4 Comparison Table. ................................................................................................... 90
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1 Introduction
The exploding growth in the number of internet users since its creation a few
decades ago, as well as the technological advancements, have led to a universal
platform for online trading, gaming, social networking and information exchange.
And as in all social structures created by humans, in the last few years, we have also
witnessed the creation of virtual communities of people with common interests that
need to interact with each other (online gaming communities, Facebook etc.) within
the web. Within these communities, there was a need for exchange of goods (usually
virtual) and services and thus they created digital currencies to serve this purpose,
creating a new type of money, which is not regulated by governments or financial
Immediately this becomes a center of discussion about the extent to which this
type of currency has or can have positive or negative effects on the economy. The
European Central Bank or ECB (Anon 2012), in an attempt to clarify and define what
virtual currencies are, provides the following definition: “a virtual currency is a type
of unregulated, digital money, which is issued and usually controlled by its
developers, and used and accepted among the members of a specific virtual
One possible classification of virtual currencies is to divide them in three types
based on how they interact with currencies in the real economy(Anon 2012). The first
one can be described as a closed scheme, which is typically used in online games,
where players after paying a subscription for the game, earn virtual money as the
game progresses and according to how well they perform. This type of virtual
currency cannot be traded with real currencies and it’s only used for the purposes of
enabling the exchange of virtual goods in a specific virtual community.
The second type is a scheme that uses a unidirectional flow with the real
economy. In this scheme the virtual currency can be bought using real money but it
cannot be exchanged back to real money afterwards. It is mainly used for the purchase
of virtual goods and services as for example Facebook Credits (FB), Facebook’s
virtual currency.
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The third scheme provides a bidirectional flow. In this case, virtual money is
exchanged as any other currency in the real world and can be used to buy both virtual
and real goods and services, as is the case of the virtual currency Bitcoin.
The rate at which virtual currencies are exchanged is based on the demand and
supply for the specific currency. There is no central control from a financial
institution over these currencies and they are not regulated or undergo supervision like
electronic money issuers, for example, are (ECB, 2012).
Figure 1: Types of virtual currency schemes (ECB, 2012)
All these characteristics of virtual currencies have of course raised
discussion about their safety and reliability as well as the risks that their use might
engage. On the other hand virtual currencies can also be seen as a promoter of
innovation and an enabler of an alternative type of payment in the digital world.
Especially in the third type of virtual currencies we can even see competition
between these currencies and real currencies. Bitcoin is one of the cases that this
applies to, as a virtual currency that is gaining popularity and attempts to bypass the
traditional financial system, where central banks regulate the money supply and
currencies are regulated.
Another way to differentiate between the different types of virtual currencies
is technology-wise. Here there are two categories; the type which uses a client-server
model and the type that uses a distributed peer-to-peer model for the currency.
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The Bitcoin case:
Bitcoin was created in 2009 by Satoshi Nakamoto(Sompolinsky, Y. et al.
2013) using a peer-to-peer scheme with no central control over the money flow by a
financial institution and today it is one of the most exemplary cases of virtual
currencies (ECB, 2012). It can be used for the purchase of goods and services of all
types, just like any real currency, like the euro or the US dollar. The demand and the
supply of Bitcoin are the only factors that influence the exchange rate. There are
many online exchange platforms for it and users are responsible for performing public
transactions with no intermediaries. Bitcoin users have their own digital wallet (free
software) on their computer or mobile device and transactions are anonymous and
performed from computer to computer. In addition, there are no or very low
transaction costs charged. Transactions are registered and stored after they are first
validated by the Bitcoin network and this task is performed by “miners”.
Miners are computers in the Bitcoin network with significant computing
power that perform complex mathematical computations and obtain Bitcoins after
they solve the mathematical problems, thus creating new Bitcoins that go into
circulation in the Bitcoin network. Bitcoin is designed in such a way that the
complexity of the computations to be done by miners increases as more Bitcoins are
mined and this happens until they reach a maximum of 21 million.
The discussions around Bitcoin include illegal activities in the Bitcoin network
(for example money laundering), caused by the feature of anonymous transactions. In
addition, there have been many cases where malware was used to steal digital wallets
from their owners as well as many other hacking activities that compromise the
integrity of the system. Such security as well as legality issues have yet to be faced by
the Bitcoin community today.
1.1 Motivation
These are very exciting times in the virtual world. Internet usage is increasing
every month and so do the Quality of Service and the bandwidth. This growth is
general both in the developed world and in the developing countries as presented in
figure 2 below [1].
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Figure 2: Internet users per 100 people. Source: [2].
All this growth has led to innovation in the way that online payments are done
on the Internet. Crypto currencies are using the various open source algorithms and
technologies, like peer to peer algorithms.
Bitcoin is the most prominent crypto currency nowadays and it’s valuation in
the last few years made it come from the shadows to the mass market. The fact that
this currency respects the very basic supply and demand system makes it have very
fast and wide variations in contrast with regulated currencies(figure 3 below).
The case of Bitcoin is a very interesting one, both from a technological but
also from an economical point of view. The fact that a technology like Bitcoin has
managed to disrupt the financial and banking systems of the whole world makes it an
appealing case study. In addition, research on this case is a good combination both
from an engineering point of view but also from the learning perspective in the
business track of our study program.
Another reason that we chose this case study, is that some of the authors of
this project have been using Bitcoin and have been extremely interested in this
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Figure 3: BitStamp in USD. Source:[3].
1.2 Problem Definition
What are the main reasons for the monetized peer-to-peer virtual currencies’
growing popularity?
What are the reasons behind Bitcoin’s supremacy to other peer-to-peer
currencies (economic and technological perspective)?
What are the possible future trends regarding peer-to-peer virtual currencies?
What are most important regulatory trends related to virtual
Is a standard being formed (Bitcoin), or is there a growing spread of
virtual currencies being used?
1.3 Methodology
In this chapter we present the tools we used in this project and the way we used
them to complete this project and answer to the questions posed in subchapter 1.2. In
the following figure (figure 4) we indicate the process of how we conducted our
project work using those tools as well as how they interrelate with each other.
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Figure 4: Methodology Diagram
In this project we conducted both primary and secondary research. Initially we
started by doing desktop research (secondary research) in order to accumulate
information and knowledge about the subject of virtual currencies as well as our case
study, Bitcoin.
The next step was primary research. We distributed a questionnaire survey
about Bitcoin (quantitative research) and we conducted an interview with a company
producing and selling ATMs for Bitcoins.
In the meantime, we described several theoretical frameworks found in the
literature (secondary research) in order to use and combine them in the last chapter
and conclude about the questions of our project.
The methods used in order to answer the questions in the problem definition of
this project are:
Desktop research: Includes a literature review providing information from the
material already available on the subject and giving a deeper understanding of
virtual currencies as well as the technology relative to it.
Qualitative research: Includes an interview conducted with an ATM company
producing ATMs providing Bitcoins. In this way we are able to understand
how virtual currencies like Bitcoin create opportunities for innovation in the
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Quantitative research: Includes the distribution of a questionnaire about
Bitcoin. The results from this survey were used and analysed in order to see to
what extent people and especially in the younger age groups, like students, are
familiar with Bitcoin or even used it and get an idea about its levels of
popularity and people’s concerns and compare to the information provided by
the literature.
Convergence: The theory of Convergence is used to analyse and explain how
in an era of major technological advancements, different technologies are
brought together creating innovative products and services targeting the
financial and payment markets.
Innovation: The theory of Innovation is used to analyse how the creation of
virtual currencies and especially Bitcoin, whether disruptive or not, become
drivers for innovation from a technological and financial point of view.
Bitcoin creates this way, new opportunities and challenges for all stakeholders
making them directly or indirectly involved in this innovative product.
Network Economics: The theory of Network Economics and more specifically
the concept of the “network effect” play an important role in this project as the
success of virtual currencies like Bitcoin is based purely on the demand for it.
But in order for this demand to exist, there needs to be a large number of users
and the larger this number becomes the more value the currency acquires.
Consequently, more and more people will want to use it.
Lock-in: The growing popularity of Bitcoin and the fact that its value and
market share is by far the largest compared to other digital currencies, makes it
a potential creator of lock-in” effect in this market and so this theory needs to
be included in this project [4].
Demand & Supply: One of the most basic theories that needs to be used in
order to analyse virtual currency and our case study, Bitcoin, is Demand and
Supply. This theory helps explain the volatility that virtual currencies present
and look into how they function in the market.
1.4 Delimitations
Crypto currencies create challenges that are very interesting from the point of
view of macro economy, for example the impact on banking industry, the tax
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repercussions from having crypto currencies and generally speaking, the impact of
this currency in international trade. Nevertheless, our background and the time
constraints that we have for this project don’t allow us to give a meaningful analysis
and discussion on these topics. So we will limit the scope of this project to
microeconomics, lock in effect, supply and demand, standardization and the
technologies evolved to communicate and to give security and privacy to the users.
There are many technologies associated to virtual currencies. This project is
limited to distributed peer-to-peer virtual currencies, as Bitcoin, our case study
belongs to that category. There are also many interesting virtual currencies that could
be the subject of the case study but just as we explained before, in motivation, Bitcoin
was an important aspect in our choice of this topic and as such we will limit the scope
of this project to Bitcoin. But it is possible that in punctual locations, parallels will be
drawn to other currencies, some of them virtual possibly, for comparison and
argument reasons.
Finally, another delimitation for this project is related to the questionnaire
distributed in order to get some quantitative data about its popularity and user
concerns. The replies to this questionnaire were limited to 80 and they come mainly
from the University’s student community. Thus, the sample taken might not be
representative enough, but it provides an indication of Bitcoin’s popularity, especially
among younger age groups.
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2 State of the Art
2.1 Background
Nowadays Bitcoin is the most prominent and valued virtual currency in the
sense that it can be exchanged in both ways with traditional money [4]. But besides
being the most famous, it is far from being the first one.
The first attempts to create electronic money were made by Digicash with the
brand name e-cash, DigiCash was conceived in 1982 by David Chaum. In his article
computer science in the University of California he describes these early challenges of
electronic money as the following:
“Automation of the way we pay for goods and services is already underway,
as can be seen by the variety and growth of electronic banking services available to
consumers. The ultimate structure of the new electronic payments system may have a
substantial impact on personal privacy as well as on the nature and extent of Criminal
use of payments. Ideally a new payments system should address both of these
seemingly conflicting sets of concerns.”(Chaum, D., 1982)
The problems he wanted to solve were lack of proof of payment, theft of
payments, media, and black payments for bribes, tax evasion, and black markets.
For this David Chaum proposed a currency that had the following characteristics:
“Inability of third parties to determine payee, time or amount of payments
made by an individual.”
“Ability of individuals to provide proof of payment, or to determine the
identity of the payee under exceptional circumstances.”
“Ability to stop use of payments media reported stolen.” (Chaum, D., 1982)
Later in 1990 David Chaum founded Digicash and created the e-cash, his
technique selling this e-cash to banks only one implemented USA a few others around
the world and the DigiCash went bankrupt in 1998. But the legacy of the blind
signatures would later prevail…
Since 1990 a lot has changed. The definition of virtual currencies is a very wide
one and it includes from air miles and coupons to Bitcoins and game-based
currencies. The market for virtual currencies used within apps or currencies used to
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obtain content or other goods is growing faster than the rest and it is expected to
increase in value by $1.2 billion from 2012 to 2017 and reach $3.2 billion, as it is
shown in figure 5.
Figure 5: App-Based virtual currencies are among the fastest growing (McKee, J., 2013)
The first Bitcoin appearance as proof of concept was published back in 2009 in a
cryptography mailing list by Satoshi Nakamoto. Satoshi work in the project until late
2010 and left without revealing much about himself. On other hand the community
has since then grown exponentially with many developers working on Bitcoin [5].
The Bitcoin growth in the last years was very fast, not only in its value but also in
the transactions per day. This is one of the most important indicators of its market
importance and it can be seen in the chart below.
Figure 6: Bitcoin transactions per day. Source:[6]
But the revolution started by Bitcoin didn’t stop here. New currencies are being
created at a very fast pace, by a vast variety of different people, associations and even
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companies. Today there are already more almost 300 peer-to-peer currencies being
traded and this is a number that will be very fast obsolete, as can be seen in the
webpage that lists all the currencies values in a 24H actualization
period [7].
Bitcoin’s popularity has increased against the real economy(Rogojanu, A., 2014).
The currency is accepted in different countries or business entities as means of
payment. For example, reddit, mega accept payments in Bitcoin. Due
to the wide popularity and advantages of the cyberspace, Cyprus and Canada
introduced ATMs which can exchange virtual currencies into real currencies
(Rogojanu, 2014). Moreover, in Cyprus, there is the first university that accepts
Bitcoin as payment for tuition fees, and its representative stating that the strategy is to
convert the alternative currency in to euro zone [8]. During the recent banking crisis
in Cyprus, Bitcoin demand has surged due to people fearing the failure of their
country’s banking system. Investors start to transfer their wealth holding to Bitcoin as
a safe. That lead to an increase in Bitcoin demand and its price went high [9] (Wan,
P.N., 2013).
2.2 Categories of virtual currencies
The European Central Bank or ECB (2012: 13) in its paper about virtual
currencies, provides the following definition: “a virtual currency is a type of
unregulated, digital money, which is issued and usually controlled by its developers,
and used and accepted among the members of a specific virtual community”. They are
currencies that can be obtained either in exchange for “real” money or by performing
other types of activities (for example, mining in the case of Bitcoin). Since there is no
standard classification for virtual currencies, and for the purpose of this project, the
categorization following is based on the paper by ECB (2012: 13-16). This
classification divides virtual currencies in three major categories based on how they
interact with real currencies, using online currency exchange platforms and providing
the ability to their users to buy goods and services in the real world.
Closed virtual currency scheme:
This type of currency is almost not at all connected to real currencies and
transactions in the real world and is typically being used for online games. So in the
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case of closed currencies online game players can earn this type of money throughout
the game and according to how well they perform. The reason they are called
“closed” is because they cannot be used for the purchase of goods and services in the
real world, but only for the purpose of the specific online virtual community. Lately
there have been initiatives, for example Currency Connect [10], that allow the
exchange of closed type virtual currencies, as long as the virtual communities that
have partnered with this exchange platform. Still there is no link to any real economy.
Especially in the world of online games, f.ex. RPG games (role-playing
games) virtual money play an important role. They can be used to enhance the
characters, buy special equipment and items that help throughout the game or even in
order to progress in the game. Examples of such currencies used in game platforms
are Zenny in Breath of Fire and Gold in World of Warcraft.
Figure 7: Zenny virtual currency (Source: [11] and World of Warcraft Gold (Source: [12]
Virtual Currencies with unidirectional flow:
This type of virtual currency can be bought using real money but it cannot be
exchanged back to real money afterwards. It is mainly used for the purchase of virtual
and in some cases, real goods and services.
In this category belonged Facebook’s virtual currency, called Facebook
Credits (FB). It was first introduced in 2009 as an attempt to provide additional
revenue to the developers and Facebook itself, through the games developed for the
platform. Users could use their credit card to buy Facebook credits in exchange for
US dollars (initially) with 1 FB=USD 0.10, and use them to buy items, mainly for the
gaming apps on the website. The payment can be done in many local currencies, for
example US dollars, British pounds etc [13].
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Figure 8: Facebook Credits (Source: [14]
Another unusual type of exchange medium that could fall into this category is
the bonus points (air miles) that airline companies offer their customers as a reward
when they buy a ticket. The air miles then can be used to either buy another flight or
to upgrade the passenger to first class. This way airline companies provide incentive
to flyers to travel with them again and it’s a strategy that has been proven very
successful so far, since they have existed in many years (they were introduced in 1981
by American Airlines originally) [15]. Consequently they constitute a type of virtual
currency that can be used for the purchase of real goods.
Virtual currencies with a bidirectional flow:
In this type of virtual currency, money is exchanged as any other currency in
the real world and can be used to buy both virtual and real goods and services. The
currency can be used any other real type of currency. Bitcoin, LiteCoin, Dogecoin,
Peercoin, BlackCoin and many more virtual currencies belong to this category, with
Bitcoin owning more than half of the market share and with a significantly higher
value than the rest. All these currencies, despite their use just as any other real
currency, they are not regulated by banks or other financial authorities and their value
is based only on the supply and the demand.
Security concerns have also been raised especially after the latest
developments with Bitcoin, when the biggest exchange platform for Bitcoins, MtGox,
shut down, after several digital wallets were stolen, resulting in millions of dollars of
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loss. Other concerns raised are about Bitcoin being involved in illegal transactions
and money laundering [16].
Figure 9: Source:
Another interesting example, that is slightly different than the ones mentioned
above is the case of Linden Dollars (L$), a virtual currency that was created and is
being used in the virtual world of Second Life were users can create their own
character and operate in the virtual world’s virtual economy where the can buy goods
and services, just like in any other real economy. In order to acquire Linden Dollars,
people can use a credit card and then they can exchange it back to US dollars if they
want. The user can also earn Linden Dollars by creating and selling virtual goods, or
even by getting a virtual job [17].
2.3 Regulatory issues
Electronic transactions with credit and debit cards are becoming more and
more popular, reaching $6 trillion worth of transactions worldwide, every year. Most
vendors around the world accept electronic payment with a surcharge of 2-5% of the
sale. Businesses that accept to get paid in Bitcoins could charge fees that can be down
to 1% of the sale, without using credit card companies like Visa and Mastercard as
intermediaries for the electronic transaction. In such an industry Bitcoin shows major
potential, although this is not so apparent yet, as Bitcoin and its weaknesses hinder its
adoption on national levels. One of its major weaknesses is its legitimacy (Alcron T. e
al., 2013)
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When we mention legitimacy, when we talk about currencies, we normally
refer to transactions being conducted between parties, according to national laws and
while the government is aware and interested in helping conducting such business.
Bitcoin’s link to illegal transactions regarding black markets and money
laundering is making governments hesitant towards its adoption or legitimization. The
U.S. government for example, does not recognize Bitcoin as a real currency but
merely as a virtual currency. In the U.S. there is no clear decision about Bitcoin from
the government and so the possibility that in the future Bitcoin can be declared illegal
by the U.S. government is worrying for businesses operating with Bitcoin and raises
risk factors when it comes to investing in such businesses. (Alcorn T. et al., 2013)
Consequently, where there is lack of legislation, it is unclear whether Bitcoin
transactions are legal and innovation is hindered. Legal regulation by national
governments is necessary to clarify the situation. (Alcorn T. et al., 2013).
The following section presents the regulatory decisions made by several
governments regarding Bitcoin, as today more and more countries take a clear stance
as to what Bitcoin is in their district.
2.3.1 Germany:
One of the first countries where Bitcoin has gained popularity, forming a
significant Bitcoin community, and the government has taken an official stance
regarding this virtual currency, is Germany. The German Federal Financial
Supervisory Authority (BaFin) released a statement on Bitcoin in the beginning of
2014 evaluating Bitcoin and stressing on the risks for its users [18].
In this statement it is clarified that Bitcoins are not a currency or e-money
according to the definition by the German Payment Services Supervision Act
(Zahlungsdiensteaufsichtsgesetz). It recognizes the use of Bitcoin as a substitute for
real currencies and as such processes like mining and purchasing are not subject to
authorization requirements (licensing). However the exchange of Bitcoins in a market
where a special fee is paid is a type of trading that is subject to licensing requirement,
according to the German Banking Act (Kreditwesengesetz). This means that trading
with Bitcoins is a process subject to regulations.
Anyone offering Principal Broking Services in Germany needs license from
BaFin. This is also the case for buying and selling Bitcoins on behalf of others,
making Bitcoin trading platforms falling into this category.
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Bitcoin trading platforms are also subject to regulations regarding Multilateral
Trading Systems in Germany. Such systems serve as a platform for selling and buying
between third parties. Bitcoin trading platforms can also relate to this and thus can be
subject to regulation according to German law.
Looking at the business models can define whether a financial activity is
subject to regulations or not and this is what is being defined in this statement.
The second part of the statement states the risks for Bitcoin users. Just like real
money, e-money or any sort of valuable object, Bitcoins can be stolen (through a
cyber-attack for instance) and not recovered. In addition BaFin warns users of a rise
in transaction costs as expenses will rise in order to increase computing power for
generating Bitcoins as the process becomes more and more complex. Finally, they
warn about the quickly fluctuating prices of Bitcoin, giving the opportunity to
speculators to speculate and earn from the losses that simple users could be subject to.
Bitcoin is defined by BaFin as a risky investment to make and warns its users
of the possible risks. Nevertheless, the fact is that they are trying to regulate it and that
means that Bitcoin is growing in popularity in Germany.
2.3.2 Scandinavia:
In Scandinavia, governments have also started to pay attention to the Bitcoin
In Denmark, the National Bank and the Financial Services Authority
(Finanstilsynet) have stressed that virtual currencies are not to be considered
currencies but more like valuable items, like gold, silver etc. with no support from the
authorities but trading it is nonetheless legal [19]. Since Bitcoin is not subject to
regulations it cannot be considered as a currency but no steps towards taxing it have
been taken yet in Denmark, as the Danish Tax Board does not recognize it as real
money and therefore it does not generate taxable gains [20].
Norway on the other hand, although they also concluded that Bitcoin is not to
be regarded as a currency, they decided on placing profits from Bitcoin under the
wealth tax, with a 25% sales tax imposed on businesses [21]. And although tax
revenue from Bitcoins is not a major one, it is an important step towards its
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In Sweden, the Swedish Tax Agency classified Bitcoin as an asset and as such
put taxes on it [22].
2.3.3 China:
In late 2013, People’s Bank of China declared that Bitcoin is not a currency
and banned Bitcoin transactions for financial institutions, which resulted in Bitcoin
losing 20% of its value at the time. The public is free to transact with Bitcoins at their
own risk. Although Bitcoin is not a threat to China’s financial system, the regulatory
authorities are worried that its growing popularity could create an unstable situation
2.3.4 USA:
The U.S. is expected to take regulatory actions regarding Bitcoin later this
year, especially after the failure of MtGox in Japan. Regulators in the U.S. are looking
into what position Bitcoin should have in the markets and move towards some type of
regulation [24]. The US Treasury considers Bitcoin transactions legal and businesses
that are involved in the exchange of Bitcoins are considered money service businesses
according to the Bank Secrecy Act. More specific regulations are to be taken by each
state separately [25].
2.3.5 Iceland
In Iceland the Central Bank declared buying Bitcoin as an action of taking
money out of the country and so such a transaction is illegal according to the rules
imposed after the banking crisis in 2008 about capital controls and so trade of goods
in and out of the country cannot be done in exchange for Bitcoins [26].
2.4 The Bitcoin Ecosystem
In order to study Bitcoin itself, it is necessary to take a look at its “ecosystem”.
The term ecosystem stems from biology but in the business world it is defined as:
“An economic community supported by a foundation of interacting
organizations and individualsthe organisms of the business world. The economic
community produces goods and services of value to customers, who are themselves
members of the ecosystem. The member organisms also include suppliers, lead
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producers, competitors, and other stakeholders. Over time, they coevolve their
capabilities and roles, and tend to align themselves with the directions set by one or
more central companies.”(Moore, T., 1996).
Of course Bitcoin is not a business itself but we can describe its surrounding
entities as part of its environment. In this environment, companies form symbiotic
relationships. In this type of relationships, when one part is thriving then the others
can also benefit from it. This means that each part can also be affected in a negative
way if another one has problems. In the Bitcoin Ecosystem there are “entities” that are
part of it and interact with each other, such as the merchants, the mining pools, the
exchanges, and the user’s remote wallets (Böhme, R., 2013).
All these entities interact with each other in various ways. For example, an
exchange’s activity might affect the value of Bitcoin and in return, the merchants’
business. For instance, if the value of Bitcoin rises, then the merchants can make more
2.5 The Bitcoin Algorithm
Bitcoin algorithm has no central server and is base in a peer to peer system.
This means that the processing power from Bitcoin is divided by all the nodes of the
network. The algorithm of Bitcoin relies on digital signatures to prove the ownership
and public history of transactions to prevent double usage. The transactions history is
also shared in the peer to peer network, where nodes have to agree about the history.
(Nakamoto, S., 2008).
Like the picture below shows, the users from Bitcoin have two different keys,
one public and one private. They can be used in many devices like phones, by using a
web wallet or PCs by using local wallets or even a physical wallet. These keys are
used to both digital sign in and secure the transactions. All the transitions are stored
in a public Ledger and the ledger is processed by the Bitcoin network (Nakamoto, S.,
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Figure 10: Bitcoin Network. Source: [27]
The Bitcoin Network is made of all users that have active wallets in their local
PC. They store all the information from all the transactions ever done in Bitcoin. And
by mining they help the network information get processed (Nakamoto, S., 2008).
What miners do is to help process block chains (which will be explained in
more detail in the security subchapter). By doing so, the miners are rewarded with
Bitcoins for their work. In the early years, these coins were abundant but the amount
of them being rewarded is decreasing through the years to ensure that in the future
there will still be attractive for miners. Small fees are being charged to the people that
do transactions and then feed these Bitcoins back to the miners when they process
(mine) a special block chain. The block chains with Bitcoins are similar to a lottery
ticket but very common (Nakamoto, S., 2008).
2.6 Privacy
The privacy aspect is one of the key aspects that attracts users to Bitcoin and for
the most part all the attempts and search done, is to show that it is reliable. But the
users sometimes make actions that can allow their privacy to be exposed (Reid, F. et
al., 2012).
There were several tests made regarding Bitcoin and other software,
surrounding this virtual currency safety and privacy. One of them is the case of
TCP/IP Layer Information by Dan Kaminsky that will be discussed below. Still, many
of the cases of disclosure are voluntary.
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2.6.1 Voluntary Disclosures
One of the major sources of identifying information is the voluntary disclosure
of public-keys by users, when posting to the Bitcoin forums. These keys are very
easily indexed by search engines.
In the paper An Analysis of Anonymity in the Bitcoin System Fergal Reid
and Martin Harrigan (Reid, F. et al., 2012) said “We identified many high-degree
vertices with external information using a search engine alone. We scraped the
Bitcoin Forums where users frequently attach a public-key to their signatures”. This
is a problem because these users lose the privacy that they got by using Bitcoin (Reid,
F. et al., 2012).
2.6.2 TCP/IP Layer Information
TCP/IP Layer Information was another way identified that the privacy of
Bitcoin can be compromised. Security researcher Dan Kaminsky did tests and
analysis to the Bitcoin system, trying to identify problems in the TCP/IP layer. With
this analysis, he discovered that unless the users use anonymizing proxy technology,
such as TOR, it is possible to map the IP addresses of the Bitcoin Public-keys(Reid, F.
et al., 2012). Although this is true and it is indeed a problem, Bitcoin users can use
TOR, a network of virtual tunnels that allows privacy, security and anonymity on the
internet [28].
2.7 Security
Bitcoin protocol has a strong security track [29]. Bitcoin security is well defined
a Hash function algorithm is used to transmit the block chain over the peer-to-peer
nods. However, Bitcoin uses pseudonyms in the network to transmit the block chain
so that the user can be anonymous (Decker, C. et al., 2013). But while the block chain
is transmitted around the network, it will take 10 minutes to verify by the nods
(miners) in the network so that dishonest users cannot double spend (two different
users signing over the same coin) their coin (Nakamoto, S., 2008). Below is the
Bitcoin secure transaction model:
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Figure 11:Peer to Peer secure Transaction Model (Nakamoto, S.,2008)
Every user has two keys for their nods one private key and one public, which can
also be referred to as signature key. While one owner transfers his Bitcoin to the next
owner, they broadcast it using the owner’s private key and a pseudonym including the
owner’s previous transaction history and the next owner’s public key plus some
transaction fees, typically 0.0005 BTC or lower(Taylor, M.B., 2013). These hash
function contains all the transition information (from beginning to current time) of a
particular coin, which makes the coin secure because no dishonest or hacker nods
could replicate the coin.
The security of Bitcoin relies on the distributed consensus achieved by the
mining process (Kroll et al., n.d.). This means that a cartel of miners is not possible
because of the Bitcoin distributed peer-to-peer network. That is because a single
miner or coordinated group of miners cannot hold more than 50% of the network’s
mining (puzzle solving) computing capacity(Kroll et al. n.d.). For the same reason
double spending is also prevented.
Bitcoin can suffer a type of attack called 51% attack. Although it is very hard for
such an attack to take place, in theory it is possible. If someone hold 51% of the active
nodes could disrupt the entire network (King, S. et al., 2012).
Bitcoin can be stored digitally in the user’s mobile, computer wallet or third party
service provider server. There is a security risk in the user level, because Bitcoins can
be stolen from third party Bitcoin service providers and from individual Bitcoin
wallets(FBI, 2012). For example, one way to steal Bitcoins is by sending malware to
the Bitcoin user computer or service provider server and transferring the coins from
one account to another. Another very important aspect for the end user is the private
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key, also called signature key. If a user loses or forgets their private key, the account
is useless and all the coins they have are lost. It is the same as losing one’s wallet in
real life. Private Key retrieval from the system is impossible.
Bitcoin transactions face the same risks as today’s online banking transactions
(hacking, fraud etc.) and virtual wallet theft is the same as someone having their
physical wallet being stolen. The difference lies in the fact that governments have not
recognized Bitcoin as a currency and since there is no regulation by financial
institutions, it cannot be backed by the government. This is what creates an unsafe
feeling in those who consider investing in Bitcoin and hinders Bitcoin’s extended use.
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3 Theoretical frameworks
In this chapter of the project several significantly relevant frameworks will be
These frameworks will be used later in the analysis part of the project report. The
first theoretical framework is convergence theory that deals with the standardization
process. This theory will be succeeded by Innovation Theory. After this Network
Economics and lock-in will be described and the value created by having more users
and merchants. Then the chapter will be finalized with the Demand and Supply
3.1 Convergence
3.1.1 Definition
Like the word convergence says this framework is about coming together. And
it’s done by studying the field from two perspectives - industry and technology. In
1997 convergence was defined as a merger of two or more industries producing
substitute or complementary products (Greenstein, S., 1997), also in the same year
and this time by the European Commission in their green paper, convergence was
defined as the ability of different platforms to carry essentially similar kind of
services and the process of coming together, one example can be consumer devices
such as the telephone, television and personal computer (European Commission,
3.1.2 Historic Perspective
The first time that the term convergence was used, was in 1963 by Rosenberg
(Rosenberg, N., 1963). The term was used in order to find a more precise description
of the implementation of specialized machine tools in the US industry. In his article
he is referring to it as a trend concerned with manufacturing a broad variety of
products by using a similar type of machinery and technology. The result of this
process was that process industries that were previously separated became very
closely related on a technological basis.
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The second important landmark, this one especially in ICT field, was the
already referred green paper from European Commission in 1997. In this paper the
convergence wasn't only about industry or even only about technology, it was also
about services and platforms. The global nature of communications platforms at that
time, in particular, the Internet, were providing a key which would in time open the
door to the further integration of the world economy like it happen (European
Commission, 1997).
3.1.3 Types of Convergence
Industry convergence is normally defined as the converging of two or more separate
and distinct industries like explained before. But the basic push towards industry
convergence occurs normally due to technological convergence. Nevertheless there is
a possibility for other factors involved like customer demands, regulation and the
industry structure needs, etc. (Greenstein, S., 1997)
Technological Convergence is very common in the present days and is shown by a
vast array of different types of technologies performing substitute tasks. The examples
are countless. One simple example can be the usage of smartphones to listen to music,
see movies and navigate in the internet (European Commission, 1997).
Service Convergence is present in several aspects of today. One of the most common
examples was the digitalization of the telecom market. This process allowed one shift
in the way telecommunications were done. From the one-service via one-network
concept the new concept of multiple services via multiple networks (Han, S.P, et al.,
3.1.4 Drivers of convergence
Most of the academic theory around convergence has been centered on
drivers, typologies and consequences of convergence. So after discussing the
typologies and its consequences, it is important to also discuss the drivers.
The two factors driving the market convergence can be examined industry-
and technology-wise, with these two aspects closely related with each other. But the
main driver pushing for convergence has always been technological change and
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innovation. This driver includes the appearance of integrative technological platforms
(Gambardella, A. et al., 1998), such as the Internet (Lei, D.T., 2000; Wirtz, B. W.
3.2 Innovation
Joseph Alois Schumpeter was the first who started working on what is
innovation. In his economic model directed to innovation, he defines the process of
innovation as a Trilogy: “Invention - Innovation - Diffusion(Mahdjoubi, D., 1991).
Schumpeter theory can also be used in R&D production marketing and only in
What is Innovation?
Innovation theory can be defined in many ways but some bright people have
defined it as:
“The ability to deliver new value to a customer” (Jose Campos)
“Change that creates a new dimension of performance” (Peter Drucker)
So innovation is when something new or improved is created to address and meet
new requirements or existing market needs. In addition, innovation doesn’t come only
in one form. In fact there is many ways innovation can be defined:
Sustaining vs Disruptive
o Sustaining innovation that improves product performance (Clayton,
C.M., 1997)
o Disruptive innovation that brings an entirely different value
proposition to the market and cause existing products’ performance
worse (Clayton, C.M., 1997)
Incremental vs Radical
o Incremental Innovation that improves the cost or the features of
already existing products or services (Leifer, R. et al., 2000)
o Radical Innovation that creates a completely new product, with new
customers, creating new business models, changing the economics of a
business (Leifer, R. et al., 2000)
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What can be concluded from these cases, is that the choice when creating a
new product or service, is between building upon an existing product or service in the
market, by making it better, or developing something entirely new. Sometimes this
means to create an entire new category of product that can substitute the old one or
even make it obsolete. In some cases the product is ahead of time and it fails.
3.2.1 Diffusion of innovation
Diffusion of Innovation theory was created to understand how new ideas both
scientific and corporate are diffused to the public. Everett Rogers first created
Diffusion of Innovation Theory in his book in 1962. The categories that he created
back then where: innovators, early adopters, early majority, late majority, and
laggards (Rogers, E.M., 1962)
Figure 12: Diffusion of Innovation. Source: (Rogers, E. M., 1962)
Innovators: People with a strong interest in technology and who like to
experiment with new technologies
Early adopters: People with deep technical knowledge who might use a new
technology for professional and academic purposes
Early majority: People who consist big part of the mainstream who are
comfortable with technology
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Late majority: People who consist the second part of the mainstream but are
not so comfortable with technology
Laggards: People who are more conservative towards a technology.
The speed of diffusion is also an important factor, and there are several aspects
that can help or constrain the growth of a technology. Nowadays the consumption of
new products spreads faster than before due to the many ways to communicate, better
knowledge about technologies, etc.
Figure 13: diffusion of technologies. Source: [30]
Everett Rogers explains this diffusion with five factors that he believes influence each
individual’s decision to adopt or reject a new technology (Rogers, 1962):
Relative advantage - What the new generation brings as new.
Compatibility - Compatibility with the individual’s life.
Complexity or simplicity - If the users see a technology as simple to use or
difficult to use
Trialability - How easy an innovation can be tested. If a user tests the new
product and likes it, then the more easily they will adopt it.
Observability - User can understand the extent of the innovation.
The theory of Innovation is central in this project, it will help analyze everything
new that Bitcoin has brought to the markets, both from a technological and a financial
perspective and explain how that affects Bitcoin’s growth.
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3.3 Network Economics
Network economics is a theory that studies the effect of a growing network, in a
business. In a network there are externalities, that is when an individual is affected by
the actions of other individuals. When the individual is affected in a positive way and
receives benefits from it, then it is called a positive externality. When they are
affected in a negative way, then it is called a negative externality (Easley, D., et al.,
In networks we may have network effects. This means, that the increase of the
size of the network will also mean an increase in the utility that a user receives by
using a certain product or service (Shapiro, C. et al., 1999). And this effect will get
stronger as other consumers join in the usage of product or service. This means that
the network effect today has the complete opposite meaning than in neo classical
Network effects can be either direct or indirect. A direct network effect is when
for example the utility for a user of a telephone increases as the total number of
telephone users increases. The indirect network effects come from complementary
products or services. For example a DVD player becomes more valuable to its owner
when the variety of DVDs that can be played increases. And the more the users, the
more variety there will be (Clements, M.T., 2004).
Networks are composed of links and nodes; the links connect the nodes to each
other. In most cases nodes are complementary to each other. Networks can be
classified in two ways. The first one is about the way they are linked. That can be
physically (Telephone) or virtually (social networks). And the second is about the
direction of connections. If IT is a two-way communication like the Internet or one-
way communication like an ATM network (Zang, L., 2009).
One other important aspect about network economics is the feedback. The
negative one can be hazardous for the future of a company and the positive one has
very good effects on it. In addition, according to Shapiro and Varian, “positive
feedback is a more potent force in the network economy than ever before” (Shapiro,
C., et al. 1999). In general, feedback could directly impact on the market share and
popularity of certain business sectors. In other words, positive feedback makes a
company get stronger than it is and negative feedback makes companies get weaker
than they are (Shapiro, C., et al. 1999).
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Normally positive feedback follows a predictable pattern with the correlation
adaption of new technology, which is represented in the S shaped curve bellow.
Figure 15: Adoption of new technology (Shapiro, C., 1999)
It has three phases such as:
In the first phase during the launch the angle of the curve is flat, then
with the positive feedback there is a steep rise during takeoff and saturation is reached
and the curve starts to level of. Another aspect that influences the angle of the growth
is the Demand side and supply side economic aspect, which also impacts network
economics, and will be discussed, further below in the next chapter.
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This theory is extremely relevant in this project, because the value of a
virtual currency that isn’t based in any institution or any commodity is only based on
the strength of the network and the demand generated from it.
3.4 Lock-in Effect
In markets subjected to network effects, like the ICT industry, a phenomenon
called “lock-in effect” is also present. This describes a situation where on standard or
technology is adopted by everyone in the market. As the utility from the use of a
specific technology increases for a user when more and more people use it (network
effects), we often see that the adoption of this technology is so widespread that it ends
up dominating the market. As a result every participant in the market is “locked-in” to
the specific technology even if it might not be the best one or the cheapest one
(Draisbach, T. et al., 2013).
Figure 16: The QWERTY keyboard lock-in (Source: [31]
The QWERTY keyboard is one of the most well-known examples of a lock-in
effect. When the type-writer was invented, in order to reduce the type-bar clashes,
there was a rearrangement of the alphabetical order of the letters on the keyboard
which resulted to what we know today as the QWERTY standard. There were three
main factors that lead to the dominance of this keyboard from the days of the type-
writers until today. First, when this keyboard came out, typists were professionals
whose ability to perform faster on a type writer contributed to the adoption of one
keyboard. Second the wider adoption lead to a cost decrease (scale economies) for the
QWERTY keyboards and finally switching to a different keyboard arrangement
would be a costly investment (David, P.A., 1985).
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This theory is necessary for exploring the possibility of a lock-in effect being
created with Bitcoin.
3.5 Demand & Supply
3.5.1 Demand
The law of demand says that if we hold all other factors constant (ceteris
paribus), a decrease in the price of a good will cause consumers to increase their
consumption of that good.”(Fox M. et al., 2012)
Figure 17: Demand curve. Sources: [32]
There are also different factors determining the demand for a good. Those factors
can shift the demand curve from left to right and vice versa. Moving the curve to the
right means increase in demand, while moving the curve to the left means decrease in
demand. (Fox M. et al., 2012) The factors determining demand are:
Income: An increase in a person’s income means increase for the demand of
normal goods (the most common goods) and a decrease for the demand of
inferior goods (for example bus tickets, secondhand clothing etc.) A decrease
of someone’s income leads to the opposite results for these two categories of
Tastes: A consumer’s taste might change from time to time. If their tastes
switch to the favour of a good then it increases its demand, while if tastes
switch a consumer from one product to another then the demand for the first
one is decreased.
Prices of related goods: A good might have complementary (used together
whit this good) or substitute (used instead of this good) goods. An increase in
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the price of a complementary good means a decrease in its demand and since
the two goods are used together, the demand of the first good is going to
decrease as well. A decrease in the price of a complementary good means and
increase in the demand of both goods. With substitute products, if the price of
one of them increases then its demand decreases and so the substitute’s
demand increases.
Expectations: If a consumer expects the price of a good to fall at some point in
the future, then they will decrease its demand today in order to buy it when the
price is lower. Or if a consumer’s income is expected to be increased then
their demand for a good might increase as well.
Number of buyers: More buyers mean more demand for a good, while less
buyers mean less.
(Fox M. et al., 2012)
3.5.2 Supply
The law of supply says that if we hold all other factors constant (ceteris
paribus), an increase in the price of a good will cause suppliers to increase their
production of that good. (Fox M. et al., 2012)
Figure 18: Supply curves. Sources: (Fox M. et al., 2012)
Next are the factors that affect the supply of a good and either shift it to the
right when they increase the supply or to the left when they decrease it:
Input prices: When the price of a good needed for the production of another
good changes, then it also affects the supply of the latter. If, for example, the
price of such a good increases, then the cost of producing the final good also
increases moving the supply curve to the left.
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Production technology: The use of a new technology for the improvement of
the production of a good, can lead to the increase of supply.
Prices of related goods and services: The supplier of a good might change the
supply of a good if they have more profit from another good they produce. For
example, if the price of one of the goods produced from a supplier increases,
then the supplier might increase the supply of the more profitable good and
decrease the supply of another one less profitable.
Expectations: Suppliers, just like consumers have expectations about the
prices of a good. If the price of a good is expected to increase at some point in
the future, the supplier will decrease the supply today and increase it when the
price is higher.
Number of producers: The more producers produce a good, the bigger the
supply for it will be.
(Fox M. et al., 2012)
3.5.3 Supply and Demand
The supply and the demand of a good determine its price in a market. Putting the
demand and supply curves together in a graph shows the point of equilibrium where
the quantity demanded by the consumers equals the quantity supplied by the
Figure 19: Supply and Demand curves and point of equilibrium. Source: [33]
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There are four basic laws of supply and demand (Braeutigam R., 2010):
An increase in demand while the supply remains the same means shortage for
the good and a higher equilibrium price.
A decrease in demand while the supply remains the same means surplus for
the good and a lower equilibrium price.
An increase in supply while demand remains the same means surplus for the
good and a lower equilibrium price.
A decrease in supply while demand remains the same means shortage for the
good and a higher equilibrium price.
Demand and supply play an important role for our case study, Bitcoin, as they are
basically the reason for its value’s volatile behavior. Bitcoin is not an asset with value
unless there is demand for it. Consequently the demand and supply theory needs to be
thoroughly examined to define to what extent it is applied to Bitcoin, which are the
factors that affect Bitcoin’s demand and supply and what the role of Bitcoin
alternatives and substitutes is.
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4 Analysis
In this chapter, the project focuses on the case of Bitcoin as well as the data
collected from the interview, the survey conducted and other sources from our
desktop research. The analysis will be done both by applying the theories presented in
chapter 3 to the case of Bitcoin and by analysing the data extracted from the
qualitative and quantitative research. In order to do that, an analytical framework has
been developed and is going to be presented in chapter 4.1 that combines the different
elements studied regarding Bitcoin.
Analysing Bitcoin as well as the parts that comprise its ecosystem and the factors
that affect it, provide a good overview of the growing trend for the development of
virtual currencies as well as their position in today’s economy. This way it becomes
easier to answer the questions posed in the beginning of this project and conduct a
valid and more complete discussion and conclusion.
4.1 Analytical Framework
Figure 20: The BitPIN analytical framework
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The way this analysis of Bitcoin is constructed in this chapter is presented in
the analytical framework sketched in the figure above, which helped structure the
analytical part of this project and explain the processes that take place. In this
framework, called the BitPIN framework- a name which derives from the name of the
currency (Bitcoin) and the authors’ last names- there are five major parts which are
going to be analysed and comprise the factors that form and define Bitcoin and its
In the centre of it all, there are the users and the services that keep the Bitcoin
network “alive”. Everything else in the analytical framework revolves around them
and affects the Bitcoin network in various ways. First there is demand and supply,
which predetermine Bitcoin’s value and in the long run, its success. Innovation is
another important aspect. The innovation stemming from Bitcoin is not only the
virtual currency itself; it includes all the new services and products that were later
created because of it. In addition, there are the network effects and possibly lock-in in
the Bitcoin network, which are fuelled by the stream generated in the demand and
supply that pass through innovation, also play a vital role for the prosperity and
survival of Bitcoin. Finally, the role of convergence is discussed as a result of the
processes taking place within the Bitcoin ecosystem.
Before closing the chapter, there will be a subchapter that brings all of the
above together in order to form a complete framework and provide an analytical
overview of the chapter to summarize the important parts and facilitate the discussion
in chapter 5.
4.1.1 The Bitcoin Network-Services and Users
At the heart of Bitcoin lies its network, with its users and the services
surrounding it. The theory behind this network was explained in chapter 2. Without
them Bitcoin would not exist, as it is no national currency and its survival is based on
its user base. In order for the user base to grow, it is necessary to facilitate
transactions as much as possible so that people can find Bitcoin easier to use and have
better access to it. Ease of use is important for the network, and consequently demand,
to grow. The simplicity of Bitcoin will be further analysed in the Roger’s five factors
in chapter
In order for the Bitcoin network to function, there is need for services, mainly
software, that support the platform in various ways. The first and most important
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piece of software that facilitates Bitcoin transactions is the virtual wallet. The Bitcoin
wallet is responsible for managing a number of addresses in a seamless way for the
user. The user is able to see their balance and make transactions with other wallet by
transferring Bitcoins from their wallet to another address. The user is allowed to have
more than one address themselves (Goldfeder, S., et al., 2014).
Besides the wallet software there is the need for the completion of the
transaction and its validation from the miners. Bitcoin transactions are irreversible
(once validated by the network cannot be changed, even in the case of fraud),
automated (no human action required) and anonymous (Bitcoin addresses don’t need
to be linked to a physical person) (Goldfeder, S., et al., 2014). This means that
security is important when transacting with Bitcoin and services like BitPay were
created. BitPay provides secure payment services, similar to PayPal for traditional
currencies. Businesses and people conducting payments with BitPay decide what
percentage of the money they receive stays in Bitcoin and what is converted to real
currencies and deposited in their bank account [34].
Another type of product that was created to provide Bitcoin related services is
Bitcoin ATMs. There are different variations of this product, but most ATMs allow
the purchase of Bitcoins with cash, like Lamassu’s ATM [35]. Some others can also
be used the other way around, which means users can sell Bitcoins and receive cash,
like Robocoin’s ATM [36].
Those are some of the services and products provided today and many more
are around the corner as Bitcoin has fuelled innovation as will be later described in
4.1.3. Of course none of that would have reason for existence if it wasn’t for the users
in the Bitcoin network that need reliable services to transact with Bitcoins.
Until today, there are no official or large-scale statistics as to who the Bitcoin
users are, how and how often they use Bitcoin or what holds the rest of the world back
from using it. Bitcoin has come a long way since its creation but it’s still growing and
attracting more people to its network. The services and products that are being
developed to help the diffusion process are still at an initial stage but as the network
grows so will they.
For the purpose of this project, it was interesting to see to what extent people
know and/or use Bitcoin in order to get an idea of its popularity and so there was a
survey conducted, whose results are going to be presented and analysed in this
chapter. Of course the sample is too small in order for the results to be 100%
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statistically correct and the conclusions from it are limited, as explained in 1.4. The
sample is almost exclusively members of Aalborg University’s student community
and the questions are general questions about Bitcoin. The intention was to find
Bitcoin users and interview them but unfortunately that was not an option, since the
few regular users (monthly or yearly) that answered the survey weren’t available.
From the survey conducted it was obvious that the biggest part of the
participants had previous knowledge of Bitcoin (85%). This is an impressive number
although it is expected that this number in the general public would be lower.
Which brings us to the next observation which also brought some interesting
results. Although the participants are members of the University community and it
would be expected to know about Bitcoin through their academic environment the
next chart shows that in fact the biggest part of it knows Bitcoin through the different
media, such as TV, newspapers etc. (64.7%).
In fact the percentage of people who know Bitcoin through school or
university is only 8.8%, while social environment, like family and friends come
second with 20.6%.
The rest of the answers to our questions reflect that although most people
knew Bitcoin, very few had used it even once and there were very few regular users.
Do you know what Bitcoin is?
How do you know Bitcoin?
From School or
From Family or
From media (TV,
Newspaper, Online,
Social media)
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More specifically 91% answered that they never use Bitcoin in any sort of
transactions. That was a very interesting result and the next question attempted to find
out why that might be, by asking one of the basic questions that reflects the argument
that Bitcoin is not safe.
To the question about security concerns regarding Bitcoin, 56% answered that
they are concerned about how safe it is to use Bitcoin. This doesn’t justify entirely the
big percentage that doesn’t use Bitcoin, so although security is an important factor
that might affect people’s decision on whether to use Bitcoin or not, it is probably not
the only one.
When asked about what sort of concerns those are, most people mentioned
security concerns (hacking of their digital wallets, fraud etc.), while others were
concerned about the value of Bitcoin and its volatile price mechanism, as well as
Bitcoin’s legality, since the lack of regulation leaves Bitcoin in a legally grey area.
In conclusion, this survey is not able to show who the Bitcoin users are, but it
explains to a certain extent how people feel about Bitcoin today. And even though a
lot of people know it, not so many have tried to use it and almost all of them are
concerned about Bitcoin’s instability, security or legality. This means that people still
see Bitcoin as a risky investment and so they are wary when it comes to using it.
Do you ever use Bitcoin?
Do you have any security concerns about
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A more extended survey about Bitcoin would provide many more valuable
results, but this one is a first step to understanding Bitcoin’s popularity among people.
4.1.2 Demand & Supply in the Bitcoin Network
Each digital currency has its own rule which defines how coins are produced.
Normally new coins are created, in order to increase the supply, which are given as
rewards to those who, in one way or another, serve the digital currency platform.
Supply for digital currencies is affected by two parameters. First, the more the
transactions there are, the more work there is to be done by the people that provide
services to the digital platform and so the more rewards, in the form of coins, they
will get, increasing the supply. Second, according to the rules that each currency
abides by, there is a specific amount of coins awarded to those in the network who
perform the validation of the transactions (Evans, D.S., 2014).
For some of these currencies the rules impose an upper limit to the supply of
coins. Bitcoin belongs to a type of currency that defines this limit to 21 million coins,
while the rate of supply of Bitcoins is defined by an algorithm. After all 21 million
Bitcoins are in circulation, no more coins can be awarded to the miners. Nevertheless
Bitcoin can be divided down to eight decimal places [37]. Other currencies choose a
different path. For example, Dogecoin is one of the currencies which doesn’t define a
limit for the number of coins in circulation but increases the limit at a steady rate. The
rules for the supply of coins for each digital currency is predefined from the start and
cannot be changed later on by anyone (Evans, D.S., 2014).
Figure 21: Bitcoin's supply curve [38]
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Since Bitcoin is not a regulated currency what defines its value is mainly the
expectations regarding demand and supply, which are one of the main determinant
factors according to the theory presented in the previous chapter. While demand is
dependent on the demand for coins in order to transact in the market, supply is
dependent on the stock of Bitcoins and on the circulation of new coins in the system
until it reaches the barrier of 21 million. Demand could change for a number of
reasons that might have to do with the Bitcoin platform itself, competitive currencies
or conditions of different markets (for example, the financial crisis in Cyprus which
caused an increase in the demand for Bitcoins [39])
This mechanism makes Bitcoin susceptible to fluctuations of its value and gives a
degree of high volatility. This might affect a more extended adoption of Bitcoin since
it causes instability to its value, which a lot of people will see as a risky investment
(Evans, D.S., 2014).
Adjusting the supply of money is one of the main mechanisms national banks use
in order to control an unstable national currency (Evans, D.S., 2014). With Bitcoin
this is impossible, which means that if supply is not adjusted according to the demand
for a currency, its value will remain unstable.
Expectations about a currency or an asset are always influenced by speculation
(Feiger, G., 1976). Bitcoin is no exception to that. Since Bitcoin has no real value (as
gold or other valuable assets) it is highly susceptible to speculation that could infer
major changes to the value of the virtual currency.
The case of Cyprus:
To indicate the importance of expectations as the major factor that influences
the demand for Bitcoin, the Cypriot banks’ bailout in 2013 is an exceptional example
that proves it.
In March 2013, the financial crisis led Cyprus’ leaders to consider using part
of its people’s bank deposits in order to bail the Cypriot banks out. Facing the risk of
a banking system failure, investors started showing mistrust to national banking
systems. At the time, Bitcoin was a new currency that, only three years previously to
that event, was worth 5 cents and $47 before the bailout discussion started [39].
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Figure 22: Value of 1 BTC in $USD from 2010 to the Cyprus Banks bailout in 2013. Source: [39]
Since the discussions for the EU and IMF bailout of the Cypriot banks began
[40], in order to avoid the country’s banking system default, there was a rise of 87%
in the value of Bitcoin, reaching $88 right after the bailout, at the end of March 2013.
At the same time the number of transactions also surged within the same period
[39].In conclusion, at times of financial stress investors turned their trust from
traditional banking systems to an alternative choice.
In the meantime, grabbing the opportunity from this event, an entrepreneur
announced his hope to install the first Bitcoin ATM in Cyprus, to announce a couple
of months later that he would withdraw from the project [41]. Nevertheless, this
indicated the importance that Bitcoin acquired after the existing traditional monetary
system failed to inspire trust in people.
Bitcoin Demand from the beginning till today:
Bitcoin is a new currency counting almost 5 years of life. Yet the fluctuations
of its price over the years have been immense. One example that illustrates this better
than charts and numbers themselves is the case of a programmer from Florida, named
Laszlo Hanyecz, who back in 2010 had mined 10000 Bitcoins, which he exchanged
for two pizzas [42]. The interesting fact is that in 2013, when Bitcoin’s price spiked to
$1200 those Bitcoins spent for two pizzas would be worth $12 million. Even today,
after Bitcoin’s price dropped significantly when the Chinese government banned
financial institutions from transacting in Bitcoin [23] and after the closedown of
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Tokyo based exchange MtGox, the Bitcoins used to buy these two pizzas would be
worth $4,5 million.
Figure 23: Bitcoin's volatility compared to other traditional currencies. Source: [43]
Bitcoin might not be a traditional currency and for that reason it might be a
volatile and risky investment, but its demand keeps growing and people are putting
more trust in this new currency. The more the Bitcoin network grows and the more
people use it, it gains more and more value, although that depends highly on the
expectations for the future.
4.1.3 The need for Innovation in the Bitcoin Network
Innovation in our analytical framework is driven both by demand and supply
and by the users and services. The more the Bitcoin network and infrastructure grows
the more opportunities there are to newcomers bringing new Bitcoin-related services
and profit from an expanding market. Not that they are the only aspects influencing
the need for innovation but they are important nevertheless. Types Of Innovation
Bitcoin brought something really new and disruptive to the currency market,
and it wasn’t as much in the technology, because peer-to-peer technology was already
very common and successful in other applications, like file-sharing networks, Instant
messaging systems, online chat networks, etc. In fact the disruptive part from Bitcoin
is its decentralization and the fact that it isn’t controlled by any entity making it
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possible this way for the community to decide what to do with the future of Bitcoin.
And the possibilities that come with an open community of contributors help with its
When compared with other virtual currencies, Bitcoin can also be considered
as a sustaining development because it didn’t bring something really different from
other virtual currencies, like the already described linden dollars from second life. But
still its decentralized and open nature were revolutionary.
In addition, the Bitcoin platform uses a chain of blocks in order to keep a
public record of the Bitcoin transactions and so allow to assign the different addresses
to the correspondent balance (Nakamoto, S., 2008). This was a new addition to the
peer-to-peer technology.
In their webpage Bitcoin describes their innovation as “The Bitcoin protocol is
not just about sending money from A to B. It has many features and opens many
possibilities that the community is still exploring. Here are some of the technologies
currently being researched and in some cases, turned into real products and services.
The most interesting uses of Bitcoin are probably still to be discovered” [44].
Some of those technologies are:
Control against fraud - Bitcoins are impossible to counterfeit and the system
protects from common frauds like chargebacks or unwanted charges.
Global accessibility - Bitcoin allows any bank, business or individual to
securely send and receive payments anywhere at any time, with or without a
bank account.” [44]
Cost efficiency - Bitcoin transaction fees are much cheaper than any
alternative and use cryptography, making it possible for secure payments to be
conducted without slow and expensive middlemen.
Tips and donations -Bitcoin is a good solution for tips and donations because
sending a tip only requires one click and receiving donations can be done by
displaying a QR code with the receiver address.
Crowdfunding - One interesting implementation from Bitcoin is its
application in crowdfunding. People can pledge money to a campaign and the
Bitcoins will only be taken if the conditions of the campaign are fulfilled.
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Micropayments Bitcoin can process payments as small as one dollar and
soon even smaller, and is efficient enough to enable services that are paid per
second, like a phone call or a radio paid for the exact usage in seconds.
Dispute mediation - It’s possible for a third party to accept or deny a
transaction in case of disagreement between the parties.
Multi-signature accounts - Bitcoin wallets allow multiple signatures. This
would allow for example one company with several shareholders to have to
sign to one payment be done and this way not allow one individual to use the
assets alone.
Trust and integrity - Bitcoin nature could help people trust the banks because
it isn't allowed to do some of the actions of fraudulent banks are used to, like
selective accounting transparency, digital contracts and irreversible
Resilience and decentralization - Because of its high degree of
decentralization, Bitcoin created a very resilient and redundant network. This
network is able to handle millions of dollars in trades without requiring
military protection.
Flexible transparency - Although the identity from the users is private by
default, the transactions are public and transparent. This allows the users to
have flexible transparency rules.
Automated solutions - Automated services suffer from the cost of the credit
cards, Bitcoin could be used in a new type of machines like vending machines,
coffee machines etc. cutting their operating costs.
The possibilities are only limited by the imagination of developers and the critic of the
rest of the community. Development
These innovations that Bitcoin brought to the table were initiated by
Nakamoto, but they were improved by the community like mentioned before. At the
moment this project is being written there are eight core Bitcoin developers and two
hundred and one Bitcoin Core contributors [45].
Some of the developers have hundreds or commitments but most of them have
one or two.
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Figure 24: Bitcoin contributors. Source: [45]
Being a developer for Bitcoin the community has to learn how Bitcoin works
and all the material necessary is public in their development page [46].
The development process for new innovations uses five stages:
First the developers work in their own branches until they think their
improvement is ready. In this phase they share and test each other’s patches.
When they think it’s ready they submit to Github and post a message in the
development forum.
If there is consensus that the new patch is safe, useful, well written, match
coding style, then the new code is merged into the 'master' branch.
Bitcoin is regularly tested passing for 4 phases "release candidate" and then
the official, stable, released Bitcoin.
After being accepted bug fixes are merged or backported into the current
stable branch.
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This process is only possible by the usage of github and sourceforge where all
information related to Bitcoin is stored. This process is improving Bitcoin but people
starting using Bitcoin is another thing and mailing lists and communities of
developers can’t go so far alone. So it is important to study the process of diffusion of
innovation. Diffusion
In terms of diffusion the Bitcoin number of users has been growing very fast
and doesn’t seem to be affected by the devaluation from the currency. This can be
seen very easily in the image below.
Figure 25: Number of unique Bitcoin addresses used. Source: [47]
In 2011 there were roughly 10.000 people using Bitcoin daily. Nowadays
there are around 200.000 people’s unique addresses connected to it. This means that
Bitcoin is diffusing very fast, but put in perspective next to the cell phone or the
internet itself it isn't so fast.
So if this virtual currency is so disruptive and so innovative why isn’t it being
faster in its diffusion process and why aren’t there more people using it?
At the moment, the number of Bitcoin wallets in use are about 1.6 million
[48], a number which is very small compared to 2.9 billion internet users globally [49]
and the 7.2 billion people on earth [50]. This means that according to Roger’s model
about the diffusion of innovation that was analyzed in the previous chapter, and these
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numbers, Bitcoin is still not adopted by the early majority and it is only diffused in the
group of innovators (figure below).
Figure 26: Bitcoin diffused in the group of innovators [51].
Well the answer to why aren’t more people using Bitcoin isn’t so easy. Our
survey results taken from the academic community of our University, show that most
of the people, at least in an academic environment, know about Bitcoin. In our study
85% of the people that answered our survey knew about Bitcoin, but from that 85% of
people that knew about Bitcoin only 9% ever used it and only 1 or 2 % were using it
frequently. Comparing to another survey conducted by GfK and reported by the Wall
Street Journal, 76% of Americans are not familiar with Bitcoin [52]. The results are
contradicting and so these numbers cannot provide a definite conclusion about who
the Bitcoin users are.
To answer this question and to understand what is delaying the growth of
Bitcoin, it is important to use Roger’s five factors that influence each individual’s
decision to adopt or reject a new technology.
Relative advantage
In our survey the people that use Bitcoin say that it is good for investing,
simple, fast, almost free and untraceable. In our interview with Cláudio Castro, the
industrial designer that developed the hardware for the Lamassu ATM machine, told
us that he had never used Bitcoin before but now he is using BitPay to receive
payments from Lamassu and it is working even better than before, when he was being
paid in bank transactions. In beginning he was a little concerned about using it but
later on all went well. This relative advantage, of course is not always obvious to
people that are not involved in business transactions (merchants etc.) or users of
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online services. This is also connected to the other factor from the Rogers theory; the
“Degree to which an innovation may be experimented with on a
limited basis”(Rogers, E.M., 2003).This means that it will be faster for an innovation
to be adopted if users can try it out. A Bitcoin wallet is easy to acquire, transactions
can be done for even a small amount of money, users can have many different wallets
and buy, send or mine Bitcoins with processes similar to online banking (Byrne, A.,
2014). This means that a trial phase for Bitcoin can be easily done, by people who are
familiar with online services.
Other parts of the population though, that are not technologically literate or are
reluctant to new technologies/services might find it hard to try it out. In addition, in
order to try using Bitcoin, people need to actually invest an amount of money, which
can be discouraging in the trialability phase.
In a survey done by with 200 answers of merchants, they
answered 97% that they are satisfied with Bitcoin and they recommend it to their
peers [53].This survey shows that trialability is one of the bottlenecks from the
diffusion of Bitcoin and the word of mouth plays here an important role in the growth
of the Bitcoin ecosystem.
“Degree to which an innovation is perceived as being consistent with the
existing values, past experiences, and needs of potential adopters” (Rogers, E.M,
2003). On the one side, Bitcoin is accompanied by services that try to make it
resemble the current system. For example, the Bitcoin ATMs and services like BitPay
(a service that resembles PayPal) are trying to facilitate the use of Bitcoin and make it
acceptable by people. Also the potential adopters are mainly people that seek
Nevertheless the “inconsistency” that Bitcoin presents to the traditional
monetary system, which means the fact that it is not mediated, regulated or controlled
by any financial institution as well as the lack of regulation, is another factor that
hinders its diffusion as some people won’t find it easy to trust.
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Complexity or simplicity
“The degree to which an innovation is perceived as difficult to understand and
use” (Rogers, E.M., 2003). The fact that Bitcoin originated from the online
community and the internet, might be discouraging for some people to use it, either
because they are not comfortable with online platforms and services or because they
don’t trust online services when it comes to transacting money. Transacting with
Bitcoin today, is as simple as online banking, although as mentioned before there are
parts of the population that either don’t know how to use, or don’t want to use such
services, which hinders the diffusion of Bitcoin even more.
Nevertheless, in 2012 423.5 million people accessed online banking sites [54],
which means that even among people that use such services Bitcoin is not yet
“Degree to which the results of an innovation are visible to others” (Rogers,
E.M., 2003) Bitcoin is more and more discussed in the media and especially among
the technical communities. Google returns 39 million results when one searches the
word Bitcoin. Our survey results confirm that most people that knew about Bitcoin,
learned about it from the different media (TV, newspapers etc.) rather than from the
academic community. This means that Bitcoin is attracting attention but still the
people that know about it are few, as discussed before At the same time, Bitcoin
communities in cities around the world organize events, which they advertise through
social networks etc. which also help people get to know about Bitcoin.
One important factor that is helping the diffusion of Bitcoin is the convergence
of services and technologies and this convergence is being fueled mainly by
innovation but also by the need to solve the problems and misconceptions of the
Bitcoin network, like the period of time that one transaction takes to be processed or
the problems with security in the end nodes.
4.1.4 The role of Network Effects and Lock-in in Bitcoin
Central Banks have well defined tools for controlling the monetary system
around the world. On the contrary Bitcoin doesn’t have such tools. It has a peer-to-
peer distributed network in which a “virtual currency” is transmitted from one peer to
another. However, Bitcoin benefits from network externalities that increase its
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popularity and the utility that users receive from being part of this virtual network.
These externalities get stronger from the innovative Bitcoin services such as BitPay,
Lamassu ATMs and so on.
Since Bitcoin was created in January 3, 2009 nobody knew what it was and
how it worked. At that point Bitcoin was growing slowly until the first time it was
used by Laszlo Hanyecz, who paid 10.000 BTC for a pizza(Taylor, 2013). After that,
the utility of Bitcoin was proven as a means of exchange.
Bitcoin’s value, as discussed before, is highly dependent on demand and
people’s expectations about its value in the future. When demand for Bitcoin grows,
thus its network of users grows, so does its value, which increases utility for its users.
Like shown in the innovation chapter the innovators were the first group to
become aware of Bitcoin, and since there are only still now a days 1.6 million users
[48] the diffusion is still at that point. In our survey done with people from the AAU
Students community it showed that that 65% of people became aware of Bitcoin from
places as newspaper, TV, social media. Also like explained before the first step to
generate growth in the network is to people know about it.
After this initial period of Bitcoin being considered a novelty, the open source
community joined in and several services started being created that facilitated Bitcoin
transactions, like exchange platforms, virtual wallets, electronic payment services etc.
All these complementary services brought more value to the network, thus
strengthening the indirect network effects that stem from the growing usage of such
complementary products and services and triggering even more innovation.
This open source community is comprised of developers. Each time a new one
joins the community they bring new ideas and solutions to the problems that network
has. Sometimes they present solutions with complementary services like explained
before, but others times they improve the Bitcoin network itself with new code. When
they work on a new version of Bitcoin, they generate direct network effect.
The active nodes also contribute with direct network effect, because they store
the information related to transactions, which protects the network from losing the
public ledger and from 51% attack what were presented in the security part, so since
new wallets bring more security to the network it brings some positive direct network
In our interview with Claudio Castro, the designer of the Lamassu ATM, when
he is asked Do you think that investing in Bitcoin is safe for a company?” his answer
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was that besides the initial concerns, all worked well and the fact the he’s paying
much less fees allows for more profitability. This shows that even manufacturers, like
Claudio’s company, the network effect is present and is driving the diffusion of
Bitcoin worldwide.
Another effect that is being generated by the Bitcoin network in this
manufacturing business strategy works as a lock-in effect, because it gives them more
profitability and since business seek profitability, it is hard for them to go back to less
profitable methods.
But the network effect is not only creating lock-in for manufacturers and
retailers. Also speculators and investors are benefiting from the volatility of Bitcoin
and so they are also subject to lock-in effect, because if they stock up bigger
quantities of Bitcoin than they can easily sell due to low market liquidity they are
locked in. This is not a strong type of lock-in but it exists. There are also negative
network effects. The more users that are active (that is users trading Bitcoins) in the
network, there is an increase in the traffic and the space needed to the public ledger.
People’s expectations about Bitcoin can also be the reason for the creation of
Lock-in effect, because, since Bitcoin supply is limited, as more people join the
network, they expect that the price of Bitcoin will go up and so they are reluctant to
spend their coins.
All these theories about demand and supply, innovation, network effect and
lock-in drive the need for more convergence. As such, in the next chapter
convergence will be analyzed.
4.1.5 The role of Convergence in the Bitcoin Network
The convergence in Bitcoin started with the Bitcoin creation itself but is being
fueled every day by all the stakeholders needs in the Bitcoin ecosystem. This
convergence of services and technologies is very active and relevant. Services like
BitPay and Lamassu ATM’s are changing Bitcoin and solve some of the diffusion
problems like Complexity, Compatibility and showing the relative advantage from
using them in comparison with the traditional payment systems.
The convergence of the Bitcoin transaction and payment services, with those
of their main competitor, the banks, is unlikely to happen anytime soon and this can
also be seen by the reaction of the players in the Bitcoin industry when Zach Harvey,
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co-founder of Lamassu, was asked why their ATM only accepts notes and not credit
cards or debit, his answer was “I didn’t want to have to deal with banks” [55].
The banking industry is interesting, but like mentioned in the delimitations, it
won’t be analyzed or discussed in this project. The rest of the chapter will talk about
the new services that were created recently and the drivers that are pushing for
convergence. New Services
There are many important services that try to make the ecosystem of Bitcoin
simpler and more meaningful. But because there are always some holes in any
system, innovation is constant in order to solve the problems that appear with the
growth of the Bitcoin network.
One the major constraints in the Bitcoin world was how to buy Bitcoins
physically and companies like Robocoin, Coin Plug, Bit Access, Lamassu, etc.
answered the call and created ATM machines for people to buy Bitcoins.
Lamassu, Inc. is a company that developed the first Bitcoin ATM machine from
scratch and for this project the authors had the opportunity to interview the man
behind “the design of the physical machine the hardware part”. From this interview it
is possible to get a picture of the competitive advantages from this machine compared
to the competition. It is the most secure machine in the market in terms of robustness
because it has a very strong vault, the price is very good compared to their
competitor’s. Lamassu machine cost 5500 dollars where their main competitor’s,
Robocoin, will cost 20,000 dollars [56].
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Figure 27: The LamassuBitcoin ATM [35]
The only drawbacks from Lamassu ATM are that for now it works only one
way. You can’t sell Bitcoins in this ATM, you can only buy them and only in cash.
The movement generated by this company and others is helping the creation of
new businesses, like Claudio Castro told us in his interview. The main clients for
these machines are startups and at the point of our interview “170 machines had been
shipped and 230 had been produced”. These numbers, while small for the global
market, show that there is a huge potential for this market.
The startups that are buying these machines are using them in a similar way
that the vending machines companies do. They place them in Bars, Cafes and other
places, make an agreement with the owner to pay or share profit and make money the
same way Forex (Foreign exchange market) companies do. Putting a rate on top of the
Bitcoin value. The other clients are bars and cafes that make money the same way but
also allow the users to pay them in Bitcoin avoiding this way the transaction fees.
Also another indicator for the potential of this market is the return of
investment that the buyers of these machines are having. Claudio also told us that In
some cases the clients would break even and making profit just in one year with the
machines.” It is expected that this market will keep on moving forward and Lamassu
as a first mover and with high quality, can grab a good share of the ATM market.
But ATMs aren't the only innovative and revolutionary systems that are
helping propel Bitcoin. The payment systems are also helping a lot. In our interview
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Claudio told us how he went from being unfamiliar with Bitcoin, himself, he became
very fast and easily a user of Bitcoin and BitPay.
To our question “Do you think that investing in Bitcoin is safe for a
company?” Claudio’s answer was “yes, now more and more. I was also concerned
about using Bitcoin in beginning, I have a company and I can't pay my taxes in
Bitcoin. I didn’t know much about Bitcoin before but then I researched and read a lot
about it and in the end it worked really well for me and my company. With services
like BitPay every company can use it and it is even better because it has much less
fees. All worked fine and now I like using Bitcoin.”
BitPay Inc is in their words an electronic payment processing system for the
Bitcoin currency. We enable online merchants to accept Bitcoins, as a form of
payment, just as they accept payments from Visa, Mastercard, or PayPal.” [57]
So BitPay is a service for merchants that has some very strong advantages. In
the beginning they used a transaction fee of 0.99% in any transaction, which is less
than most other payment systems charge, but now they changed this model to a
monthly subscription for every merchant that starts from 30$ a month and without any
transaction fees [58].
Also the major headaches for online merchants is the charge backs and the
loss of information of clients and BitPay resolves both. First there are no charge
backs. Only the merchant sends the money back if he wants to and BitPay doesn’t
need personal info from the clients to send the money, so an embarrassing problem is
avoided [59].
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Figure 28: The Bitcoin App [60]
BitPay also allows companies to pay to each other using their platform and at
the both ends the deal is made in traditional currencies. They just use the platform to
make the transfer cheaper [61].
All this convergence has some drivers that make it go faster and wider. Drivers
The first driver of convergence in Bitcoin case was and is innovation and this
driver is analyzed in chapter 4.1.3.
But there was another important driver for Bitcoin, and it was the lack of
regulation. The way the currency was developed using peer to peer and decentralized
makes it very difficult to regulate.
The first moves for regulating this market are being made right now and this
will be further discussed in the discussion but the fact that there weren't any
limitations to the creation of a virtual currency helped a lot with the conception of
Bitcoin. But nowadays it might need some regulation to reduce people’s insecurities
about Bitcoin [62].
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4.2 Analytical overview
The purpose of this subchapter is to summarize all of the above and at the same
time connect them all together in a way that explains the interrelations that were
presented in the analytical framework used in the beginning of 4.1.
In this framework, there is what seems to be a cycle that begins from the vital
part of Bitcoin, which the network and the services and users around it. The growth of
this network is fuelled by this cycle, which includes the demand and supply of
Bitcoin, the innovation process and its diffusion, as well as the network effects and
lock-in that it is subject to. The convergence of the different technologies and services
that stem from this cycle is also included in this framework as an important result
from the growth of Bitcoin and the innovations it brought along.
Bitcoin counts only a few years of life, which means that it is not yet in a mature
phase and its diffusion process is difficult and at a very early stage. With a supply
dictated by its algorithm, an upper limit that will be reached in a few years, and no
governmental or authoritative control over it, Bitcoin’s value presents a volatile
Demand also affects its price and it causes fluctuations according to users’
expectations and speculation in the market, with the example of Cyprus proving this.
At the same time lack of regulation by local governments, creates uncertainty about
its legality but at the same time becomes a driver for convergence. Demand can also
be affected in a negative way, due to security concerns for instance, as explained in
the previous chapters through our desktop research and survey results.
Despite the price fluctuations, Bitcoin’s value has exploded since its creation,
which attracts attention for investors that see it as an opportunity to bypass the current
banking system, which the last few years has had problems in most countries in the
world. This way demand is growing and more people use Bitcoin. This growing
demand is an opportunity for new people with innovative ideas to create products and
services that will facilitate Bitcoin transactions (e.g. Bitcoin ATMs, BitPay etc.). By
making transactions simpler and Bitcoin more accessible to everyone, more people
can join the network.
The innovative aspect of Bitcoin can be looked at from a technological and a
financial point of view. Bitcoin itself brought some sustaining innovations to the peer-
to-peer technology as far as virtual currencies are concerned but it was disruptive to
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the financial system, as a substitute for traditional currencies that doesn’t need any
central authority to operate and it’s the network itself that is the heart of the system.
The innovative products and services that were created around Bitcoin, were not
disruptive but mashed together services and products that complement Bitcoin’s use
as a currency.
The degree to which these innovations are diffused in the market depends on
many factors. Bitcoin itself is still at a very initial stage of diffusion and subsequently
the products and services around follow the same course.
Through demand and innovation, there is a growing network being created. A
network which is subject to network effects, as the more people join it, the more value
it has for its users. No currency, virtual or not, has any value unless people use it. And
the bigger the number of people that use it, the more powerful it becomes. The
American dollar for example has been for years the currency that world trade was
being conducted in. Its importance was based on the fact that everybody wants to
transact in American dollars. The same effect applies to virtual currencies like
At the same time, when a currency or asset becomes powerful and has value it
creates lock-in effect, as people will possibly become reluctant to spend it or sell it, if
they expect it to grow in the coming years.
And on goes the cycle making Bitcoin and its network grow in value and
importance, whether at a fast or slow pace. In all this process one can recognise how
technologies and services are converge. Starting from Bitcoin itself, a technology is
used as a form of currency that can substitute traditional currencies.
The traditional concept of an ATM was also changed with the creation of Bitcoin
ATMs, which allow you to use real currencies to buy Bitcoins or take out real money
in exchange for Bitcoins. The concept of a wallet was also turned into digital form
that stores our virtual money and allows us to transact in it. The possibilities are
endless, when it comes to what innovators can do, which means that convergence is
present in every aspect of it.
Bitcoin is a relatively new virtual currency and as such it has a long way to go
before it is well-known and widely accepted. The environment of uncertainty created
around it has drawn governments’ attention, which means that the regulatory issues
about Bitcoin are an important aspect of it nowadays.
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The future of Bitcoin and the trends to follow are going to be discussed in the
next chapter where the analysis done previously will help us identify how Bitcoin can
evolve in the years to come.
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5 Discussion
In this chapter there will be a general discussion about virtual currencies, which
will be based on the analysis made for our case study, Bitcoin. This discussion will
attempt to look into the reasons for the creation of virtual currencies and their growing
popularity, as well as compare the ones with the biggest market share. Next we will
try to find out the future trends regarding virtual currencies and more specifically
we’re going to look into the peer-to-peer virtual currencies popularity.
In the chapter there will also be a discussion about the regulation trends that the
Bitcoin currency faces and to finalize there will be a discussion on whether Bitcoin is
turning to be a standard or the market is diverging from forming standards.
5.1 Peer-to-peer currencies popularity - Front runner discussion
The number of peer-to-peer currencies is growing very fast during the research
and writing of this project. More than 50 currencies were added to, a webpage that tries to track the current value for all the virtual
currencies being traded. When this project was initiated they were around 240 and
now a few months later there are 290 and it is very likely that this number will keep
on growing [63].
The table that appears next was updated with the information collected on May
25th of 2014 at 11:30 AM UTC. The information shown in the table, especially the
value of the currencies, as well as their position relative to each other, will be
constantly changing. A bigger version of this table can be found in the appendix.
Table 1: Comparative table of the frontrunner virtual currencies
During the time this project was developed many currencies passed by the top
10 in terms of Market Cap. When the last information was collected, all the peer-to-
peer currencies combined had a market cap of 7.9 billion dollars and Bitcoin would
account for almost 92% of that. Although this is true the first two currencies (Bitcoin
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and LiteCoin) have been the front runners since their creation and no currency yet was
able to challenge them.
LiteCoin currency was created from a fork of Bitcoin. It is limited at 84
million coins exactly, which is 4 times the amount of Bitcoin. The reason it was
created was to be faster and more efficient than Bitcoin. Its algorithm is capable of
handling more transactions than Bitcoin because its blockchain is more frequent.
LiteCoin was designed to be a complementary coin to the Bitcoin ecosystem.
The third coin in the list is Darkcoin, which was created at 18 March 2014 and
is already third in market value. This project was focused in the security part, the
main difference with Bitcoin being that the users can choose to make the transactions
public or not and the last ones won’t be stored in the public ledger, like in the Bitcoin
case. Maximum number of coins is 22 million (Duffield, E., et al., 2014).
The next peer to peer currency is PeerCoin, focused in solving some of the
flaws of Bitcoin, one of them being the 51% attack, where one large entity or a
government holds 51% of the network being able to disrupt the network. This is
because Peercoin moved the security from the network to the client side. In order to
perform the same attack the entity would have to hold 51% of the coins, which is
infinitely more expensive than in the Bitcoin case, because this type of attack would
raise the prices massively and then disrupt the network and cost a lot to the attacker.
Many currencies claim that Bitcoin takes too much processing power and because of
that spends too much energy. One of the cases is PeerCoin. PeerCoin doesn’t have a
limit for the number of coins that will be generated. In the code it is defined that it can
reach 2 billion coins but that can change and at the current rate of growth it will take
hundreds of years to reach that (King, S. et al., 2012).
Next comes NXT and it is the only one that is 100% different from Bitcoin.
NXT can’t be mined. Instead they call it forging; this process is requires less
computing power and there is no need to use special hardware to do it. Forging
doesn’t create new NXTs. Instead users receive a part of the transaction fee for
helping the network with processing. All the 1 billion NXTs were generated in the
genesis of the code and they were given to the stakeholders that invested Bitcoins in
the beginning. This currency also allows for data to be sent, not only currency [64].
The sixth currency in the list is DogeCoin, which started as a joke but grew to
become a serious currency. There is no limit to how many coins can be generated
which puts DogeCoin in the same league as a normal inflationary currency. By the
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end of 2014 there should be 100 billion DogeCoins out there. DogeCoin is also more
effective than Bitcoin by spending less processing power for mining it or transferring
it [65].
The Ripple has a public ledger, like Bitcoin, with all the activity in the
network. It works similarly to the email protocol and makes it easier for different
users to send money to each other. The maximum supply is 100 billion that were pre-
created and are now being distributed. There is a bridge between Ripple and the
Bitcoin ecosystem. But although it is compatible with Bitcoin it has its own code and
it isn’t a fork from Bitcoin [66].
The next currency in the table is NameCoin, which was the first fork from
Bitcoin. Similarly it is also limited at 21 million coins and it allows users to do merge
mining, which means they can mine both Bitcoins and NameCoins at the same time.
Also it created the first decentralised domain system the .bit [67].
The ninth currency in the list is MasterCoin. The protocol of MasterCoin is
using the Bitcoin protocol to enable features like smart contracts and user-defined
currencies without disrupting Bitcoin. MasterCoin is developing the concept of smart
property to users by enabling them to not only trade coins but also properties.
MasterCoin has very similar features with Bitcoin. For example, in the internet the
applications use TCP/IP to communicate with each other and build on top of it new
functionalities [68].
The last currency in the list is BlackCoin, a currency more efficient than
Bitcoin, which will have only 1% yearly inflation and doesn’t have a limit for how
many coins will be created. Its creation is very recent so many details can only be
seen by an analysis of its code [69].
From the study of these currencies it is possible to see that Bitcoin is without a
doubt the main currency. Not only because it’s 90% plus market share but also
because most of the other peer-to-peer currencies were created based on Bitcoin. Also
it is very interesting that although some of these currencies were created to compete
with Bitcoin many of them, like MasterCoin, NameCoin, LiteCoin, etc. were created
to complement Bitcoin and give a new array of services to the Bitcoin ecosystem.
It is also possible to see that there aren’t close source currencies on the top ten
and almost all of the currencies were created as a platform that companies and users
can contribute and innovate. Many tools are being created around these currencies,
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tools that are attracting innovators, investors, speculators. These tools are allowing
new possibilities and the future is wide open.
5.2 Future trends
The idea of virtual currencies goes back to the 1990s. Since then, a lot has
changed in the way that transactions are done. As technology advanced and more and
more people acquired internet access, transactions became easier and faster, electronic
payments grew and the use of credit and debit cards became the easy way to buy,
without the use of cash or the physical presence of someone in a store. Transactions
were facilitated through services offered by companies such as Visa or Mastercard,
which allowed safe and instant exchange of money between people’s bank accounts.
This globalized electronic payment system, though, took away an important
characteristic that only paper money offered before; the user’s privacy. Every credit
or debit card, every bank account, every electronic transaction is related to people’s
personal details and recorded by their bank. At the same time transaction fees are
charged for online transactions, which is another difference from paying with cash.
In a world where privacy and anonymity are no more taken for granted, virtual
currencies, such as Bitcoin, came to change that. Based on a peer-to-peer
decentralized network, they allow anonymous transactions, which are validated by the
network itself and not by a central authority, with very low transaction fees and a
public record of transactions that prevents double spending.
At the moment there are almost 300 different virtual currencies that are either
an improvement to Bitcoin or independent technologies. Nevertheless none of them
have reached Bitcoin in value or market share. And despite all the drawbacks or even
misconceptions about virtual currencies, they seem to keep growing, indicating that
virtual currencies are here to stay. At least for the time being. And since virtual
currencies are not just in-game currencies that are used to only buy virtual goods
anymore, but have actually the potential to become a substitute for real currencies and
overcome national borders, it is expected that governments will have to take an
official stance in the near future, especially as their usage grows.
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5.2.1 Virtual Currencies and regulation
The more popular virtual currencies become, the more they attract the
attention of countries and their central banks. Bitcoin and all virtual currencies are
becoming by becoming a means of transaction have turned into part of the financial
and trading system but without being controlled by it. It is too early to say that this
might be threatening to banks or other financial institutions, since their diffusion in
the market is at a very early stage, but if their popularity keeps growing, companies
facilitating transactions, like Visa, as well as banks, could lose a significant amount of
money since currencies like Bitcoin bypass the need for their services.
Moreover, governments are also not profiting, while Bitcoin remains
unregulated. Also, it is necessary for them to make an official decision about Bitcoin
or virtual currencies in general since that will clarify the situation about Bitcoin’s
legality, so that businesses and people can decide whether they will invest in it or not.
Figure 29: Regulation map for Bitcoin. Source: [70]
So far, what seems to be the trend in terms of regulatory decisions is that most
countries tend to allow Bitcoin’s usage and exchange and some have also announced
their intention to put taxes on it. Others, like China and Russia, want to put more strict
regulations on it, although there are no official actions towards it yet. Finally very
few, like Iceland and Vietnam, have a hostile stance against Bitcoin, banning it from
financial transactions.
What seems to be the most possible scenario for the majority of countries, is
that they will try to somehow integrate Bitcoin into the financial system, by calling it
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an asset and possibly receive taxes on it. Depending of course on the national laws
and financial systems, the exact legal framework that Bitcoin is going to be
surrounded by, will be adjusted by each country separately and this might take time.
Nevertheless, regulatory decisions will affect Bitcoin to a great extent in the
near future. Businesses that offer Bitcoin related services and products, not just in one
country, will have to take seriously into consideration every decision that national
governments make and adjust their products or services to them.
Finally, the regulations that apply to Bitcoin today or will apply in the future,
are only restricted to this specific virtual currency. The cases of other virtual
currencies will have to be examined thoroughly by governments, in order to become
regulated, unless a complete legal framework about virtual currencies is created in
each country.
5.3 Bitcoin: A Standard of virtual currencies?
Bitcoin counts only five years of life. And although it wasn’t the first virtual
currency created, since its creation, the number of virtual currencies has exploded,
compared to the years prior to Bitcoin. Bitcoin can be called the most successful
among the existing virtual currencies, both in terms of value and market share. At the
moment its price is valued at $517,52, which is much more than the second in row,
LiteCoin, with $11,05.
Figure 30: Most valued virtual currencies 24/5/2014. Source: [63]
In addition, Bitcoin is the only virtual currency that is complemented by
services such as Bitcoin ATMs and online payment platforms like BitPay and it is the
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only one, which has attracted attention on government level and raised discussion for
Nevertheless, saying that Bitcoin is going to be the standard among other
virtual currencies would be a hasty conclusion. It is true that Bitcoin has withstood
many events that could have been the end of the currency; the shutdown of the
exchange platform MtGox, China’s decision to exclude it from transactions within
financial institutions and many more. Its price went from $1200 to $400 and back up
to $500, within weeks, but the Bitcoin community managed to keep the currency
But whether Bitcoin will be the standard between virtual currencies and
prevail or there will be a wide spread of virtual currencies in the future, is almost
impossible to answer at the moment. The reasons for that vary.
First, Bitcoin’s future will be to a great extent defined by what regulatory
decisions will be made by the different governments. Some may recognize it as a
currency, some others may reject it. Others might call it an asset and put taxes on it.
Those decisions are important for the future of Bitcoin and the virtual currency
Second, Bitcoin, just like any other virtual currency, is not imposed by any
national government, like national currencies are. This means that any negative effect
on demand could lead Bitcoin to extinction. As demand is what makes Bitcoin
valuable, any changes in people’s expectations as well as speculation play a vital role
to its survival in the future. Therefore it is difficult to say that Bitcoin will turn out to
be the standard for virtual currencies, while all others will disappear.
Finally Bitcoin has roughly 90%, at the moment, of the virtual currencies
market share in terms of value, and in a market that as no barriers of entrance and
where all the rules from perfect competition can be applied, Bitcoin has the monopoly
(if it was a company, since according to the Sherman Act (Sherman, 1890),
companies that have more that 75% of the market share have the monopoly). But in
the case of virtual currencies everything changes very fast, especially because there
are no barriers of entrance.
Bitcoin’s growth is important for its way to become a standard in the virtual
currency market. But whether that will happen or not, is still too early to say and it
depends on all the factors mentioned previously. The next few years will determine its
future and prove whether the innovations it brought will change the scene to its favor.
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6 Conclusion
In this chapter of the project all the analysis and discussion will come to a
conclusion. The questions in the problem definition will be answered with the
information gathered and discussed during the project.
It is also important to say that the ecosystem behind these currencies is very
volatile and some of the conclusions can change with innovative or regulative steps
taken from all the stakeholders, them being the developers of all the currencies, the
governments and other institutions.
6.1 What are the main reasons for the monetized peer-to-peer
virtual currencies’ growing popularity?
Virtual currencies materialized new trend of innovative ideas that used
technology and the Internet in order to satisfy users’ need for online transactions of
not just virtual but real products and services. With virtual currencies transactions can
be done cross-border, without the implications of national governments and banks or
intermediaries for online payments, like Visa and Mastercard. And so freedom of
capital movement is enabled, although this can soon and easily change depending on
each country’s regulatory decisions.
But besides being able to transact without restrictions, another reason that
virtual currencies have become appealing to people, and most importantly investors,
is the low transactions fees they offer. So merchants, investors and even speculators
can benefit from being able to bypass intermediaries and transact with the lowest cost
Virtual currencies are also vulnerable to speculative moves, since their
volatility offers a good opportunity for major profits for the speculators. This might
also have negative effects on virtual currencies but speculation exists in a every
financial system.
Another important aspect of our research that the users seem to care a lot
about, is the privacy and security that these currencies give them. Virtual currencies
offer anonymity and privacy features that are not available in online payment systems
today. In the security section there were some problems in this area but for the most
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part the Algorithm of Bitcoin has proven very resilient and so most of the new
currencies use the code as their point of origin for their work.
Virtual currencies and especially Bitcoin have proven to be a way for investors
to secure their money in times of financial stress, just like in the case of Cyprus which
we studied in our analytical part, where the value of Bitcoin raised to double.
6.1.1 What are the reasons behind Bitcoins supremacy to other peer-to-
peer currencies (economic and technological perspective)?
There are many reasons for Bitcoin’s relative success but when compared to
the other virtual currencies Bitcoin has a very clear advantage, being the first comer in
the peer-to-peer currencies market. The first mover advantage in the peer-to-peer
virtual currency market can also be seen by the fact that Bitcoin is the first and has
proven to be a reliable platform to other currencies and services to build upon and
improve it.
The Cyprus case in 2013 helped validate Bitcoin as the frontrunner. At that
point Bitcoin was seen as a profitable asset to invest the money that the banks were
about to use for their needs. The first mover aspect played an important role because
Bitcoin ecosystem had proven itself for four years its resilience and the investors saw
the relative advantage to the other currencies that were less known and consequently
less reliable, also the gold was that all time high and it also helped some investors to
choose Bitcoin.
The rate of creation of new currencies is very high which is flooding the
markets with innovative types of peer-to-peer coins, and takes time for new users to
understand them all and make an educated decision. Bitcoin is a new currency itself
and after its 5 years of existence it is still not widely adopted. This flood of new
currencies that has been going on after Bitcoin is too premature yet and so it will take
time before all these new currencies, or at least some of them, will start being used or
invested in as much as Bitcoin.
6.2 What are the possible future trends regarding peer-to-peer
virtual currencies?
The future of virtual currencies and the extent to which they will substitute for
real currencies is still debatable, but some conclusions can be drawn from the
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indications we have today. The volatility that virtual currencies appear to have makes
it very hard to make predictions in the long run.
6.2.1 What are most important regulatory trends related to virtual
At the moment, the regulations existing in different parts of the world are only related
to Bitcoin, since it is the most popular among virtual currencies. Governments all over
the world are, in one way or another, trying to come up with regulatory acts, others
more strict, others less, in order to clarify the situation about Bitcoin’s legality and
define whether Bitcoin is a currency or not.
The trends that seem to be appearing at the moment is that most countries have
declared Bitcoin an asset and have announced that they will include it under tax law.
None however, have recognized Bitcoin as a currency but they do recognize it as a
substitute for real money. There are cases of countries whose stance against it is more
hostile, banning it from transactions.
No matter what these regulations will be, it is certain that they will affect the
future of Bitcoin and they will set the base for regulating all virtual currencies.
6.2.2 Is a standard being formed (Bitcoin), or is there a growing spread of
virtual currencies being used?
In our last view over the market Bitcoin had more than 90% market share
among all the peer-to-peer virtual currencies that exist. In itself it’s a strong argument
that Bitcoin is the standard right now but in the future it will be very hard to know if
Bitcoin will sustain this place. Every week there are many newcomers and most of
them don’t have too much expression but there are others, like the case of DarkCoin,
that is 2 months old and very similar to Bitcoin except it allows people to not publish
their transaction in the public ledger giving this way much more privacy and making
the currency much lighter in terms of harddrive space. The result was that in 2
months DarkCoin got to the third place in terms of marketshare and seems to keep on
The volatility of those virtual currencies do not allow any definite conclusions
about Bitcoin being the standard in the future but so far Bitcoin is the most important
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player while it is complemented by many other services and products and has a strong
community that supports it. Nevertheless, this can change in the future based on
regulations, expectations about its value and many other factors, making it hard to
predict the developments in this market.
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