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Bitcoin: Seven reasons to be wary

By Maria Korolov, Network World
July 23, 2012 07:00 AM ET

Network World - Of all the virtual currencies out there, BitCoin is the most interesting from a technical perspective - and the least interesting from the business point of view. BitCoin is a peer-to-peer virtual currency that uses cryptography to control the creation and transfer of money.

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Unlike all other currencies, BitCoin is completely independent. "It is company or organization agnostic," says Ajay Vinze, a professor at the W. P. Carey School of Business at Arizona State University, who is studying BitCoin.

All other currencies are either based on some standard of value, or are backed by an issuing entity such as a government or corporations. Gold, for example, is a metal which has both practical and decorative uses, though many gold coins also have additional value as historical artifacts.

Many BitCoin enthusiasts are attracted by BitCoin's independence, and the fact that its value comes directly from its network of users. But aside from its status as a technical marvel, it has little practical benefit for business users or consumers.

Here are seven reasons why.

1. Nobody has to accept it.

Traditional government-backed currencies have local monopolies on things like paying taxes or utility bills. Merchants may decide to accept live chickens as payment, but they usually have no choice about whether or not to accept their national currency. Companies that issue virtual currencies typically offer goods or services in return.

"You want it to have inherent value, you want it to have someone backing it up and exchange it to other forms if you choose," Vinze says.

Now, this isn't a guarantee. Governments fall. Companies go bankrupt - or may simply decide to discontinue their virtual currencies.
If a currency is only as strong as its backers, BitCoin isn't backed by anyone.

2. No critical mass.

For a currency to have any practical value, it has to have a critical mass of buyers and sellers.

"Technically BitCoin has no reason why it shouldn't be successful, but it certainly has no following that you would want," Vinze says.

3. No switching costs.

Say you are a U.S. business that accepts U.S. currency, and you decide to stop accepting it, and, say, accept only live chickens. You will lose all potential customers who don't have access to live chickens. You will have problems paying suppliers and employees. And you won't be able to pay taxes - in the U.S., even barter-only transactions are taxable. These are all high switching costs.

If you are a player of a popular online game, and decide to stop using their in-world currency, your game experience will suffer significantly, and you may have to stop playing the game altogether. This is a switching cost.

If you decide to sell off your existing BitCoins and stop using them, there are no switching costs. All your existing suppliers and employees will happily take other forms of payment. Your only loss would be the marketing value of accepting BitCoin, which is likely more than offset by the additional costs of processing BitCoin payments.

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