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Bitcoins and virtual currency how do businesses cope?

Bitcoin speculators have made millions of pounds in the last few months as the value of the internet-based virtual currency has exploded. But it's unclear if the virtual currency is just a passing fad, or whether it may evolve into a valuable tool for doing business.

Today Bitcoin is accepted by a small number of retailers, and David Woo, head of global rates and currencies research at BofA Merrill Lynch Global Research, believes that most do so simply for the publicity it earns them. "Companies like Victoria's Secret are probably using it to brand themselves as hip," he says. The other main reason for businesses to use Bitcoin is that it is a lowcost way to accept payments, he adds.

"Vendors get charged 2% to 3% by credit card companies, but the cost of using Bitcoin is zero," says Mr Woo. Bitcoin can also be used as a cost-free way to send money around the world. But there's a big problem with using Bitcoin for business purposes at the moment. "The overriding reason not to accept it is because of volatility," says Mr Woo. "This is the biggest challenge for Bitcoin." That's because while speculators welcome volatility - big price movements provide opportunities to make money - businesses generally don't like such risks.

How the value of Bitcoin increased in 2013

Huge swings in the value of Bitcoin mean profits on goods or services supplied can be wiped out when it depreciates; prices listed in Bitcoins have to be monitored and adjusted frequently. The conventional way for businesses to manage currency risks is by using derivative instruments such as futures and options, but even if these were readily available for virtual currencies they would not be practical at the moment, Mr Woo explains. "As a US exporter to the UK, I could buy sterling 'put' options against the dollar," he says. These would give the option to exchange sterling into dollars in the future at a set rate, regardless of the actual exchange rate on the day, mitigating the currency risk of accepting payments in sterling. "The problem is that the price of these 'puts' is a function of the currency's volatility, so with Bitcoin they would be very expensive."

But in order for Bitcoin's volatility to diminish, Mr Woo believes the virtual currency needs to become far more liquid, and for that to happen, more people need to buy and use the currency. And although Bitcoins can be divided into tiny subunits, the supply is ultimately finite. "That means if more people start adopting them then prices have to go up, and that creates more volatility," he says.

Legal status? Another problem with using Bitcoin for business is that trading it is far from easy. Its value varies significantly in different countries - Marc Warne, director of London-based Bitcoin exchange Bittylicious, says this can often be as much as 10%. In an efficient global market these price differentials could be exploited by some investors. But Mr Warne says the cost of sending money to overseas markets and the time it takes, coupled with trading fees, makes the overall market inefficient and means these international price differences persist. "In a way this proves the value of Bitcoin, because unlike bank transfers, transferring them is free and almost instant," he adds. One thing that may have to happen before Bitcoin is more widely used by businesses in Europe is clarification of its legal status and some sort of regulation.

A key question that needs to be answered is whether it has the legal status of a currency, according to Angus McFadyen, a technology and payments law expert at Pinsent Masons. "Some people say it is an investment, and others say it is a currency. If it is a currency then it should be treated as such by the Payment Services Directive. This provides the basis of refund rights for unauthorised transactions." Mr McFadyen adds that this European Commission directive currently deals with the currencies of EU member states, which clearly does not include Bitcoin.

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