Steep fees call into question bitcoin’s promise for the underbanked

Abra set out in 2014 to make mobile money movement cheap and fast worldwide, using the bitcoin network as rails.

But lately the fees for transferring value on that network have risen, creating a predicament for the startup: charge more for sending funds with its mobile app, or eat the fees.

For a time, Abra absorbed the additional cost. Given that the average transaction size for Abra is $200, and that bitcoin’s scaling problem is relatively new, “we can afford to wait for that technology to scale,” Bill Barhydt, the company’s founder and CEO, said in early July. (The company raised $14 million in Series A financing two years ago.)

But late last week, Abra notified its users that starting Aug. 21, it would charge for withdrawing bitcoin to an external wallet. Barhydt said more people are using Abra’s bitcoin service than predicted, and network transaction fees are adding up. “The mining fee there make sense” to pass on to customers, he said, referring to the fee bitcoin senders pay so-called miners to ensure their transactions are included in the next block added to the public ledger. (Abra also allows users to keep their balances on its app in fiat currency. Sending money to another Abra user will remain free, as will paying a merchant with the app and adding funds via bitcoin or a bank account.)

Bitcoin, once hailed as a fast and low-cost payment option, has become slower and more expensive to settle as the number of users increased, creating congestion in the network. The average transaction fee peaked at $5.50 in early June, making bitcoin untenable as a means of everyday payment. The fee has since fallen, but is still above $2 per transaction, according to bitinfocharts.com. While that’s negligible, in percentage terms, compared with the average transaction value of 17.97 bitcoin, or about $49,461, it’s a steep freight for smaller payments.

An impasse in the bitcoin community over how to scale the network has led one faction that wanted to expand capacity faster to start a rival currency, rather confusingly called Bitcoin Cash. The new coin was expected to split off from the main bitcoin blockchain sometime Tuesday.

The rising fees on the main chain call into question the long-ballyhooed potential for bitcoin to be a solution for the underbanked and unbanked populations. On the one hand, as an open network (anyone can download the software for a bitcoin wallet without asking permission) it is in a sense the most inclusive financial system imaginable. But for now, bitcoin transfers are priced like a luxury good.

“Cryptocurrencies have to be dramatically lower-cost than fiat currencies for a prolonged period of time to upset” the latter’s dominance, said Arjan Schütte, founder and managing partner at Core Innovation Capital, a venture capital firm.

Fees are not his main concern, however. Although three years ago he envisioned that the underbanked would use mobile wallets loaded with digital cash, Schütte said he now thinks this technology is for enterprises and financial institutions, not retail customers. His venture capital firm is an investor in Ripple, a startup that pivoted from offering cryptocurrency to the masses to selling enterprise software to banks.

Regulation, which the bitcoin protocol essentially ignores, is another roadblock, Shütte said. “You can’t go outside of regulation if you’re gonna become big,” he said.

Gideon Greenspan, founder and CEO of Coin Sciences Ltd., the company behind Multichain, an enterprise blockchain platform, said that theoretically, if the financial industry’s consortiums choose to open their private blockchains to the public, the underbanked could benefit.

“That means people can send funds denominated in dollars and euros and access the mainstream financial market without identifying themselves,” Greenspan said. But “I don’t think regulators will accept that.”

While untenable for everyday payments, bitcoin is a good option for those who want to hold assets without going through know-your-customer rules, since it’s extremely easy to convert between cryptocurrencies, he said.

On the other hand, to the extent physical cash still circulates through the economy, regulators may tolerate the use of cryptocurrencies, Greenspan said.

Shütte predicted that the underbanked will benefit as financial institutions' back offices improve using cryptocurrencies and blockchains, although such use cases are, for the moment, few and “not very interesting.”

“It’s like a B-to-B-to-C model,” he said.

Yet the B-to-C (or, perhaps, BTC-to-C) model lives. Andrew Barnard, co-founder of Bitstop, which operates a fleet of over 40 bitcoin vending machines in Florida, estimated that about half his customers are unbanked or underbanked.

“It's more than anything an assumption,” Barnard said in an email, based on the fact that Miami, where one in five households do not have a checking or savings account, is the most unbanked large city in the U.S.

His company was charging 14% per transaction as of July 31. “There aren't a lot of options right now to get bitcoin, so as long as it's convenient, customers will continue paying relatively high prices,” Barnard explained by email.

“As competition, infrastructure and economies of scale grow, customers will begin to become more aware of their options and prices will naturally come down over time,” Barnard said, predicting that bitcoin ATM prices will eventually fall to 5% to 7%.

Barhydt said he expects throughput on the (main) bitcoin blockchain to increase because of several possible upgrades: Segregated Witness, a different way to store data; an increase in the block size, now capped at one megabyte; and the Lightning Network, which will allow smaller transactions to be done off the main bitcoin blockchain before being settled on the ledger.

“If that turns out not to be the case, then we will make our own technology to mitigate that risk” of further bottlenecks, Barhydt said.

Despite the uncertainties, Barnard and Barhydt expressed confidence that more people will need bitcoin in the future.

Being in direct control of one’s money mitigates the costs of cashless transactions, Barhydt said.

“The idea that you can become your own bank is very powerful.”

Greenspan said the fee problem may eventually “sort itself out” as there are “no fundamental technical issues with scalability.” The governance issues that led to Bitcoin Cash’s secession can be overcome, he said, as in the early days of the internet. “If you have a governance crisis for bitcoin every 10 years, you still get to use it for every nine and a half years.”

“The problem is whether consumers and businesses are willing to accept it.”