Do people use cryptocurrency to pay for small daily purchases, such as a burger and fries, or a subway fare? The preferred means of payment likely hinges on cost and convenience. For small everyday local purchases, cash, cards, and smartphone payment apps are likely to be cheapest and easiest to use. Cryptocurrencies are only competitive when transactions are large and span national borders. For such transactions, cryptocurrencies compete directly with banks and non-bank financial institutions such as PayPal and informal remittance mechanisms such as hawala.
Consider, for example, the fees needed to get the blockchain to process a single bitcoin transaction. The time needed to process a transaction is inversely related to the transaction fee offered to miners. On average, a new block is processed every 15 minutes. The graph below shows that the cost of including a transaction in the next one, three, or six blocks on the blockchain has varied widely over time from a low of a few cents to as much as $37. The potential high transaction cost and variability make bitcoin an unappealing way to pay for a burger and fries.
Cryptocurrency becomes a competitive payment mechanism when transaction sizes are large and transactions span national borders. In this market, cryptocurrencies not only compete with banks but also with money transfer and remittance agents.
PayPal is a regulated electronic funds transfer agent. For a small commission, PayPal will transfer national currencies between any two parties, provided the parties have access to email and a PayPal account. PayPal transactions do not require a bank account. However, PayPal transactions are not anonymous, and single transactions must be less than $10,000.
Hawala is an inexpensive way to make small payments to remote locations without using the banking system. Hawaladars are merchants, not regulated financial institutions. Hawaladars are widely distributed across the globe and are typically interlinked by some type of trade arrangement that complements their hawala remittance business (e.g., handmade carpets, electronics, used cars, jewelry trading, etc.).
To make a payment using hawala, the party sending payment agrees on transaction terms, including the location, currency, and size of the payment. Counterparty names are not needed or recorded. The initiator pays his or her local hawaladar in local currency. In return, the hawaladar gives the payer a password and provides the password to a hawaladar in the payee’s location. The payer provides the password to the payee who uses it to receive payment from the local hawaladar. There is no written record of the transaction.
The total volume of hawala transactions reportedly exceeds $400 billion annually. To avoid detection and prosecution for violations of money laundering, exchange controls, and operating an unlicensed money transfer business, hawaladars are unlikely to process exceptionally large individual transactions.
While hawala is a potential substitute for small transaction cryptocurrency demand, it may also be a source of cryptocurrency demand. Reports suggest that hawaladars are using bitcoin and other virtual currencies to facilitate hawala remittances.
Blockchain data show that an important share of cryptocurrency transactions involve very large values. For example, Bitcoin has a number of blockchain transactions that have exceeded the equivalent of $100 million, and transactions that are equivalent in value to many millions of US dollars occur regularly on the blockchain.
Because both hawala and cryptocurrency transactions are anonymous, they are attractive among those transacting in illegal goods and services, funding terrorism, or other illegal activities. A recent paper estimates that nearly 24 million bitcoin market participants and nearly half of all bitcoin transactions can be linked to illegal activities. While hawala itself is illegal in many countries, hawala transactions are numerous, and many are generated by legitimate business activities. It has proved difficult to estimate the magnitude of illegal transactions settled using hawala.
In assessing the future growth of cryptocurrencies, it would be a mistake to overestimate the importance of money demand generated by day-to-day transactions. As Jimmy Buffet reminds us, “You may get by looking good and being funny, but life’s more fun with a little spending money.” And unless transaction costs decline, that all-important spending money is unlikely to be cryptocurrency.