E-commerce and brick-and-mortar retailers targeting millennials and other tech-savvy consumers should give serious consideration to accepting the virtual currency.

Virtual currencies — money that exists only in digital form and is used as an alternative to government-issued currencies — have been available since the late 1990s. But it took the launch of Bitcoin in 2009 for virtual currencies to begin to see any significant adoption.

Bitcoin, which allows people to send and receive payments online within an entirely decentralized peer-to-peer network, has become the most prominent type of virtual currency worldwide. While the Bitcoin currency network has a capital “B,” actual bitcoins have a lowercase “b.”

Other virtual currencies include Litecoin (which is technically nearly identical to Bitcoin), Dogecoin, Namecoin, Peercoin and many others. “None of these virtual currencies are anywhere near Bitcoin in terms of adoption,” said Patrick Byrne, CEO of U.S.-based online discount retailer Overstock.com.

There were 13,360,750 bitcoins in circulation on October 8, 2014, worth around $4.6 billion, according to Bitcoin publication CoinDesk.com. Bitcoin’s value fluctuates daily. A whole bitcoin was worth $343 on CoinDesk’s USD Bitcoin Price Index (BPI) on October 8, 2014.

CoinDesk estimates that the number of Bitcoin wallets worldwide rose from 765,039 in June 2013 to 5.4 million in June 2014 and to 6.6 million in September 2014. Bitcoin was accepted by 76,000 merchants, the vast majority being online businesses, in September 2014, up from 63,000 worldwide in June 2014.

Tier 1 merchants such as Dell, Expedia, Overstock.com, TigerDirect and Virgin Atlantic accept Bitcoin, which is helping drive consumer awareness of virtual currencies. “A small but growing segment of consumers want to pay with Bitcoin,” Byrne said. “The number of Bitcoin users is growing at 30 percent a month, and the number of Bitcoin wallets is growing eightfold year-on-year.”

Bitcoin basics

Bitcoin was developed to eliminate the middleman when two parties exchange payment for goods and services. That means no banks or third-party networks such as MasterCard or Visa are involved in the Bitcoin payment process.

According to the Mercator Advisory Group report “Bitcoin Basics, Trends, Regulations, and Usage,” the main attraction of Bitcoin always has been that it isn’t an institution, an organization or any sort of centralized entity.

“Since there’s no central authority, Bitcoin has thrived due to its transparent and hassle-free nature for both buyers and sellers,” the report said. “While the governments of the U.S., U.K. or the European Union are not likely to shut down Bitcoin, rules and regulations will likely be imposed as the digital currency’s popularity continues to grow in select markets around the world.”

In 2008, a Japanese IT expert using the name Satoshi Nakamoto published the original Bitcoin protocol and reference software and created the first bitcoins in January 2009. No one knows Nakamoto’s true identity for sure, and it is possible that Satoshi is either a person or a group of people.

Bitcoin is referred to as a “cryptocurrency,” because Bitcoin accounts are protected by cryptography. Currencies issued by central banks are known as “fiat currencies” (“fiat” being Latin for “let it be done”).

Bitcoins are generated — or “mined” — as follows: cryptographic puzzles are random-generated at a controlled rate by an open-source software program, then transmitted to a network of volunteer Bitcoin miners.

Miners perform complex calculations on powerful computers to solve those cryptographic puzzles. The first miner to solve a puzzle receives 25 bitcoins. The open-source program will continue to generate puzzles until it reaches a limit of 21 million bitcoins in issue.

Bitcoins usually are sold anonymously through online exchanges to anonymous buyers, although a growing number of Bitcoin exchanges such as Circle now are following know your customer (KYC) laws and are not anonymous. Each Bitcoin purchaser is given a unique public Bitcoin address consisting of 27 to 34 alphanumeric characters, which also can be represented as a QR code. The purchaser uses that address to exchange bitcoins with other Bitcoin users and merchants.

Bitcoin users store their Bitcoin addresses and their private cryptographic keys, which act as the digital credentials allowing them to access their Bitcoin holdings, in anonymous digital wallets. The disadvantage is that, if a user loses the private key, he or she loses the bitcoins.

Users can store their Bitcoin wallets locally on their PCs or smartphones or on an exchange. However, using an exchange is considerably less secure than local storage.

Every Bitcoin transaction is recorded in a public ledger called the block chain. Essentially, the block chain is a history of all confirmed transactions and a record of how many bitcoins each Bitcoin address contains. Bitcoin transactions are verified by a network of computers to prevent double spending, and payments are irrevocable. That means it is impossible for buyers to chargeback Bitcoin purchases.

Advantages for consumers

Bitcoin is attractive to consumers for several reasons. First, it appeals to tech-savvy millennials for whom the Internet and smartphones are a way of life.

“Bitcoin acceptance is a way of signaling to millennials that a retailer is hip and ‘with it,’” Byrne said.

Bitcoin is similar to cash payments as it doesn’t require buyers to disclose sensitive information such as credit- or debit-card expiration dates or card verification values (CVVs) to merchants. Provided consumers protect their Bitcoin wallets, Bitcoin payments are more secure than credit- or debit-card transactions.

Bitcoin transactions are mostly free of charge to consumers, or there may be minimal fees, whereas retailers may pass on their credit- or debit-card merchant fees to their customers.

Bitcoin appeals to consumers who are concerned about the stability of the financial system and about the risk of a central bank confiscating their deposits in order to recapitalize itself, as the government of Cyprus did in March 2013. Because Bitcoin is decentralized, consumers control their Bitcoin deposits, which cannot be confiscated by a central bank or frozen by a retail bank or payment processor.

Advantages for merchants

Bitcoin is attractive to merchants because it solves the problem of payment card chargebacks and fraud, says Stephanie Wargo, vice president of marketing at Atlanta-based Bitcoin merchant processor BitPay.

“Card fraud and chargebacks are huge problems, especially for e-retailers selling large-ticket items such as consumer electronics,” she said. “BitPay processes a lot of Bitcoin payments for large-ticket items where chargebacks are prevalent for card payments.”

“First-person fraud, where a consumer makes a purchase for which they don’t pay, isn’t a problem for Bitcoin-accepting merchants, since they receive their Bitcoin payment before handing over the goods,” said Robert Hughes, managing partner at U.S.-based consultancy Bank Solutions Group.

Bitcoin acceptance reduces retailers’ security compliance overhead, says Chris Ciabarra, chief technology officer at San Francisco-based point-of-sale system vendor Revel Systems.

“Not having to store credit or debit card numbers in your POS system and run the risk of a data breach is a big benefit of accepting Bitcoin.”

Bitcoin payments are instantaneous, but they take 10 minutes to be confirmed by the block chain. Merchants need to decide whether to opt for “zero-confirmation” transactions, which means they take the risk of accepting a transaction that has yet to be confirmed by the block chain. Alternatively, they can wait 10 minutes for confirmation.

“When a Bitcoin payment happens, the processor does a quick check that the transaction has gone through and is genuine,” Ciabarra said. “The full check with the block chain takes 10 minutes because of the computational processing involved. The risk level with Bitcoin payments is very low, and, for small-value transactions, it’s OK to hand over goods without waiting for the full security check. But for a $1,000 transaction, it’s definitely worth waiting the 10 minutes.”

Accepting Bitcoin as an alternative to credit card payments will help reduce a merchant’s costs. “This is because credit-card merchant fees are based on a percentage of the transaction value,” Hughes said. “But debit-card transaction fees are fixed and low, so merchants need to compare the cost of Bitcoin acceptance to the cost of accepting debit cards.”

Because of its low cost base, Bitcoin makes it viable for online merchants to accept micropayments. “If a consumer makes a micropayment with a credit card, the merchant processing fee will account for most of the transaction revenue,” Wargo said. “Bitcoin is also attractive for cross-border payments because it eliminates the need for currency conversion. An international e-retailer will save money and avoid foreign transaction headaches by accepting Bitcoin.”

(This piece was excerpted from "Virtual Currency 101 for Retailers," available for download here.)