The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.

As one of the world’s largest online retailers, Amazon has been plagued by negligible profits throughout its existence. With its high-volume business model, Amazon needs every point of margin available and currently does itself a disservice by giving up an estimated 1.9% per transaction to credit card companies. The company has openly prioritized sales growth over profits as a key objective. By focusing on increasing margins upstream in the payment processing industry, the company could maintain its core objectives while simultaneously increasing profits.

Is Cryptocurrency the Solution?

The world of cryptocurrency has seen a tumultuous couple of months. Most recently, the largest Bitcoin exchange, Mt. Gox, filed for bankruptcy after revealing that it had lost almost 850,000 Bitcoins. These coins, valued at about $300M as of late February, were apparently stolen due to a technical bug in Mt. Gox’s software. The price of Bitcoin immediately dropped by roughly $100 to a three-month low of about $450, a far cry from a November high of $1,100.

With such volatility and apparent security concerns, it is logical that eRetailers like Amazon are hesitant to get in on the cryptocurrency craze. But recent turmoil hardly paints the full picture of what this technology is capable of. With news of more serious financial players, including whole countries getting into the cryptocurrency space, there is clear potential for the technology. The early stage volatility and security concerns may be masking the true potential of cryptocurrency.

The New Online Currency

Cryptocurrencies are digital mediums of exchange which allow users to transfer electronic units of account wirelessly over peer-to-peer (P2P) networks. Proponents of cryptocurrencies cite its decentralized nature as a major benefit: The supply of cryptocurrencies is not controlled by any central organization but rather slowly distributed to “miners” based on a pre-established algorithm. Miners solve a computational problem necessary to facilitate the transaction and receive a cryptocurrency stipend as a reward. With the security of military-grade cryptography, transactions are safer and less susceptible to transaction fraud than existing transaction mechanisms.

The current “proof of concept” of this technology is Bitcoin, with $8.3 billion USD in circulation (at the time of writing). Bitcoin was created in 2009 by pseudonymous developer Satoshi Nakamoto, but since then other cryptocurrencies such as Litecoin, Ripple, and Dogecoin have been released based on the original, with slight variations to the protocol. One version, Auroracoin, is even sponsored by the national government of Iceland. Set for release on March 25th, it will become the first national cryptocurrency, with every Icelandic citizen eligible to claim a free amount.

Cutting Out The Middleman

The main business case pushed by proponents of cryptocurrencies is for its use in transaction processing. Transaction fees for cryptocurrencies are immaterial, with the only real consideration being the market exchange fee charged at both ends of the transaction. These fees can be as low as 0.25%, translating to a total transaction fee of 0.5%, considering both the merchant and buyer. Compared to the estimated 1.9% charged for credit transactions, cryptocurrency payments could result in a significant savings.

With this in mind, if even 5% of all Amazon purchases were to be made using cryptocurrency, operating cost savings would amount to over $57 million annually. In addition, cryptocurrencies almost completely eliminate fraudulent purchases and identity theft from the payments value chain, which generally affect 5% of traditional credit payments. Amazon, as the leading e-commerce retailer with over $74 billion in revenues, has a lot to benefit from accepting cryptocurrencies.

Risky Business

Adopting cryptocurrency would be enticing for Amazon, but its risks are still disconcerting given the early stage of the technology. First, significant security concerns have been exposed as a result of the failure of Mt. Gox. While these specific failures have been attributed to the mismanagement of the exchange, which has officially filed for bankruptcy, lingering consumer concerns are likely to limit user adoption in the near future. Many analysts suggest that the entrance of stronger players such as SecondMarket might remedy these problems, but it’s still uncertain whether such moves could have a significant impact on consumer confidence.

Another big concern for cryptocurrencies is its rampant volatility. Cryptocurrency prices fluctuate 10% on the average day, and several commonly double or halve in value. Considering that Amazon’s business model is focused on creating a ubiquitous customer experience, volatility could seriously hurt its ability to attain mass adoption. This creates a classic “Chicken & Egg” type problem where stabilization can only be achieved with mass adoption, yet the major barrier to mass adoption is the price volatility.

Regulatory action also poses a serious threat, considering that at any time governments can regulate cryptocurrencies either positively or negatively, heavily impacting their value and long-term viability. Both Russia and China have limited the use of cryptocurrencies, and with the recent collapse of Mt. Gox, a US senator has demanded a ban in the States. Even with positive sentiment from US regulators, any regulative actions focused on illicit activities are difficult to predict, creating an ambiguous regulatory environment that may not subside for quite some time.

The Amazon eCoin

The uncertainty associated with cryptocurrencies is not in itself a deal-breaker. There are tools Amazon could use to implement the technology successfully: consumer concerns can be addressed with marketing, volatility can be addressed through offering discounts and Amazon cobranding, and regulatory risk can be addressed through lobbying efforts. But cryptocurrencies aren’t the only way to cut credit card companies from the transaction value chain. Automated Clearing House (ACH) transactions, i.e. direct bank account transfers, often charge a fee of below one cent per transaction. In fact, the cryptocurrency transaction chain would need to start and end with ACH transactions regardless. Therefore, the introduction of cryptocurrencies simply introduces additional intermediaries.

Amazon currently does facilitate ACH transactions but has limited adoption due to consumer hesitance to share bank account information online. Amazon could thus use the hype and media attention surrounding cryptocurrencies to spur ACH adoption by launching its own pseudo cryptocurrency. Simply put, this would essentially be a digital currency with a one-to-one conversion rate to USD, effectively removing all volatility risk. Amazon could then integrate this “eCoin” system into its Amazon Payments platform to replace its current ACH play. This would allow users to make ACH transactions as they have before, with Amazon facilitating direct transfers and no requirement to hold eCoins. Simultaneously, Amazon could also facilitate peer-to-peer transaction functionality, with eCoin holdings possibilities, for the added convenience that users of traditional cryptocurrencies enjoy.

Amazon should further encourage adoption by offering a free year of Amazon Prime to customers who sign up to the eCoin by entering their bank information. Once this bank information has been added, the eCoin payment choice will appear as the preferred payment method every time the user makes a subsequent purchase. This has the dual purpose of growing the Amazon Prime subscriber base, a current strategy aimed at growing consumer spending with Amazon, and facilitating the switch to low-cost transactions. This has the overall effect of growing profitability, a tactic in the best interest of the eRetailer infamously known for its razor thin margins.

To strengthen the offering and mass adoption potential, Amazon should also partner with other progressive online retailers to accept eCoins through the Amazon Payments system. Amazon is in a unique position in the payments processing space because it is not necessarily motivated to make its profits from Amazon Payments. Amazon could willingly undercut the going transaction processing rates, like those from credit cards and PayPal, because its motivations lie in pulling down transaction rates industry wide. By offering a substantially lower rate to partnered merchants, it not only spurs merchant adoption, but also places downward pressure on transaction processing rates charged by Visa and MasterCard. Not only could Amazon save on the in-house transactions converted to its new eCoin, it would also save in the long-term on all transactions as other providers are forced to drop their prices.

Going Mainstream

While this pseudo cryptocurrency can replicate the cost savings features of cryptocurrencies, there are many other benefits of cryptocurrencies that need to be considered. For one, the distribution and decentralization of cryptocurrency can help expedite global expansion. By not dealing with a country’s domestic currency and instead accepting cryptocurrency, Amazon could have foregone much of the currency and political risk associated with international expansion. This is a feature not inherently replicable in the eCoin pseudo cryptocurrency.

Additionally, cryptocurrencies enable microtransactions, allowing consumers to pay for goods in arbitrarily small denominations. With microtransactions, charging a few cents online for a good or service becomes feasible due to the immaterial transaction fees associated with cryptocurrency. This could be the catalyst for new and profitable business models for high volume, low cost services. This could especially fit with Amazon’s moves towards media streaming services, including a rumoured foray into the music streaming business. While arbitrarily small denominations could easily be implemented into the eCoin protocol, users of this service aren’t incentivised to hold a balance, a required feature for facilitating microtransactions.

Cryptocurrencies then still offer substantial value beyond just that of transaction cost savings, but most of this value can’t be realized until the uncertainty in cryptocurrency is resolved; secure exchanges need to be created, volatility needs to subside, and regulators need to make their position clear. Also, with the proliferation of cryptocurrencies, Amazon would need to wait for the market to choose a winner. But Amazon, with their eCoin offering, can build experience with digital currency transactions, accumulate an eCoin user base, and develop the capabilities needed to effectively compete when a cryptocurrency reaches the mainstream. Amazon can actually go one step further. By ensuring that it builds out its eCoin platform in a flexible way, Amazon can transition its service to a real cryptocurrency when the uncertainty subsides and the strategic benefit of geographic expansion and microtransaction features becomes compelling.

Amazon, with a semi-cryptocurrency strategy in the short term, can take advantage of the transaction cost savings today while gaining digital currency experience to tackle the brave new digital currency world of tomorrow.

Amazon, the Rainmaker?

Hitting the Road

Miracle on Mice