Digital Money Substitutes in a Two Sided Marked Perspective - A Case Study on Bitcoin

Abstract

In January 2009 a payment system that enabled transactions in a new digital currency, called bitcoin, were launched. Bitcoin is based on a peer-to-peer (P2P) network where users in the network collectively process and verifies the transactions. One of the main attributes in Bitcoin is independency from financial institutions and trusted third parties. Hence, no centralize third party is involved when performing payments. Bitcoin also enables the opportunity to perform pseudo anonymous payments and it is voluntary to pay transaction fees. With the evolvement of such a radical new payment system, the interesting question yet to be answered is how it will affect established online payment systems. Thus, the purpose of this thesis is to build a model that enables the investigation of the future adoption of Bitcoin relative to the current dominating online payment system, PayPal.A payment system is a classic example of a service that operates in a two-sided market where customers and merchants represents the two distinct user groups. Since development in such complex markets are affected by numerous factors and that multiple dependencies often are present, a theory foundation through a background study on network effects, two-sided markets and system dynamics is given in the first part of the thesis. Secondly, a presentation of PayPal, alongside with a more in depth examination of Bitcoin is used to perform a feature analysis that compare the two systems. Areas that are investigated in the analysis include, among others; anonymity, convertibility, cost, payment speed, stability and security.A model that accounts for feedback loops, network effects, and two-sided market dynamics, as well as specific features in each system and irrational users, are then developed. Finally the model is used to simulate the future adoption of Bitcoin relative to PayPal. Different scenarios including a cost only scenario, a Bitcoin favorable scenario, a PayPal favorable scenario, and a complete scenario where all the examined information was included in the model, were run.It is shown that PayPal has a clear advantage early in the adoption life cycle due to strong cross- and same-side network effects, which is caused by an initial large user base. Thus, during simulations that values network effects as the most important main variable, PayPal retains its market position and fights of the new Bitcoin system. However, largely due to Bitcoin?s cost advantage on the merchant side, Bitcoin is able to experience substantial market traction in most simulation scenarios, and surpass PayPal when the focus on network effects is less dominant.