Bitcoin and Virtual Currency:

Hype or Necessity?

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For discussion purposes only.

This Report, and all information, analysis andconclusions hereunder, is in all respectssubject to and governed by the terms andprovisions of the Engagement Agreementbetween The Strawhecker Group and theClient.© Copyright 2015. The Strawhecker Group.All Rights Reserved.

The information is based upon information we consider reliable, but its accuracy and completeness cannot be guaranteed.

Snapshot

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Report Overview

WHAT IS THIS REPORT?Despite an explosion in media coverage, virtual currencies such as Bitcoin are misunderstood. So what is it? This 43-page report reviews the mechanics of the currency and offers some thoughts on its characteristics and future applications. The report also provides detailed information around the current state of Bitcoin including merchant acceptance figures.

The second half of the report provides a deeper analysis on how Bitcoin compares to the current payments infrastructure, niche payment opportunities where Bitcoin can be leveraged and recommendations for payment players concerning the evolving virtual currency ecosystem and how they can prepare for the rapidly changing virtual currency market.

WHY IS THIS USEFUL?This report will provide newcomers, and industry veterans across the merchant industry and payments landscape, with analysis on the evolution of virtual currency and Bitcoin. The report is an exceptional tool for reference purposes on the Bitcoin payments ecosystem, how the currency is operated, and the advantages and disadvantages associated with Bitcoin. The report also provides analyses on how the evolving virtual currencies market may impact the payments and merchant environment.

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Content Listing

Executive Summary 4

What Is Virtual Currency and Bitcoin? 5

State of the Bitcoin Ecosystem 16

Bitcoin Merchant Acceptance 18

The Advantages and Disadvantages of Bitcoin 24

Bitcoin Versus Payment Incumbents 27

Where Can Bitcoin Play In the Payments World? 31

Bitcoin Beyond Payments 33

Why Should Payment Players Care About Bitcoin? 35

Recommendations for Payment Players 38

Content

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What Is Virtual Currency and Bitcoin?

Ways To Obtain and Spend Bitcoins

Obtaining Bitcoins Spending Bitcoins

Exchanges: Virtual currency exchanges converts Bob’s traditional currency, such as U.S. dollars, into Bitcoins and transfers them to a Bitcoin address in his virtual wallet. Exchanges also convert Bitcoins into traditional currencies.

Other Bitcoins users: Bitcoin users transfer Bitcoins directly to a Bitcoin address in Bob’s virtual wallet as a gift or for payment of goods or services.

Bitcoin kiosks: Bob deposits traditional currency into a Bitcoin kiosk. The kiosk sends Bitcoins from its operator’s Bitcoin address to a Bitcoin address in Bob’s virtual wallet.

Mining: Bob installs Bitcoin mining software on his computer which is used to solve complex math problems for the Bitcoin network. If Bob successfully solves the problems, he receives newly created Bitcoins.

Other Bitcoin users: Bob transfers Bitcoins directly to Bitcoin addresses in the virtual wallets of other Bitcoin users as a gift or as payment for goods and services.

Businesses accepting Bitcoins directly: To pay for goods and services, Bob transfers Bitcoins directly to Bitcoin addresses of businesses that accept payments in Bitcoins.

Businesses accepting Bitcoins through payment processors: To pay for goods and services, Bob transfers Bitcoins to a businesses' payment processor. The processor converts the Bitcoins into traditional currency and remits the traditional currency to the business. In some cases, the processor converts only a portion of the Bitcoins into traditional currencies.

Bob’s virtual wallet

Source: GAO (Government Accountability Office); Federal Reserve Bank of Boston

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Bitcoin Merchant Acceptance

Despite The Weaknesses of Bitcoin, Notable Merchants And Payment Service Providers Have Started Accepting Bitcoins Overstock.com, one of Bitcoin’s early champions, stated that Bitcoin sales approached $8 million in its first year as a Bitcoin merchant. Most recently, PayPal declared it would start processing Bitcoin payments through its Braintree subsidiary. Larger merchants are earning buzz by welcoming the currency, in some instances experiencing an initial boost in sales. Most accepting merchants use Coinbase or another Bitcoin middleman, shielding themselves from risk while paying less in fees versus card transactions.

Merchant Acceptance

Rank Company Annual Revenue ($bn)

1 Microsoft $86.8

2 Dell $56.9

3 Dish Network $13.9

4 Expedia $5

5 Intuit $4.5

6 Monprix $4.3

7 Time Inc. $3.4

8 NewEgg $2.8

9 Overstock $1.3

10 TigerDirect $1.0

Total $179.9

Top 10 Largest Bitcoin-Accepting Retailers

Accepts Bitcoin for hotel reservations, with plans to eventually extend bitcoin payments across its system. Since the June launch, fewer than 1% of sales have been in Bitcoin, but an Expedia executive said bitcoin sales have exceeded estimates.

First company with at least $1 billion in annual sales to add Bitcoin, using Coinbase as its payment processor. By August, Bitcoin users had spent more than $2 million on the site, and Overstock’s CEO was forecasting that tally would reach $6 million to $8 million by year-end.

First major newspaper to accept Bitcoin. In the first week of launch, 11% of new subscriptions used Bitcoin.

Was the first major professional sports franchise to accept Bitcoin. Through a partnership with BitPay, the team now allows Bitcoin users to buy tickets, jerseys and basketballs.

Source: CoinDesk; TSG analysis

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Eliminating Need For Trusted Third Parties

• The most appealing feature is that Bitcoin eliminates the need for a trusted third party to a financial transaction that does not take place face to face. The payer in the transaction transfers the ownership of their coins on the block chain to the recipient, and the validity of the transaction is verified by the many computers verifying transactions.

The Advantages of Bitcoin

Why Would A Merchant or Consumer Want to Use Bitcoins?There are six main aspects of the design of Bitcoin that make it appealing: elimination of trusted third-party intermediation, payer-initiated payments, the enormous processing power behind it, the absence of a single point of failure to the system, the fact that participation in the network is entirely voluntary and privacy.

Payer-Initiated Payment• Bitcoin payments are initiated by the payer, and do not require that the payer reveal any sensitive information to the

payee or to any other person or entity. By contrast, card transactions are initiated by the recipient of the payment, rather than the payer, and require the recipient to be privy to information which can be compromised.

Processing Power• The Bitcoin network has grown into what is by far the world’s largest supercomputer. The processing power dedicated

to Bitcoin is estimated at around 3,205,028.64 PetaFlops. The world’s top 500 supercomputers combined have a processing power of 273.76 PetaFlops. The combined processing power of the global network of computers validating Bitcoin transactions is 11,700 times larger than the world’s top 500 supercomputers combined.

No Single Point of Failure

• The lack of a centralized authority to issue bitcoins and monitor transactions is the chief strength of Bitcoin. Not having a central server that processes all transactions means that the system has no single point of failure, making it extremely resilient to attack or technical failure, if not impervious to them.

Voluntary

• The operation of the Bitcoin network is entirely consensual: people who have traded bitcoins for goods, services, or other currencies, and people who have dedicated hardware processing power towards the maintenance of the network have done so out of their own accord. Banking failures through contagion or liquidity shortages, as well as currency devaluation for political purposes, are examples of phenomena that cannot, by design, happen in Bitcoin.

Increased Privacy

• Those who seek a heightened degree of privacy may find more comfort using Bitcoins. The risk of identity theft may also be less, and some may find the removal of government from a monetary system attractive. However, Bitcoin transactions do not have the anonymity afforded by cash transactions, as there is a permanent and complete historical record of Bitcoin amounts and encrypted identities for all transactions on the Bitcoin system.

Source: Davis Wright Tremaine LLP; Federal Reserve Bank of St. Louis; University of California, Berkeley/Palo Alto Research Center; American Banker; TSG analysis

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Comparable Company AnalysisAbout TSGThe Strawhecker Group (TSG) is a management consulting company focused on the electronic payments industry.

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