Sunday, December 29, 2013

Bitcoin Analysts Contribute to a Post-Legal Tender Age

By Jon Matonis
Monday, December 23, 2013 

The year 2013 saw at least three bitcoin analyst reports from financial investment firms, an astonishing achievement for a young five-year-old digital currency. In some economic circles, bitcoin has slowly entered the ‘reserve currency’ lexicon.

Are we entering a post-legal tender era, where the provision of money is determined by the market and not by central bankers? Why do we see mainstream analysts reporting on price and economic impact for bitcoin when we never really saw that with other digital currencies?

The reason is simple – previous digital currencies were not decentralized with an independent floating exchange rate and they did not operate beyond confiscation.

Examples such as Digicash and e-Gold were brilliant proofs of concept, but their centralized nature also offered a single point of failure. Governments are not going to accept a challenge to their monetary authority if they don’t have to.

In a paper entitled “Regulating Digital Currencies: Bringing Bitcoin Within the Reach of the IMF,” Nicholas A. Plassaras suggests that the International Monetary Fund is ill-equipped to handle the widespread use of bitcoins into the foreign exchange market, highlighting the inability of the Fund to intervene in the event of a speculative attack on a country’s currency by bitcoin users.

He also hints at some of the tools that the IMF may consider deploying in the face of the global bitcoin challenge.
That academic study was followed by three analyst reports from the institutional investment industry. Together, all four studies solidify bitcoin’s maturity into a new and unique asset class with broad implications for both fiscal and monetary policy.

On 31st July, BBVA Research released “Bitcoin: A Chapter in Digital Currency Evolution” which concludes that bitcoin is here to stay and that the regulators and financial institutions embracing bitcoin early will likely become the leaders of the future digital monetary system.

On 1st December, Wedbush Securities released “Bitcoin: Intrinsic Value as Conduit for Disruptive Payment Network Technology” by Gil Luria and Aaron Turner.
The report observes three key sources of demand for bitcoin:
(a) as a disruptive payment network technology,
(b) an alternative uncorrelated asset class, and
(c) a safe haven currency.
Additionally, the report states that bitcoin represents another potential low-cost funding method for PayPal, leading Wedbush to predict “that with more regulatory clarity PayPal would likely embrace bitcoin.”

On 5th December, BofA Merrill Lynch Global Research published “Bitcoin: A First Assessment” by David Woo, head of global FX and rates strategy. Since Woo is considered to be one of the leading currency minds on Wall Street, his 14-page report represents a massive endorsement for bitcoin.
Woo states:
“We believe bitcoin can become a major means of payment for e-commerce and may emerge as a serious competitor to traditional money transfer providers. As a medium of exchange, bitcoin has clear potential for growth, in our view.”
Placing a $1,300 price target on bitcoin, he also identifies the three things that need to happen in order to justify the current bitcoin valuation – it will need to account for at least 10% of all global e-commerce B2C transactions, become one of the top three players in the money transfer industry, and acquire a store of value reputation close to silver.

As a contra indicator, the Bank of America Woo report can probably claim responsibility for diffusing the most recent bitcoin rally that took the cryptocurrency to an intraday high of $1,156.00 on the CoinDesk BPI.

As we gradually enter a post-legal tender era, it behooves us to examine the possible implications for fiscal and monetary policy within a bitcoin economic environment. This article focuses on fiscal policy while a future piece will focus on monetary policy.

Aside from the beneficial wave of new job creation and economic opportunity, bitcoin as a competitive and successful monetary unit influences some pretty substantial adjustments forthcoming to fiscal policy.

High on the list, of course, is the effect on true income determination and the resulting taxation policy. A growing army of bitcoin independent contractors and informal merchants selling labor and goods will operate off-the-grid, adhering to the same honor system that exists for paper cash today.

To fill State coffers, it is likely that the bulk of tax revenue from individuals will shift from taxing income to taxing consumption (or spending).

Good riddance. A progressive income tax is one of the fundamental tenets of Marxism and it holds back incentives for innovation and achievement.

Far more likely in a bitcoin environment would be heavy taxes on consumption, which are regressive in nature but also more equitable than progressive taxes. The ease of bitcoin merchant identification and point-of-sale audits makes consumption taxes nearly inevitable for a worried nation-state with diminishing revenue.

Other fiscal policy impacts revolve around how the spending beast will be starved by a lack of sufficient revenue to pursue global military adventurism and other unpopular spending programs made possible only by the ability to print prosperity.

The arrogance of control maintained through the unlimited issuance model of the world’s reserve currency will be dealt a mighty blow.

For the first time in modern history, a government will actually be forced to justify why they want to increase direct taxation and to demonstrate why that particular activity should be funded. Consequently, everyday people will become more empowered in the government actions executed under their name.

However, many in society will be left behind by this monumental shift of real wealth leaking out of national fiat currencies, because people have largely underestimated the widespread, latent demand for a non-political currency.

Joerg Platzer, founder of Crypto Economics Consulting Group, encourages individuals to start preparing for this day in advance to ensure economic survival. He also emphasizes the need for governments to be honest and to anticipate the vast swath of society that will simply be impoverished after the great wealth transfer to a cryptocurrency society.

Further economic thoughts on the cryptocurrency and free banking space will undoubtedly be filled out by other bitcoin economic thinkers, such as Peter Šurda, Konrad Graf, JP Koning, and George Selgin.

Thursday, December 26, 2013

Bitcoin Ideology and the Tale of Casascius Coins

By Jon Matonis
Tuesday, December 17, 2013

A weekend article in The New York Times examined the ideological underpinnings of the bitcoin cryptocurrency. While the article got most of it correct, it missed some additional principles that are core to the adopters of bitcoin.

First of all, a vote for bitcoin is essentially a vote against the established monetary order with its centralized authority, legacy infrastructure, and diminishing financial privacy. Moreover, it is also a vote for an individual’s choice in currency and freedom of transaction without payment blockades and surveillance. To both the technical and non-technical, bitcoin represents fungibility, irreversibility, and user-defined privacy.

As The New York Times pointed out, additional facets that bitcoin adopters find attractive include how bitcoin demonstrates the absurdity of a central bank’s unlimited issuance model and the irrelevancy of self-serving capital controls.

A decentralized cryptocurrency separates a functioning medium of exchange from state control.

Nothing illustrates this more starkly than a physical bitcoin on a coin-shaped metal disc, which could be considered a negotiable monetary instrument in some jurisdictions. Lately, bitcoin has appreciated so much that the older 10 BTC and 25 BTC Casascius coins must now be declared to US Customs when entering or exiting the US.

FinCEN’s involvement

On November 27th, Casascius founder Mike Caldwell received a letter from FinCEN, the US Treasury bureau responsible for safeguarding the financial system from illicit use and combating money laundering. The letter implied that his three-year-old business of selling coin-shaped pieces of metal could be defined as a money services business requiring registration with FinCEN and possibly registration with the money transmitter regulators in each individual state.

The FinCEN claim rested largely on the premise that Caldwell had no way of verifying that the coins were being shipped to the same person, or persons, that purchased the items with bitcoin. Caldwell believes that the coins should be viewed as collectibles.

Subsequently, Caldwell suspended operations of his coin-shaped metal business and ceased taking orders for purchases of new product. He also engaged legal counsel to ascertain if his business was indeed acting as a money transmitter under the law.

In telephone conversations with Caldwell, he reiterated to me that the ongoing operation of his business was secondary to establishing the important freedom-to-contract principles and choice in currency principles.

According to Caldwell, he took the drastic step to suspend as a precaution, however he does not believe that he is in violation of any existing laws as he is only sending empty private keys in the mail.

Business model

Under the current business model, Casascius receives an order and the payment received does not involve any US currency or any other countries’ currency. He accepts bitcoin for the sale of a round metal disc with a private key attached under a hologram. The strong reputation of Casascius and its process is paramount to the success of a physical bitcoin, because it involves trusting the integrity of a third party.

During shipment, the coin-shaped piece of metal is valueless and corresponds to a bitcoin address containing zero bitcoin. When the recipient receives the coin-shaped piece of metal, an appropriate amount of bitcoin is transferred to the corresponding public key, or bitcoin address.

In an alternate approach, Casascius could send the coin-shaped metal and allow the recipient to initiate the transfer of bitcoin to the corresponding bitcoin address, thereby removing Caldwell from handling the bitcoins at all. In that scenario, Caldwell would not be handling US dollars or bitcoin so it would be difficult to see how any possible money transmission was occurring.

Recalescence Coins, LLC in Port Orchard, WA has already moved to the model of selling blank coins as a result of the FinCEN letter received by Casascius.

Caldwell and his attorney plan on responding to the FinCEN letter, describing their process and outlining a satisfactory business model.

Casascius uses brass tokens in the shape of a coin. Another business based in the UK sells similar coins. Other companies could just as easily use rectangular plastic or special paper to store a hidden private key. They could even be divided, sent separately, and re-joined later to form a complete private key. However, the requirement to separate a private key would mean sending empty private keys in the mail somehow represents a form of money transmission which it does not.

Form factors

Also, form factors matter legally, or they should. Phil Zimmermann faced a somewhat similar situation when he could not export his email encryption program, Pretty Good Privacy (PGP), due to US restrictions on the exporting of encryption with “munitions-level” strength. A group of volunteers then transcribed the computer code line-by-line into a book format to export PGP as a book to be re-transcribed and compiled on the other side.

Money is the speech of commerce and “we need freedom of speech in our financial commerce,” says Mike Gogulski, a stateless ex-American living in Bratislava, Slovakia.

The Liberty Dollar case exemplified how far a government will go when alternatives to the compulsory unit of account begin to emerge. The Liberty silver coins containing real silver were embarrassing to the government that was issuing the fake silver coins, so the public had to be protected from thinking that the real silver coins were actually money. Huh? Government prosecutors in the case laughingly described Bernard von NotHaus as representing a “unique form of domestic terrorism“.

All money is an illusion at some level, because like language and religion, its proliferation and success depends on growing adoption from an increasingly larger pool of adherents.

The creator of the Bitcoin protocol gave the world a method to conjure up its own monetary illusion. The reason this is a gift is because, prior to bitcoin, other monetary illusions depended either on legal tender laws for their illusory value or physical objects like gold and diamonds which are easily confiscated.

Bitcoin put the power of “survivable” money directly in the hands of the masses. It is a testament to bitcoin’s survivability that it still exists today.

Bitcoin is not permitted to exist because various governments are bitcoin-friendly or pledge to support innovation. Bitcoin exists today precisely because it is distributed and decentralized, designed to outlast political institutions.

And, it is beyond confiscation because it is digital. If it could be eradicated, it would have been eradicated as soon as it broke out of its niche market with a few pizza deals back in early 2010.

I understand from sources that approximately twelve such letters were issued by FinCEN in the last 30 days. If so, the purpose hopefully is to better understand these bitcoin business models and not just to use impressive letterhead in persuading voluntary business suspensions. In the case of Casascius, I fear the latter.

Monday, December 9, 2013

Why Bitcoin Fungibility is Essential

By Jon Matonis
Sunday, December 1, 2013

What is the essence of bitcoin fungibility and why is it so important?

Fungibility refers to the concept that every unit or subunit remains equivalent and identical to any other unit or subunit. It is the property of a good or commodity whose individual units are capable of mutual substitution.

For instance, one bitcoin is considered the same as any other bitcoin when it comes to price and acceptance. Gold bullion has fungibility with identical degrees of fineness or purity. Government paper cash has fungibility provided that the bills have not been marked or serial numbers have not been ‘blacklisted.’ In other words, you cannot be held responsible for the historical path of that banknote prior to its acceptance by you.

Herein lies the controversy. Should you care where your money came from and how does a monetary system cope with the resultant risk placed upon the bearer?


Recently, it has become fashionable in some bitcoin circles to suggest that blacklisting, or the more palatable term of redlisting, can be implemented to discourage the large-scale stealing of bitcoin wallets or even the ransom demands of petty criminals like CryptoLocker. Either way, it boils down to some form of coin validation with the more insidious side effect being government collusion with the coin validators for purposes of linking individuals to all of their transactions.

A related Scottish monetary case from the 1700s suggests that coin validation is a misguided premise. Fortunately, the judges in that case upheld the principle of unrestricted fungibility. Altering the monetary framework through blacklisting, redlisting, whitelisting, or any variant of subjective taint measuring would have catastrophic implications for the integrity of the financial system, thus detrimentally impacting economic prosperity for the whole.

Although opt-in efforts at sanitizing bitcoin or ensuring proper clean coins will inevitably emerge in a free market, that does not mean they are necessarily beneficial for the larger bitcoin economy and the principles of a non-politicized monetary unit.

Technical solutions

Fortunately, the political and market-based efforts to disrupt the integrity of a digital currency will be met with high-powered technical solutions, effectively rendering coin validation techniques useless in a sea of powerful circumvention.

Anonymizing and mixing solutions such as Zerocoin, CoinJoin, and SendShared will proliferate and encompass a larger and larger portion of overall bitcoin transactions despite the politics.

Bitcoin core developer Gregory Maxwell commented on the recent coin validation efforts:
“To stop this nonsense we have to make it impractical to pull off by changing the default behavior in the bitcoin ecosystem. We consider the lack of a central authority to be an essential virtue, which means that we can’t be protected by one either. We must protect ourselves. This means things like avoiding address reuse, avoiding centralized infrastructure, adopting— and funding!— privacy enhancing technology.”
Distributing mining and Hashcash creator, Adam Back, was simply astonished, exclaiming: “Their technical representatives of Coin Validation should be ashamed. How can someone who doesn’t understand a concept as basic as fungibility and its relation to transaction costs, and the difference between identity and coins hope to exist in this ecosystem.”

Harming bitcoin growth

Private sector attempts at promoting coin validation to seek favor with regulators are doomed to failure, because Bitcoin operates as a worldwide network with a border-less monetary unit. At the jurisdictional level, economies that embrace coin validation knowingly erect barriers to the free flow of digital capital and restrict the beneficial properties of bitcoin-induced growth in that particular region. It would be similar to “blacklisting” that entire jurisdiction from the world economy.

With the Unites States at an embarrassing 2% of all worldwide exchange volume for bitcoin trading, I cannot imagine that government authorities would want to take any steps which make the jurisdiction even less appealing.

Quite the opposite would be the economically sound position for US regulators to take.
If Director J. Shasky Calvery at FinCEN were sincere about attracting bitcoin-related companies to the US and not inhibiting innovation, she would have FinCEN make a public pronouncement that banks in compliance with existing AML laws and KYC guidelines have nothing to fear from engaging in business with bitcoin companies.

Additionally, FinCEN should state explicitly that it rejects coin validation and any other attacks on unrestricted fungibility for bitcoin, because this would undoubtedly taint the jurisdiction.

This type of leadership action would accomplish two objectives. First, it would serve to establish the longer-term principle that bitcoin trading does not require regulation as a government-issued financial instrument (as other jurisdictions have done).

Secondly, it would lift the cloud of the chilling effect emanating from one of the country’s leading law enforcement agencies, which we all know is an obtuse method to control and gain preemptive compliance in an extrajudicial manner.

User reaction

At the economic level for bitcoin businesses, any exchange or merchant that attempted to launch or participate in a coin validation scheme would find themselves largely shunned by the user community. Given such massive disapproval from the bitcoin user community, organized boycotts against certain companies could become a reality.

Conversely, any exchange or merchant that rejected coin validation schemes or redlisting would experience a dramatic increase in business volume. This fact alone should produce a stabilizing effect due to the incentives aligned against the validation trolls.

Protecting the core Bitcoin protocol, including unrestricted fungibility as it relates to bitcoin transactions, mining, and acceptance, requires vigorous defense of bitcoin transactions that are free from third-party validation because such validation jeopardizes overall fungibility and creates transactional friction.

Proactively, I call upon the Bitcoin user community and Bitcoin infrastructure companies to oppose any initiatives that attempt to undermine bitcoin fungibility and to support solutions that promote the broad adoption of privacy enhancing technologies for bitcoin.

However, do not worry, for bitcoin fungibility is inherently protected by design. If all else fails, there is always the ultimate solution to “fork off” the debilitating, validation-seeking Govcoin chain and become free again.

Sunday, December 8, 2013

Exante’s Bitcoin Fund Reports YTD Performance of 4,847%

By Jon Matonis
Monday, November 25, 2013

Although technically launched in late 2012, Malta-based brokerage Exante released their 2013 year-to-date (YTD) performance statistics for The Bitcoin Fund last week. Listed in Bloomberg’s Comparative Fund Analysis section, The Bitcoin Fund came in with a 4,847% return, leading its peer group by a wide margin.

The closest funds in the comparative analysis registered a year-to-date performance of 33.7% and 25.4% respectively. The Bitcoin Fund gives institutions and high-net worth individuals easy, secure and rapid access to the vibrant bitcoin market with a unique licensed product.

The company also offers a reliable secondary market for the trading of fund shares on both a long and short position basis. Recognising that speculative bitcoin trades exceeded transactions for goods and services by 20 to 25 times in the latest quarter, Exante co-founder Vladimir Maslyakov told Bloomberg that:
“The real economy is not growing as fast as the price, speculators are usually much faster.”
It is impossible to know with certainty the motives behind a trade (or if liquidity-enhancing speculation is even detrimental), but this new chart from attempts to measure the ratio of trade volume to transaction volume, as explained by David Perry.

However, this imbalance is expected to adjust as Bitcoin has now surpassed PayPal and Discover to become the world’s fifth largest payment network by daily transaction volume, as measured by Coinometrics.

Lately, increasing demand for bitcoin has been driven by China which recently eclipsed the US in active bitcoin nodes on the network. This rapid price appreciation tends to put pressure on bitcoin-related startups because entrepreneurs must increasingly justify how a placement into their company will yield a higher rate of return than simply investing straight into the digital currency. Building out the ecosystem benefits everyone.

Arguably, bitcoin represents a binary investment: either ultimate success as a world reserve currency, or capitulation to a zero price point.

The key challenge for venture capitalists and startup investors will be to leverage any investment into a scalable infrastructure company for dual participation by maintaining asset balances denominated in bitcoin. It would be counter-productive to financially support a bitcoin ecosystem company without also supporting the underlying base currency.

Union Square Ventures’ Fred Wilson seems to miss this point when he declares that his primary interest in Bitcoin is its ability to become the “financial and transactional protocol” for the global Internet, and that he and his firm own very little bitcoin. Wilson makes this statement as if Bitcoin can achieve the lofty protocol role without any impact on the monetary value of the underlying base currency unit.

It is almost as if he believes that USV’s portfolio company Coinbase will be better off by converting bitcoin-operational proceeds into US dollars and keeping balance sheet assets in US dollars. Unfortunately, I suspect this is the case at Coinbase.

Meanwhile, the Exante Bitcoin Fund’s assets under management currently total over $35m and the fund does not charge a performance-based fee because there is no discretionary management or use of leverage. However, there is an annual management fee of 1.75% as well as a 0.5% transaction fee.

Exante is regulated by the Malta Financial Authority and, as of 18th November, the value per unit of the Bitcoin Fund was $658 where one unit equals one bitcoin. Exante is not alone in the bitcoin fund business, since SecondMarket launched the private, open-ended Bitcoin Investment Trust (BIT) in September 2013.

The private investment vehicle is based in the US and open to institutional and accredited individual investors. SecondMarket also intends to facilitate two-way trading of the trust shares on its proprietary platform to enable both long and short positions. Barry Silbert, CEO, said:
 ”US investors, including wealthy families, are allocating more of their investments into Bitcoins in order to diversify portfolios.”
Silbert also confirmed that he’s working with Pensco Trust Co, Entrust Group Inc and Equity Trust Co to offer investors the ability to purchase bitcoin for individual retirement accounts. In a little under two months, SecondMarket’s Bitcoin Investment Trust has already attracted $46.8m under management.

Thursday, December 5, 2013

Financial Services Club in Vienna

On December 3rd, 2013, I participated in my first Financial Services Club meeting. The event was held at the stately Residence of the British Ambassador to Austria in Vienna.

The panel discussion was “Virtual Currencies” – a phenomena, a trend or future money? moderated by Thomas Labenbacher, Chairman of the Financial Services Club CEE.

This will be a Panel Discussion Thomas Labenbacher - Chairman of the Financial Services Club CEE will moderate the panel - See more at:

Monday, November 25, 2013

US Has Already Ceded Dominance in Bitcoin Trading

By Jon Matonis
Saturday, November 16, 2013

Expertise and dominance in a particular industry sector doesn’t come about by decree. It is achieved over years through repeated practice and creative experimentation.

During the first three-and-a-half years of bitcoin’s development from 2009 to 2012, a large portion of that technological experimentation had been occurring in the US with multiple bitcoin trading exchanges and bitcoin-related businesses.

Now, there exists only one functioning exchange in the US with diminishing volume compared to its competitors. The Atlanta-based exchange, Camp BX, had reached such a low point of average daily trading volume that it was removed from the CoinDesk BPI earlier this month.

Although the future may not look bright for the US jurisdiction, it does not appear to be a conscious decision on the part of legislators and regulators. The evolving body of law known broadly as “digital currency law” applies at both the federal level and the state level creating overlapping licensing regimes and a considerable compliance investment for new startups.

Senate hearings

A pair of Senate hearings will take place next week in Washington, DC, with the first hearing being held by the Committee on Homeland Security and Government Affairs and the second hearing being held jointly by the Banking Subcommittee on National Security and International Trade and Finance and the Banking Subcommittee on Economic Policy.

These government hearings will be largely educational briefings focusing on law enforcement, regulatory environment, national security, and the possible opportunities for bitcoin in payments and global transactions. Several bitcoin-related companies will be testifying along with the Bitcoin Foundation.

Of course, there isn’t a ban on bitcoin in the US. But there doesn’t have to be an outright ban when there is a chilling effect on banking that translates into an unwillingness for banks and credit unions to engage with bitcoin-related companies.

Given the labyrinth and ambiguity of state-by-state compliance issues, financial institutions conclude that it’s far safer and easier to ignore bitcoin-related opportunities. This is the largest single barrier to payments innovation in the US.

Adversely, the unintended consequence is that viable and innovative companies seek more hospitable locales in non-US jurisdictions. So, where is the bitcoin trading volume going? How does important price discovery occur for bitcoin?

Top exchanges

Currently, the top four bitcoin exchanges by volume are located outside of the US, with the world’s leading exchange based in China.

Less than 2% of worldwide bitcoin trading and real-time market making occurs within the US jurisdiction. (Coinbase provides only fixed-rate conversion with the US dollar and they do not hold any customer funds in US dollars.)

All four of the world’s leading exchanges have demonstrated a capacity for serious, engaged banking relationships that would have been unobtainable in the United States.

As of 14th November, here is the list in sequential order based on 30-day cumulative bitcoin trading volume (for single trading pair):

(1) BTC China traded $298.4m in XBT/CNY (based in China)
(2) Mt. Gox traded $232.8m in XBT/USD (based in Japan)
(3) BitStamp traded $200m in XBT/USD (based in Slovenia)
(4) btc-e traded $119.8m in XBT/USD (based in Bulgaria)

Separately, in terms of active bitcoin nodes on the network, the US ranks first, followed by Germany, China, the UK, and Russia. Representing 25.7% of all active nodes, the US can probably claim the largest number of worldwide bitcoin users as well.

However, this measure is severely disproportionate to its slice of worldwide trading volume. Trading volume and liquidity is “sticky” and the jurisdictions adopting the bitcoin exchanges will exert the most influence over the new bitcoin economy. They will become entrenched.

Strategic evaluation

We have arrived at the point where the US jurisdiction must strategically evaluate a path going forward. Either they enable a climate that appeals to bitcoin exchanges and businesses or they maintain barriers that silently drive innovation in the space overseas.

Delaying that moment serves only to increase the clout and power of the other jurisdictions competing for this lucrative business. A free and robust bitcoin economy drives growth and jobs, provides relief for the unbanked, and facilitates global financial inclusion.

Another interesting metric is the ranking of the Narrow Bitcoin Money Stock (M1) compared to the money stock of all separate nations (and the European Union). At approximately $5bn, bitcoin money stock currently ranks at 100 out of 191, recently surpassing Iceland and Lebanon.

In some ways, government hearings on the Bitcoin protocol are like studying gravity. It’s useful information if you didn’t already understand the properties, but it does not allow much latitude for alteration. A futuristic potential Govcoin would be merely one of many cryptographic monetary units.

At the end of the day, all this attention on anti-money laundering laws and financial crime may be misplaced, because the real show with bitcoin will be at the Federal Reserve and the potential impacts on administering monetary policy.

Saturday, November 23, 2013

Banks Squander Opportunity in Bitcoin

By Jon Matonis
American Banker
Monday, November 18, 2013

It wasn't that long ago banks made the pitch, "Think of it as Money."

It was captured for eternity on the walls of the Atlanta-Fulton County Stadium where Henry "Hank" Aaron surpassed Babe Ruth's all-time record of 714 home runs. This was just 39 years ago.

Banks led the evolutionary shift from cash to card payment networks. Visa (V) originated from the BankAmericard project launched in 1956 for a general-purpose credit card. By 1975, Bank of America (BAC) had given up control of the BankAmericard program and Visa founder and former CEO Dee Hock assumed the reins. In true startup fashion, the bank-owned card brands of Visa and MasterCard (MA) eventually had successful IPOs. The inspiration is clearly there.

Where are the visionaries in banking now?

Today, banks are often thought of as the dinosaurs of financial services and the U.S. the backwater because they typically wait for clear market penetration and several upgrade releases before adopting any new technology. As a result of their low tolerance for risk, they voluntarily "niched" themselves out of the market share in the global remittance market and more recently, online commerce and mobile payments. Alternative payment companies like PayPal (EBAY), Stripe and Square have essentially built their businesses around what banks were not responding to and now they are national powerhouses – international, in the case of PayPal.

With the breakthrough development of digital money, banks have the opportunity to lead the industry once again. Yet instead, banks appear paralyzed about understanding and harnessing this emerging technology. Just as they block and freeze the accounts of competitive money transmitters in the U.S., banks routinely freeze the bank accounts of innocent bitcoin exchanges and consumers, hiding behind the rationale that they are being watchful of and adhering to regulatory guidelines.

Interestingly enough, because of their regulatory status, refined customer identity procedures and global infrastructure, banks could actually brand and offer bitcoin exchange services themselves, quickly becoming the de facto leaders of modernizing financial services.

For example, exchange services, the primary way to purchase and sell bitcoin for national fiat currencies, are mostly launched by technology experts who may or may not have any experience in the intricacies of federal and state anti-money laundering laws or know-your-customer guidelines. Efficient exchange services are also the domain of banks. Trading and market making for bitcoin (which even has a ticker symbol, XBT) pose no more challenges than dealing in foreign currencies, derivatives, or interest rate swaps. Coupled with their existing global infrastructure, banks are a natural fit for bitcoin currency trading.

For better or worse, despite the mounting inconveniences, a majority of people still prefer banks over trusting Apple (AAPL), Google (GOOG), or PayPal with sensitive data. Security at banks and financial institutions usually represents the strongest in the world. For those individuals desiring a safe storage option for their bitcoin balances, banks could provide several obvious advantages.

We know that banking in the future will be something you do – not some place you go– and aggressive fintech startups already provide the innovation that's occurring in financial services. In a 2010 report by McKinsey & Co., a reported 2.5 billion people are unbanked - the majority in the global south. Just as much as a middle-class kid in suburbia doesn't want to step foot in a bank branch, a poor woman living  in a dirt hut in Africa is not going to spend the money or time to find a bank in the city where she wouldn't even be approved. She has SMS texting. If the option is available, she'll bank with her phone.

Online bitcoin wallet companies like Blockchain's My Walletand Coinbase, which provide direct safekeeping services for the holding of customers' bitcoin balances online and via mobile apps, look and feel like banks of the future because they offer sophisticated access control and integrate seamlessly with mobile phones. So what is the holdup? One could argue that it's the question "how do banks make money with bitcoin?" On a primary level, bitcoin represents a new currency opportunity for banks. The term "banknotes" is actually left over from the period when banks issued their own currency notes in an environment of free banking and currency competition.

I've said this before: Banks have to return to thinking like Silicon Valley and Silicon Alley startups. Without this mentality, banks face an ever-increasingly niched market share and at worst, obsolescence. Innovation in banking is dependent on embracing Bitcoin – will they play or be left in the dust? Therefore, it is by no means out of historical context for banks to re-establish themselves in the competitive money business.

Friday, November 8, 2013

Bitcoin: The Internet of Money

By Naval Ravikant
Startup Boy
Thursday, November 7, 2013

Bitcoin will eventually be recognized as a platform for building new financial services.

Most people are only familiar with (b)itcoin the electronic currency, but more important is (B)itcoin, with a capital B, the underlying protocol, which encapsulates and distributes the functions of contract law.

Bitcoin encapsulates four fundamental technologies:
  • Digital Signatures – these can’t be forged and allow one party to securely verify a transaction with another.
  • Peer-to-Peer networks, like BitTorrent or TCP/IP – difficult to take down and no central trust
  • Proof-of-Work prevents users from spending the same money twice, without needing a central authority to distinguish valid from invalid transactions. Bitcoin creates an incentive for miners, who run powerful computers in the network, to validate transactions and to secure them from future tampering. The miners are paid by “discovering” new coins, and anyone with computational resources can anonymously and democratically become a miner.
  • Distributed Ledger – Bitcoin puts a history of each and every transaction into every wallet. This “block chain” means that anyone can validate that a given transaction was performed.
Thanks to these technical underpinnings, bitcoins are scarce (Central Banks can’t inflate them away), durable (they don’t degrade), portable (can be carried and transmitted electronically or as numbers in your head), divisible (into trillionths), verifiable (through everyone’s block chain), easy to store (paper or electronic), fungible (each bitcoin is equal), difficult to counterfeit (cryptographically impossible), and can achieve widespread use – many of the technologists that brought us advances on the Internet are now working overtime to improve Bitcoin.

Proponents of the role of government argue that a currency with fixed supply will fail. They posit that inflation is required to keep people spending and that prices and wages are still as sticky as they were decades ago. They overlook that the world functioned on fixed money supplies until 40 years ago (the gold standard), and that bitcoin can gather many uses and value long before it has to become the main currency in which all prices are denominated. Another fear is that a central actor could take over the Bitcoin computing network – but the combined Bitcoin distributed supercomputer runs at the equivalent of 2,250 PetaFLOPS, 90x the rate of the fastest supercomputer (note – in Nov, it’s now 48,000 PetaFLOPS!), and consumes an infinitesimal fraction of the resources used by a bloated banking system. Many label it as a speculative pyramid scheme – without realizing that all government-printed money is such. To the extent anyone holds cash over other assets, they are speculating that other assets will decline in relative value. Concerns abound over the security of the encryption scheme, the speed of transactions, the size of the block chain, the irreversibility of the transactions, and the potential for hacking and theft. All are fixable through third-party services and protocol upgrades. It’s better to think about Bitcoin the protocol as Bitcoin 1.0, destined to evolve just as HTTP 1.0 evolved beyond of simple text and image-only web-browsers.

So why not just use Pounds or Dollars? One can use bitcoins as high-powered money with distinct advantages. Bitcoins, like cash, are irrevocable. Merchants don’t have to worry about shipping a good, only to have a customer void the credit card transaction and charge-back the sale. Bitcoins are easy to send – instead of filling forms with your address, credit card number, and verification information, you just send money to a destination address. Each such address is uniquely generated for that single transaction, and therefore easily verifiable. Bitcoins can be stored as a compact number, traded by mere voice, printed on paper, or sent electronically. They can be stored as a passphrase that exists only in your head! There is no threat of money printing by a bankrupt government to dilute your savings. Transactions are pseudonymous – the wallets do not, by default have names attached to them, although transaction chains are easy to trace. It has near-zero transaction costs – you can use it for micropayments, and it costs the same to send 0.1 bitcoins or 10,000 bitcoins. Finally, it is global – so a Nigerian citizen can use it to safely transact with a US company, no credit or trust required.

Even more importantly, Bitcoin the protocol will enable financial services transactions that are not possible today or require expensive and powerful third-parties.

Bitcoin has a scripting language which enables more than a “send money from X to Y” transaction. A Bitcoin transaction can require M of N parties to approve a transaction. Imagine Wills that automatically unlock when most of the heirs agree that their parent has passed, no lawyer required. Or business accounts that require two of any three trusted signatures to approve an expenditure. Or wire escrows that go through when any arbiter agrees that the supplier sent the goods to the buyer. Or wallets that are socially secured by your friends and family. Or an allowance account accessible by the child and either of two parents. Or a crowdfunding of a Kickstarter project that pays out on milestones, based on the majority of the backers approving the next payment. The escrow in each case can be locked so that the arbiters can’t take the money themselves – only approve or deny the transaction.

The scripting language can also unlock transactions based on other parameters. Unlocking them over time can enable automatic mortgage, trust, and allowance payouts. Unlocking them on guessable numbers creates a lottery auditable by third parties. One can even design smart property – for example, a car’s electronic key so that when and only when a payment is made by the car buyer to the seller, the seller’s car key stops working and the buyer’s car key (or mobile phone) starts the car. Imagine your self-driving car negotiating traffic, paying fractional bitcoin to neighboring cars in exchange for priority.

Everyone has a copy of the Bitcoin block chain, so anyone can verify your transactions. You can write software that will crawl the block chain and generate automatic accounting histories for tax and verification purposes. You can engaged in “Trusted Timestamping” – take a cryptographic signature of any document, timestamp it, and put it into the block chain. Anyone can verify that the document existed at a given time. If you sign the document with your private key and another party signs it with theirs, it becomes an undeniable mutually-signed contract. This entirely eliminates notaries and websites like are showing the concept. The Namecoin project is building a distributed Domain Name System that allocates and resolve Domain Names without needing ICANN or Verisign, by using the block chain to establish proof-of-ownership. Similarly, look for entrepreneurs to apply this authoritative proof-of-ownership to built P2P Stock and Bond Exchanges – at least one Bitcoin site, “Satoshi Dice,” has sold shares and issues dividends without using a stock exchange. The ownership and dividends are easily verifiable by anyone who wants to look inside the block chain. is combining the transaction scripting and the verifiability to create a prediction market in which you cannot be cheated and third-party arbiters can allocate the winnings.

Bitcoin’s “send-only” and irreversible nature makes it much less vulnerable to theft. Today, anyone with your Credit Card or E-Checque (ACH) information can pull money from your account. This creates chargebacks, expensive dispute resolution and merchants double-checking your identity. Bitcoin is send only. Anyone who has received bitcoins from you can’t request or pull more money from your account.

Most importantly, Bitcoin offers an open API to create secure, scriptable e-cash transactions. Just as the web democratized publishing and development, Bitcoin can democratize building new financial services. Contracts can be entered into, verified, and enforced completely electronically, using any third-party that you care to trust, or by the code itself. For free, within minutes, without possibility of forgery or revocation. Any competent programmer has an API to cash, payments, escrow, wills, notaries, lotteries, dividends, micropayments, subscriptions, crowdfunding, and more. While the traditional banks and credit card companies lock down access to their payments infrastructure to a handful of trusted parties, Bitcoin is open to all.

Silicon Valley knows a platform when it sees it, and is aflame with Bitcoin. Teams of brilliant young programmers, entranced by the opportunity, are working on Exchanges (Payward, Buttercoin, Varum), Futures Markets (ICBIT), Hardware Wallets (BitCoinCard, Trezor, etc), Payment Processors (, Banks, Escrow companies, Vaults, Mobile Wallets, Remittance Networks (, Local Trading networks (, and more.

Looming over them is how governments view Bitcoin and the entrenched financial powers it threatens. The last few decades have seen a move towards a cashless society, where every transaction is tracked, reported, and controlled. Bitcoin takes powers from the central actors and returns it to merchants and consumers, savers and borrowers. Bitcoin brings back some pseudonymity in the transactions, and can be irrevocably traded like cash. And finally, it points a way towards a single currency – it is a bug, not a feature, that we have multiple global currencies with exchangers and transaction fees in between.

Governments have been cracking down on the bitcoin exchanges, making it harder to obtain and slowing its development. Strict and expensive Money Transmitter regulations, designed to slow terrorist and child porn financing, threaten the next great technological revolution – never mind that terrorists can use cash just fine, the means of terror are cheap, and that they account for an infinitesimal fraction of global commerce. The development and innovation in Bitcoin has already begun the move to friendlier jurisdictions, where its innovation can continue un-impeded. Regulators in the US and UK would be wise to proceed with a light touch, lest they push the development of Bitcoin and its entrepreneurs to places like Canada, Finland, and the Sino-sphere. The United States has benefited enormously from being home to the majority of global companies driving the Internet revolution. The country that is the home to the Internet of Money could one day end up as the guardian of the new Reserve Currency and the Global Money Supply.

Thanks to Shawn O’Connor, Lucas Ryan, Paul Bohm (@enkido), and Oleg Andreev (@oleganza) for feedback. Follow me at @naval

Monday, November 4, 2013

Banking Innovation Depends on Bitcoin

By Jon Matonis
Thursday, October 31, 2013

With one firm swoop, banks could eliminate the threat from Apple, Google, and PayPal by embracing the new bitcoin cryptocurrency. Disruption doesn't always come from the outside but revolutions do form at the periphery which is precisely where Bitcoin sits today.

It's easy to talk about conventional financial services disruption such as digital banking and mobile payments, because we've seen the information age already disrupt entrenched industries. We know that banking in the future will be something you do -- not some place you go -- and aggressive fintech startups already provide the innovation that's occurring in the financial services space.

Combine that fact with the existing platform behemoths of Apple (iPhone iOS) and Google (Android) and banks fear losing the customer relationship on the road to becoming a non-strategic utility.

By altering the monetary unit of account and deploying it as a competitive wedge, bitcoin offers disruption within disruption, or even supreme disruption. But the question invariably becomes "how do banks make money with bitcoin?"

On a primary level, bitcoin represents a new currency opportunity for banks. The term banknotes is actually left over from the period when banks issued their own currency notes in an environment of free banking and currency competition. It is by no means out of historical context for banks to re-establish themselves in the competitive money business. Besides, bitcoin doesn't even claim to represent anything similar to legal tender.

Imagine the following bank board meeting around a giant mahogany wood table where the board directors are more obsessed with escalating compliance requirements than innovation.
Bitcoin Advocate: Our bank needs to embrace Bitcoin because we need some of Schumpeter's "creative destruction." Beyond simple return-on-equity, we need relevancy and survival.

Board Director: But won't all this innovation and disruption raise the level of scrutiny from the regulators? Our entire bank staff is already 30% anti-money laundering compliance attorneys acting as quasi-agents for law enforcement.

Bitcoin Advocate: You need to leverage that legal advantage and not be afraid. Bitcoin is not against the law in any jurisdiction in the world. Our bank needs to lead and be first because if we don't, then some other bank will, or even worse, a non-bank.

Board Director: Well, doesn't bitcoin ultimately dis-intermediate banks? Where is the long-term revenue opportunity?

Bitcoin Advocate: It's a new and decentralized world with block chains, hash rates, and distributed consensus. The business opportunities are about efficiency, more clients, new revenue streams, frictionless global payments, and improved risk management. Let me show you.

It's not really hard to imagine that type of conversation, especially considering the demographics of digital currency users. What's even worse for banks is that the current generation doesn't ever want to step into a branch. It's difficult for banks to formulate a strategy that doesn't involve "eating their young."

The digital currency revolution is already happening in deposit taking, online trading, mobile payments, and merchant processing. Shifting the monetary unit of account to cryptographic money supported by market-based legitimacy rather than regulatory-based legitimacy is allowing innovation on an entirely new level thus permitting engineers and businesses to enter the value transfer market without being subject to the confines of legacy systems or preconceived notions of "exclusive" legal tender.

Deloitte in the United Kingdom recognizes this seismic impact on retail banking and IBM's executive architect believes that the Bitcoin technology will change the world.

Entrepreneur-led startups with few employees and no formal financial expertise manage millions of dollars worth of bitcoin deposits as global cryptocurrency banks.

Small fintech companies link to banks online and make a two-way market in bitcoin 24 hours a day and seven days a week.

Elegant bitcoin wallets on Android and iOS offer point-to-point transaction clearing making the mobile telephone dongle attachment look old-fashioned and unnecessary.

Startups process merchant deposits in bitcoin providing immediate conversion services to national currencies.

Banks own the trust game and it is their game to lose. For better or worse, a majority of people still prefer banks over trusting Apple, Google, or PayPal with sensitive data. Security at banks and financial institutions usually represents the strongest in the world among private businesses. For those individuals desiring a third-party safe keeper for their bitcoin balances, banks could provide several obvious advantages.

Efficient exchange services are also the domain of banks. Trading and market making for bitcoin (XBT) pose no more challenges than dealing in foreign currencies, derivatives, or interest rate swaps. Bank expertise in this area is a natural fit for bitcoin currency trading.

Think of it as a typical build versus buy decision. In many cases today, banks are being asked to serve as financial partners for bitcoin-related enterprises that are a direct assault on a bank's core competencies. Adopting the business model of some of these bitcoin-related companies goes a step beyond mere banking services, however that is the difference between an innovator and a utility.

We are witnessing the emergence of a new paradigm made possible by peaceful monetary revolution. Banks can either play or watch. As coach George Allen famously said while leading his Washington Redskins to victory, "The future is now."

Tuesday, October 29, 2013

Silk Road Case Could Set Bitcoin Legal Precedent For Many Years

By Jon Matonis
Saturday, October 18, 2013

Now that an all-star attorney has been selected for the Silk Road operator’s defense, the big show moves to key disclosure laws and whether the Silk Road assets can ever be confiscated by the government.

While the government presumably has control over the 26,000 or more bitcoin held in escrow for Silk Road customers, the larger asset base is the primary bitcoin addresses containing over two years worth of operating commissions. FBI estimates place this amount at nearly 600,000 bitcoin (currently worth $80m), however it is probably significantly less than 600,000 since earlier bitcoin was not worth what it is now and some of it would have been paid out to employees or reinvested back into ongoing operations.

Regardless, if access to those bitcoins is maintained via a brain wallet, then the only way for the government to gain access would be by compelling the defendant, Ross Ulbricht, to reveal his passphrase and private keys. A high-profile case such as this one making its way to the US Supreme Court would be as significant for bitcoin user rights as Roe v Wade is for women’s abortion rights.

In the US, the government has typically run into the Fifth Amendment when attempting to gain access to passphrases and demand private key disclosure. Last year, Marcia Hoffman of the Electronic Frontier Foundation gave an excellent presentation on the evolving nature of these legal cases and how the privilege against self-incrimination is seen by the government as having boundaries and limitations.

Bitcoin may not have tremendous anonymity by default, but it does have tremendous deniability and that would be the preferred legal route for Ulbricht, according to Susan Brenner, professor of law and technology at the University of Dayton.

For deniability and beyond the “forgone conclusion” test, Brenner suggests in TIME that Ulbricht must demonstrate surrendering the password makes it evident that the bitcoin are his:
“If I represented Ulbricht, I would argue that while the generic existence of the bitcoins is a foregone conclusion, his ‘possession’ of them is not . . . and that by providing the password would conclusively establish that they belong to him, which would mean that he would, under the act of production as testimony standard, be ‘testifying’ and, since the testimony would incriminate him, he could take the 5th Amendment.”
Executive editor of Laissez-Faire Books and organizer of the Crypto-Currency Conference, Jeffrey Tucker, asks:
“But what’s the message here? That bitcoin is a hugely valuable property, that it is hard for the government to rob, that it is the real thing and an authentic store of wealth, that it is a viable replacement for the dollar. These are the messages that are being sent by the government’s actions.
The supreme irony: the Silk Road shutdown and looting might go down in history as the greatest boost to private currency ever. We could look back and see this as the event that finally unraveled the government’s money monopoly and the world’s problem with dollar imperialism.”
And there you have it. The most interesting aspect of the Silk Road case may not be the demonstrated capability of a regulation-free commercial zone. Nor may it be the breakthrough in merchant anonymity with a ratings system powering a digital agorism.

The most interesting aspect of the Silk Road case will most likely be the sweeping legal precedent set for compulsory key disclosure and the Fifth Amendment. If your online wealth cannot be robbed by common bandits or government officials, then the world truly has a digital money worth paying attention to.

Compelling an individual to turn over passwords or private decryption keys affects more than just access to financial property and information. It extends into any digital property or private information that is under the custody of an individual where its revelation constitutes self-incrimination.

But, it is the bitcoin area that has the greatest relevance for financial matters because access to the distributed bitcoin block chain is how ownership and transfers of that ownership are determined. Comprehending bitcoin ‘ownership’ requires an understanding of both peer-to-peer distributed computing and public key encryption for bitcoin addressing.

When it comes to financial matters, protected wealth beyond confiscation has profound implications that alter society from its current trajectory of absolute financial surveillance. Key disclosure laws have much to say about how this scenario plays out and it will vary among jurisdictions. Due to growing and pervasive cryptography in our lives, it will come to be the single defining issue for liberty in the digital age. We must have universal and unconditional privileges against compulsory self-incrimination.

The effect of upholding the Fifth Amendment against compulsory key disclosure benefits not just drug crime defendants, but everyone that uses non-retrievable passwords.

For instance, pretrial legal funds could be segregated and deployed when necessary so that targeted defendants are no longer drained of the means for immediate and complete representation, as was the case with Kim Dotcom.

The alarming and repeated abuses of civil asset forfeiture would thankfully become a thing of the past.

Tax haven assets and other offshore banking activity, such as Cyprus, would no longer be subject to the trust of a bank or third-party custodian that shifts trusted privacy policies based on the latest politics or Nation-State bullying.

Levels of overall financial privacy, including retirement and inheritance instructions, would be determined by the individual without inversely asking for permission to retain your financial privacy.

The government is only discovering the power of the bitcoin block chain for the first time now, but its liberating properties are seductive on multiple levels. Even if the government and police are able to seize access to the bitcoin property involved in a criminal or civil asset forfeiture, they can no longer secretly divvy up the booty as graft and that is good for all of us.

Friday, October 18, 2013

Bitcoin Foundation Comments on the Shutdown of Silk Road

By Jinyoung Lee Englund
Bitcoin Foundation
Friday, October 4, 2013

We received several requests to comment on the shutdown of Silk Road. First and foremost, it is important to note that the sanctity of the Bitcoin protocol remains intact and it was not a weakness of the core protocol that led to the apprehension of Mr. Ulbricht. Although Bitcoin is not anonymous by default, Bitcoin addresses were not a factor in solving the case.

“The FBI was able to capture an alleged criminal without any new investigative methodologies being needed and without having to get into changing the nature of the Bitcoin protocol,” Bitcoin Foundation General Counsel Patrick Murck said. “They caught him the same way they would catch somebody using cash.”

This is good for the Bitcoin economy in general and the reputation in specific because it proves that Bitcoins are in and of themselves a neutral store of value or medium of exchange and that privacy does not necessarily have to be compromised for law enforcement purposes.

Bitcoin’s principal attributes of irreversibility and user-defined privacy continue to provide benefits for bitcoin users globally. The Bitcoin Foundation would like to reaffirm that financial privacy sits on a sliding scale expressed differently by different individuals. However, within the Bitcoin transaction network, the specific level of that privacy is determined, managed, and set by the user.
Furthermore, the FBI acknowledged that “Bitcoins are not illegal in and of themselves and have known legitimate uses.” (DOJ Filing Section 21, Subsection v)
For more information on Bitcoin and anonymity, please see:
For Tor and the Silk Road takedown, please see:

Saturday, October 12, 2013

SecondMarket's Bitcoin Offering Defines New Asset Class

By Jon Matonis
Monday, October 7, 2013

It’s not every day that a new asset class is born. The last time was probably a few decades ago when managed futures funds became an accepted asset class among portfolio managers.

Now, alternative trading system company SecondMarket has launched The Bitcoin Investment Trust (BIT), an open-ended, private trust that is exclusively invested in bitcoin and derives its value solely from the price of bitcoin.

The private investment vehicle is based in the US and open to institutional and accredited individual investors. Alternative Currency Asset Management (ACAM), a wholly-owned subsidiary of SecondMarket, is BIT’s sponsor and SecondMarket has also made a $2 million seed investment in the BIT.

Certainly, a bitcoin trust can be thought of as a unique proxy for investing in bitcoin startups that would not carry the specific risk of management team execution or adopting the correct business model.

Not many other currencies in the world can serve as a proxy investment for an entire high tech, venture-funded sector. Until the bitcoin ecosystem matures and deepens, it will be possible to bet on its success simply by going long on the actual monetary unit.

Generally, the bitcoin funds, or trusts, can also be thought of as precursors to more retail-oriented exchange-traded funds (ETFs) which require substantially more due diligence and regulatory clearance.

When bitcoin ETFs start appearing on a regular basis, bitcoin will have completed its transition into both retail and wholesale asset class.

The bitcoin offering from SecondMarket has been in development for over a year now and it will set the standard for best practices of bitcoin as an asset class in the US.

Non-correlated to other investment classes and alongside more conventional portfolio components like equities, bonds, real estate, and commodities, a position in bitcoin allows a portfolio to participate in the potential upside from an economy based on digital currencies.

Following Exante’s Bitcoin Fund from Malta which debuted last year, SecondMarket also intends to facilitate two-way trading of the trust shares on its proprietary platform enabling both long and short positions. This is significant because commercial processors and large merchants of bitcoin would have a reliable method to hedge their bitcoin inventories without having to liquidate actual bitcoin on a daily basis.

For instance, if a bitcoin merchant processor, such as BitPay, wanted to “lock in” a certain aggregate exchange rate for their merchants or for their own books, they could initiate a short position in the Bitcoin Investment Trust without the need to sell bitcoin on the open market.

The company has established relationships with over 100 players in the bitcoin space, including large merchants, early adopters, and exchanges which should aid in the development of additional liquidity.

The critic's view

Last week, the forlorn and chronic bitcoin skeptic Felix Salmon, of the Reuters blogging world, took a shot at SecondMarket and their new trust. Salmon says that “no sensible investor should go anywhere near it” and he doesn’t “really understand why [Silbert's] doing this.”

Correctly stating that bitcoin is a combination of currency and commodity, Salmon goes on to claim “this trust strips out the interesting bit, which is the currency part, leaving just the stupidly speculative commodity aspect.”

As with most professional critics at the beginning of a new asset class, the cries of disbelief and suggestions of investor imprudence are to be expected because prior to becoming portfolio orthodoxy an element of risk weeds out the non-brave.

I wouldn’t expect Salmon to promote the adoption of largely undefined risk, but I would expect him to understand why a particular investment vehicle makes sense for certain investors.

Firstly, there is the aspect of institutional participation and the possibility of favorable tax treatment for investments made through retirement funds.

Many endowments and institutions that administer investment funds have strict guidelines for placing those investments such as placement must be with registered broker-dealer. Therefore, a straight investment into bitcoin “on your own” would not satisfy those institutional parameters.

Secondly, Salmon must also realize that larger aggregated wholesale purchases of bitcoin can be accomplished at more preferential pricing terms than smaller individuals would be able to achieve acting on their own. The consolidated purchasing power of a trust could easily make up for a good portion of those fees.

Thirdly, and most importantly, the custodial features of safe-keeping and private key management are paramount.

The Bitcoin Investment Trust administrative and safekeeping fee is analogous to the storage fee assessed on gold and precious metals warehousing. Also, a professionally-managed trust provides protection against a slew of risks that could prove overwhelming for the casual weekend bitcoin investor.

For instance, as enunciated by Exante, top-level risks include data loss risk, hardware failure risk, jurisdictional risk, external hacker risk, dishonest employee risk, and employee death or disability risk. Also, succession planning and inheritance are just as important with a bitcoin asset as with any other asset.

Perhaps some year in the future Salmon will look back at this bitcoin article and say “I was not a True Believer when I really should have known better.” Or, maybe he will be smugly proud of himself for establishing a massive short bitcoin position in 2013. I doubt the latter.

According to the private placement memorandum, ACAM has retained prominent service providers including Sidley Austin LLP (legal counsel), Ernst & Young (auditor), Continental Stock Transfer & Trust (transfer agent) and SecondMarket (marketplace, custodian and authorized participant).

Investors who purchase shares in the BIT will have the opportunity to gain liquidity through periodic auctions on SecondMarket beginning in 2014. The Net Asset Value (NAV) of the BIT will be calculated daily and made publicly available.

Disclosure: Author is Executive Director of Bitcoin Foundation and participates on the Advisory Board for Alternative Currency Asset Management (ACAM).

Monday, September 30, 2013

Armory and the Monetization of Bitcoin Wallets

By Jon Matonis
Wednesday, September 25, 2013

A group of prominent investors recently made a play in the bitcoin wallet space by backing startup Armory Technologies, Inc. The $600,000 seed round investment will go mostly towards funding and expanding development.

Interestingly, this placement brings into focus a much larger issue: the monetization of bitcoin wallets.

It’s no mistake that Armory founder and CEO Alan Reiner told CoinDesk: “This first 12 months is more about developing a quality product than it is figuring out how to monetize it.” An effective wallet monetization strategy doesn’t exist yet.

Even lead investor Trace Mayer agrees. Wallets being in dire need of improvement is “actually very problematic and a tragedy of the commons problem which I fear will likely only get worse because it is so difficult to monetize wallets,” he wrote. Mayer also said: “There is no immediate plan for how to monetize Armory.”

Indeed, wallet development may get funded, but revenue and profitability are different issues. Here is how I see this market playing out.

It may be comforting to wallet investors that open source Mozilla Firefox has 18.29% worldwide market share of the free browser market, but receives $300 million per year from a Google search deal. Similarly, eyeballs from bitcoin wallets could steer exchange choices but that’s in the long term.

Armory is an open source bitcoin wallet with a strong reputation for security and it is considered a ‘thick client’, meaning that downloading the entire block chain is required to verify transactions.

For low overhead and faster mobile applications, future releases will support a spectrum of block chain access options and the desktop-to-mobile interaction will be important.

Just as with web browsers, the client front-end (or wallet) is part of a grander play in the space. With the online wallets of traditional payment methods, the grander play for transactional and value-add revenue is currently being executed by the technology giants, telecoms, and banks.

But what’s the main driver for bitcoin wallets and payments, especially given that tech brands like Apple may actively be blocking certain bitcoin features for their own strategic benefit?

The answer lies with the bitcoin service providers. Today’s hosted wallet services, merchant processors, and integrated exchanges offer the best near-term choice for wallet monetization, but it will most likely involve a third party and a mobile app.

Bitcoin exchanges already experience a good portion of their customer base using the exchange as an online wallet of sorts. As the bitcoin economy matures, service providers will be searching for unique differentiators to gain a competitive advantage.

Either the service providers evolve into turbo-charged, sophisticated wallets or the bitcoin wallets themselves emerge as premier service providers as seen with the Send Shared mixing service from Blockchain’s My Wallet.

Since it’s a convergence either way, the future of wallets probably includes a combination of both approaches. Armory’s management team has a tabula rasa business model in front of them now and they will no doubt be presented with several promising opportunities to build or partner. So let’s focus instead on the evolution of the third-party service providers becoming sophisticated wallets.

For corporate security reasons, there’s probably a place for desktop wallets in the future, but the majority of innovation will be in the web-based and mobile wallets.

Hybrid wallets, where the user maintains the private keys, and hierarchical deterministic (HD) wallets offer two of the most promising areas for development.

To see where all of this is headed, just look at the feature set of the Blockchain Android App for My Wallet and that doesn’t even include P2SH and split key support.

Take Coinbase for example. The company operates a hosted bitcoin wallet with two-way exchange capabilities and it smartly realizes that consumers are also merchants, and vice versa.

A Coinbase-Armory mobile wallet app could broaden out the Coinbase offering by allowing customers more direct control over their coins using different hosted wallet scenarios. Their primary downside right now is that they only provide a domestic exchange service for the US.

LocalBitcoins is a decentralized approach to trading bitcoin because it matches buyers and sellers in various local regions for trade clearing and settlement.

Sellers maintaining bitcoin balances on the LocalBitcoins wallet is the preferred way to operate. With greater functionality, the site could easily evolve into a primary hosted wallet service in its own right. The company is already offering support for multi-currency and has a global following.

Not wanting to get left behind, exchanges like Mt. Gox and Bitstamp could see themselves adding robust and mobile wallet features that are quite separate from the exchange business.

In addition to exchanges expanding into the wallet space, the merchant processing operators like BitPay and BIPS both benefit from increased functionality at the wallet level.

As more bitcoin balances are kept by the merchants rather than exchanged out to national currencies, the merchant processors start to resemble a hosted wallet because the exchange services become less important. The online secure access and management reporting capabilities of the wallet become the wedge for competitive differentiation.

Going outside of the bitcoin ecosystem, it’s easy to imagine commercial banks and portfolio managers offering specialized bitcoin custodial services to their client base, including branded hardware wallets. When the online casino world goes full bitcoin, the wallet integration issues will be front and center. All present excellent revenue opportunities for leading wallet vendors, not excluding transaction-based revenue.

As new companies and new business initiatives enter the bitcoin market, they will look to the well-known wallets.

Established wallet leaders with reputable brands and diverse offerings will be able to leverage that into a service-oriented model. With integration, maintenance, and even hosting potential, the superior bitcoin wallets like Armory have a bright future.

Sunday, September 22, 2013

Bitcoin Gaining Market-Based Legitimacy as XBT

By Jon Matonis
Tuesday, September 17, 2013

Punctual trams run quietly along the street out front. It looks like any other office building in Zürich. But inside the nondescript building of SIX Interbank Clearing, a small unit of professionals maintains the list of the world’s currency codes.

Last week in that very same building, I had the honor of presenting the bitcoin cryptocurrency to a gathered audience of various bank officials at an e-commerce conference. And I mentioned that the individual, or committee, that endorses and finalizes XBT as the ISO currency code for bitcoin will earn their spot in history next to Satoshi Nakamoto.

Of course, a new code for a brand new asset class is not comparable to an achievement in financial cryptography and distributed consensus, but it is significant nonetheless because of its impact on the evolution of math-based currencies.

The ISO 4217 standard for currency codes is published by a voluntary, non-governmental organization independent of any national agenda. It operates more or less as a body that approves the three-character currency codes of new countries or regions. In some cases, the code reflects a non-governmental unit such as gold (XAU) and silver (XAG).

Beyond the regulations and government approval that so frequently underpin discussions about the legitimacy of bitcoin, a different type of legitimacy is emerging and it has the ability to out-survive the elected administrations of legal jurisdictions.

This market-based legitimacy holds the key to bitcoin’s success – not the sanctions and official blessings for what’s an appropriate monetary unit. Governments and regulators may come and go, but customs and convention persevere.

Currency code XBT is a sign of this growing market-based influence, at least among the organizations currently depending on such codes. Governments generally follow rather than lead market adoption because it is too difficult to alter the course of momentum.

Uniquely, bitcoin operates as both a value transfer network and a separate unit of account. Therefore, it doesn’t require the services of a third-party intermediary to approve and route transactions. However, as a monetary unit, bitcoin offers great opportunities for those who desire to trade or price in bitcoin and perhaps layering services on top of the protocol.

At the top of the pyramid is SWIFT, a member-owned cooperative that provides the communication platform to connect more than 10,000 banking organizations in 210 countries (16 more countries than the United Nations).
SWIFT’s influence is so pervasive that its ecosystem is a daily barometer of global economic performance such as GDP growth rates, capital flows, and foreign exchange trade volatility.

Once again, bitcoin is a major topic of conversation at Sibos, the annual SWIFT conference being held in Dubai this year.

In prepared remarks yesterday, SWIFT CEO Gottfried Leibbrandt said, “I would not see why we at Swift could not send transactions in bitcoin as a currency.” If they do, they will undoubtedly look to the ISO for the currency code. The Bitcoin Foundation had two scheduled appearances at the SWIFT conference.

Also, the payment networks like VISA, MasterCard, and American Express all rely on the ISO 4217 codes for international transactions and currency conversion. Once the member banks start requesting settlement in bitcoin for certain transactions, the payment networks will look to the ISO for the corresponding currency code., one of the world’s leading providers of Internet foreign exchange tools and services, recently began displaying bitcoin prices in XBT across their data feed. Founded in 1993, the company licenses over 35,000 XE Currency Converters, provides commercial currency data to over 1,000 clients, and serves 18 million unique users per month.

Service provider OANDA also displays bitcoin prices using the currency code XBT. OANDA is a market maker and a trusted source for currency data, serving both individuals and financial institutions. Founded in 1995, it provides access to one of the world’s largest historical, high frequency, filtered currency databases serving over 30 million requests per month.

Not to be outdone, Bloomberg in August announced that they were testing XBT price quotes internally lending more ammunition to the push for formal code adoption.

In the bitcoin trading world, exchange operator Kraken became the first to make the formal switch to XBT this week and other bitcoin exchanges are expected to follow suit.

In the retail foreign exchange trading world, platform market leaders like MetaTrader 4 are witnessing client firms undertaking the bitcoin modifications on their own. Although not expressing trades in XBT yet, the gradual adoption of bitcoin into existing forex platforms signals a huge shift in market trading. So far, only three companies are known to have incorporated bitcoin into the MT4 environment, including AvaTrade, BTC-E, and Bit4X.

XBT may represent the beginning for bitcoin standards and market-based legitimacy, but it is certainly not the end. Next up on the standards agenda is the Unicode symbol for bitcoin with B⃦ or ฿ as the two leading contenders.