Thursday, August 16, 2012

My Answer To A VC’s Bitcoin Question

By Jon Matonis
Forbes
Saturday, August 11, 2012

http://www.forbes.com/sites/jonmatonis/2012/08/11/my-answer-to-a-vcs-bitcoin-question/

Fred Wilson is a venture capitalist and principal of Union Square Ventures. On his popular blog, he recently solicited feedback (for the second time) on the bitcoin cryptocurrency. I was tempted to reply directly on the blog, but with over 400 comments posted already I did not want to be lost in the scroll.

My reply is directed first at Fred for sparking the discussion but also to those many other investors pondering bitcoin deals. Throughout, I will refer to bitcoin investments as investment in bitcoin-related deals as opposed to a direct investment in the currency itself which an entirely different business proposition.

Let's get some basics out of the way. First of all, an investment in a bitcoin entity will be a gut-wrenching, difficult investment to make if a particular VC has an inherent fundamental belief in any of the following: (1) the cashless society as promoted by the anti-cashists; (2) capital controls enforced at national borders; (3) the appropriateness of any government monetary policy; and (4) the taxation of income.

For a VC, this can be a soul-searching exercise. But it does not mean that the decentralized digital currency is political by nature. It means that through its cryptographic nature bitcoin reduces the monetary Statist to irrelevancy. Bitcoin has some pretty powerful and disruptive byproducts.

With optional, user-defined transaction privacy, the use of money for purposes of identity linking falls by the wayside. True, it enables a paper cashless society but not with the attributes that the tax-efficient anti-cashists want. Without government checkpoints for financial institution wire transfers, bitcoin capital flows freely, without limits, and perhaps anonymously. The harmful tools of centralized monetary policy would also not exist. And finally, the taxation of income that began in the United States in 1913 would operate on the honor system -- the honor of the taxpayer, that is. This could be welcome news for some as a progressive income tax was a fundamental tenet of Marxism.

In his first post, Fred mentioned "the emergence of currencies that are not controlled by nation states in my lifetime." He clearly acknowledges that significant ramifications result from the "decoupling of currencies from governments," but I wonder if he has come to terms with what that actually means.

What sounds cool and hip because it is technologically advanced can also turn a lifetime of engrained political assumptions on its head. If a VC happens to believe that Greece's problems can be solved by eliminating anonymous paper cash transactions and that the taxation of income is morally justified, how does he reconcile that with bitcoin dominance?

Definitely not for the faint of heart, those skilled and experienced venture capitalists entering the arena will be
playing with fire. This is not a game of targeting an app and throwing seed money at developers located in Silicon Valley or Silicon Alley. Nor is it like catching the social media wave or jumping on the mobile payments bandwagon.

Bitcoin is the quintessential disruptor for not only does it disrupt established primary-level players in the field of payments, like VISA, Mastercard, and PayPal, but it disrupts the very nature of monetary authority.  Bitcoin is disruption within supreme disruption.

Failing to recognize this maxim, especially as a venture capital investor, can be fraught with pitfalls. Regulatory acquiescence will be tempting, but counter-productive. In a company's strategic plan, relegation of bitcoin to just another national currency type among equals fails to exploit its incredible transformative properties. The venture capitalist could become boxed in by the lack of courage to set legal precedent, by the unwillingness to go overseas, or even by the reluctance of the board. To be fair, there will be VC plays in the regulation-friendly exchange space and processor space but they won't be the home runs!

The home runs will be transformative and that just may not be possible for a NewCo in all countries. I maintain that it is more a game of multiple jurisdictions that leverages the relative strengths of competing legal jurisdictions for the best foot into the global infrastructure.

Gibraltar made an early, and deliberate, strategic decision to embrace and promote the online gambling business. They executed it brilliantly and Gibraltar is now home to the industry's leaders like publicly-traded bwin.party [BPTY:London]. Just as with online gambling, some jurisdictions around the world will be more bitcoin-friendly than others. Negotiating that outcome is the real frontier.

Many readers have commented and agreed that the investment opportunities will revolve around bitcoin-related services more than any type of client software play or attempt to control the mining and transaction fees. While I generally agree, I also think that a new company does not have to be bitcoin focused exclusively.

Also, keeping bitcoin value in bitcoin on the block chain will be the key. It may be an opportunity that moves significantly beyond an existing business model simply by having bitcoin in its arsenal. For example, a third-world e-commerce platform could bring massive shopping to the unbanked by leveraging the non-national and frictionless attributes of bitcoin. Or, asset vehicles could be designed that transfer inter-generational wealth without the need for trusts or trust administrators.

So, my advice to VCs seeking their piece of the block chain is study the FATF blacklist of 15 non-cooperative countries, go to airports you never heard of, and most importantly, surround yourself with management teams that mentally embrace bitcoin's powerful derivative byproducts.

For further reading:
"Sit down and shut up!", BLOGDIAL, August 13, 2012
"Cash Is Essential For A Free Society", Stowe Boyd, August 10, 2012
"Secure multiparty Bitcoin anonymization", Edward Z. Yang, July 20, 2012
"Nerdy Money: Bitcoin, the Private Digital Currency, and the Case Against Its Regulation", Nikolei M. Kaplanov, March 31, 2012

2 comments:

  1. What do you mean by "asset vehicles could be designed that transfer inter-generational wealth without the need for trusts or trust administrators"? I do not believe that I understand how that would work. Thanks!

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  2. I mean that Brainwallets could be designed that contain a certain amount of private wealth that was known only by the four phrase holders, who in turn would each hold 1/4 of the total phrase.

    See... http://www.forbes.com/sites/jonmatonis/2012/03/12/brainwallet-the-ultimate-in-mobile-money/

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