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."