Banks Squander Opportunity in Bitcoin

By Jon Matonis
American Banker
Monday, November 18, 2013

http://www.americanbanker.com/bankthink/banks-squander-opportunity-in-bitcoin-1063722-1.html

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.

Bitcoin: The Internet of Money

By Naval Ravikant
Startup Boy
Thursday, November 7, 2013

http://startupboy.com/2013/11/07/bitcoin-the-internet-of-money/

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
  required.
• 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 https://www.proofofexistence.com/ 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. Predictious.com 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 (bitpay.com), Banks, Escrow companies, Vaults, Mobile Wallets, Remittance Networks (bitinstant.com), Local Trading networks (localbitcoins.com), 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

Banking Innovation Depends on Bitcoin

By Jon Matonis
CoinDesk
Thursday, October 31, 2013

http://www.coindesk.com/banking-innovation-depends-bitcoin/

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."

Silk Road Case Could Set Bitcoin Legal Precedent For Many Years

By Jon Matonis
CoinDesk
Saturday, October 18, 2013

http://www.coindesk.com/silk-road-case-bitcoin-legal-precedent/

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.

Bitcoin Foundation Comments on the Shutdown of Silk Road

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

https://bitcoinfoundation.org/bitcoin-foundation-comments-on-the-shutdown-of-silk-road/

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)

Here is the U.S. Department of Justice filing link: http://www.scribd.com/doc/172766650/Criminal-Complaint-Against-Alleged-Silk-Road-Proprietor-Ross-William-Ulbricht

Silk Road seized assets on the bitcoin block chain: https://blockchain.info/address/1F1tAaz5x1HUXrCNLbtMDqcw6o5GNn4xqX

For more information on Bitcoin and anonymity, please see:
https://en.bitcoin.it/wiki/Anonymity

For Tor and the Silk Road takedown, please see:

https://blog.torproject.org/blog/tor-and-silk-road-takedown

SecondMarket's Bitcoin Offering Defines New Asset Class

By Jon Matonis
CoinDesk
Monday, October 7, 2013

http://www.coindesk.com/secondmarkets-bitcoin-offering-defines-new-asset-class/

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).

Armory and the Monetization of Bitcoin Wallets

By Jon Matonis
CoinDesk
Wednesday, September 25, 2013 

http://www.coindesk.com/armory-monetization-bitcoin-wallets/

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.