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May 21, 2015

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INTRODUCTION  

May 21, 2015 Bloomberg Brief Bitcoin 2

INTRODUCTION  Bitcoin Growing Pains: Matching Reality to the Rhetoric

Bitcoin introduced a lot of people to the idea of computerized money. Now the digitalcurrency, which set off a minor frenzy when it broke into public consciousness in 2013, istrying to grow up.

Novelty has given way to the hard slog of starting and funding new companies, likebrokerages and bitcoin storage sites, that can be boring and profitable. Utopian fantasieshave subsided as consumers remain largely unconvinced of the value of swapping theircash for bitcoins, or using it to buy goods and services or for transferring money.

There are plenty of people in Silicon Valley, Wall Street and other tech or money hubsaround the world working on it, but no definitive answers are in sight. With price swings that have shown that owning bitcoins isn’t a sure path to riches — the currency lost halfits value over the course of 2014, a worse showing than the ruble — you have to believein the brainpower invested in bitcoins if you want to believe that the reality will eventuallymatch the rhetoric.

Even as entrepreneurs look for new business models, the bitcoin community has beenworking through some legacy issues, like the 2013 indictment of the operator of SilkRoad, an anything-goes online market where drugs were peddled for bitcoins, or thebankruptcy filing by Mt. Gox, a Tokyo-based exchange, after hackers pilfered 850,000bitcoins.

Regulators are proving to be a bigger challenge than many entrepreneurs had hoped.Benjamin Lawsky, the outgoing New York state superintendent of financial services, proposed rules on digital currency companies that drew often-unprintable reactions frombitcoin entrepreneurs before being scaled back. European banks were warned againsthandling bitcoins until new EU regulations take effect. The U.S. Internal RevenueService ruled that bitcoins would be treated as property, not currency — meaning thatbuying a $2 cup of coffee with bitcoin you bought for $1 could trigger a capital gains tax.And the Bitcoin Foundation is fighting an internal battle over whether supporters shouldfocus on advocacy or improving the software that makes transactions in the currencypossible.

Virtual currencies aren’t new — online fantasy games have long used them — but thedevelopment of a secure digital currency without a central issuer rightly turned heads.The pseudonymous creator of the bitcoin system, Satoshi Nakamoto, solved a problemcentral to any currency: how to control its issuance, i.e., prevent counterfeiting. He alsosolved one specific hurdle for digital money — how to stop users from spending thesame unit of currency twice. His breakthrough involves an online ledger that recordsideaevery single bitcoin transaction, one maintained by a network of bitcoin “miners” whosecomputers perform the calculations that validate each transaction, preventingdouble-spending.

The miners earn a reward of newly issued bitcoin. The pace of creation is limited, andno more than 21 million bitcoins will ever be issued. Bitcoins can be used to buy anever-expanding list of things, including a Tesla sports car. That’s still a fraction of the fiatcurrency economy, but a band of well-funded startups with names like Coinbase, BitPay,Xapo and BitGo are making it easier to exchange and store bitcoins safely.

A bitcoin boom early in 2014 led to call it a with no intrinsic value. Butsome bubbleentrepreneurs in the field say that focusing on the price of bitcoins is missing the point —the currency’s value is as the basis of a new kind of payment system.

Dreams of replacing the dollar aside, putting bitcoins to work is a matter of applyingenough time and money, they say. Convincing applications of the bitcoin system includemoving money abroad and as a medium for micro-payments in emerging countries.

Tim Draper, a legendary Silicon Valley venture capitalist, bought about 30,000 bitcoinsfrom the U.S. government (they had been seized from Silk Road) and aims to helppeople break free from weak local currencies. But even some of the currency’s canniestboosters realize there is no guarantee that bitcoin ever will break into the monetarymainstream.

Mike Hearn, a member of the core team that updates the bitcoin software, said that the is that it retains only a niche appeal.“most plausible outcome”

— Carter Dougherty, Bloomberg News

BITCOIN PRICE VOLATILITYBitcoin has fallen the most of anycurrency against the U.S. dollar sinceits November 2013 peak.

BITCOIN NEEDS TO MATURE FORBROAD USE: LURIAWedbush's Gil Luria says the currentversion is good for the "sandlot andthe lab."

INDUSTRY DEVELOPINGMININGAS DIFFICULTY INCREASESThe speed of increase in bitcoin'shash rate has slowed, data show.

STRONG REGULATION ISSOLUTION TO RISKS: WILLIAMSBoston University's Mark T. Williamssays many risks are unaddressed.

N.Y. TAKES THE LEAD ON RULESNew York's Department of FinancialServices granted the first charter to abitcoin firm in May.

BITCOIN BEGIN TODERIVATIVES EMERGE, LIQUIDITY STILL THINA growing number of marketparticipants race to bringinstitutional-scale derivatives tobitcoin trading.

UTILITY IS BEST BAROMETERFOR BITCOIN SUCCESS: BRITOCoin Center's Jerry Brito says theU.S. has done a good job of balancingfreedom and the law in this area.

TOP BITCOIN BANKRUPTCIESMt. Gox and Cointerra are the top twofilings by liabilities so far, courtdocuments show.

SPLIT ONCENTRAL BANKSDIGITAL CURRENCYThe world’s central banks are stillstruggling to understand their role, ifany, in the digital currency landscape.

BITCOIN IS DIGITAL EQUIVALENTOF WHATSAPP FOR CASH: HOSECoins.ph's Ron Hose says bitcoin canlower the cost and time it takes tofinalize remittance transfers andpayments in emerging markets.

IN THIS ISSUE

CONTRIBUTORS

May 21, 2015 Bloomberg Brief Bitcoin 3

 

CONTRIBUTORSIn this special issue of Bloomberg Brief, we examine the potential opportunities and pitfalls the new digital currency might bring to achanging marketplace. For some, bitcoin offers a chance to change the world, particularly when it comes to transfers and payments inemerging markets. For others, the bitcoin boom could be a bubble threatening to burst. With so many regulatory unknowns ahead forthe currency, time will tell whether this is an investment with staying power or a tech-savvy flash in the pan. Contributors to this specialedition of Bloomberg Brief include:

Steven Lord is editor of The ModernMoney Report. He has founded and ledseveral companies in the financialtechnology, investment media and assetmanagement sectors in the U.S. andEurope. He was an early investor in bitcoin,but is no longer invested. In this issue, helooks at topics including bitcoin mining,leverage, privacy vs. anonymity and theemergence of bitcoin derivatives.

Bill Rochelle is a bankruptcy columnistand editor-at-large for Bloomberg News.Before joining Bloomberg in 2007, Bill wasa bankruptcy lawyer for 35 years, the last17 as a partner in the New York office ofFulbright & Jaworski LLP. In this issue, helooks at why future bitcoin bankruptcieswouldn't be a boon for underemployed U.S.bankruptcy professionals.

Jerry Brito is executive director of CoinCenter, a non-profit research and advocacycenter focused on the public policy issuesfacing cryptocurrency technologies. In thisissue, Jerry says the U.S. has done"remarkably well" at finding a balancebetween preserving freedom of action todevelop bitcoin technology while alsoupholding the law.

Barry Silbert is founder and CEO of theDigital Currency Group, as well as thefounder of SecondMarket Inc. and BitcoinInvestment Trust. DCG has backed morethan 50 bitcoin startups and created theBitcoin Investment Trust, the first publiclytraded bitcoin investment vehicle. In thisissue, Barry says he's looking to developingmarkets for the next round of startups.

Gil Luria is managing director for financialtechnology research at WedbushSecurities. Previously, he was in equityresearch at Sanford C. Bernstein and amanager at Deloitte Consulting. In thisissue, Gil explains why he doesn't thinkbitcoin is ready yet for broad, institutionaluse.

Mark T. Williams is a risk managementexpert and lecturer at Boston University. Prior to teaching, he worked as a seniortrading floor executive, a bank trust officerand as a bank examiner for the FederalReserve Bank. In this issue, Mark examinesthe need for stronger regulation andoversight in the nascent bitcoin sector.

Ron Hose is co-founder and CEO ofPhilippines-headquartered Coins.ph, aremittance company. Previously, he was afounding partner at Innovation Endeavorsand co-founder of TokBox, which wasacquired in 2012 by Telefonica. In thisissue, Ron explains the appeal of bitcoin inemerging markets.

Mike Belshe is co-founder and CEO ofBitGo. He previously worked at Microsoftand Google, where he was one of the first10 members with Google Chrome. In thisissue, Mike explains the reasoning behindbitcoin storage and the ways his companyis trying to keep it safe.

   

Source: LinkedIn

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VOLATILITY

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VOLATILITYIt's Been a Roller-Coaster Ride for the Price of Bitcoin

Bitcoin hit its high price of $1,137 backon Nov. 29, 2013. Since then, the digitalcurrency has plummeted in value by morethan 79 percent against the U.S. dollar.This is the largest fall of any currencyagainst the greenback. However, thisdoesn't tell the whole story of bitcoin's fall.

The decentralized digital coin hasshown itself vulnerable to volatile priceswings, closing almost 20 percent lowerthe day the Mt. Gox platform went offline.The price more than recovered thefollowing day, finishing the day at $609 —a 35 percent spike.

Bitcoin came into 2015 valued around$314, and has dropped as low at $183since then. Still, the virtual currency hasseen gains of almost 27 percent againstthe dollar from that year-to-date low.

— Ben Baris, Bloomberg Brief Editor

A Timeline of Bitcoin's Ups and Downs

Bitcoin Has Largest Decline vs. USD Since Nov. 2013 Peak

May 21, 2015 Bloomberg Brief Bitcoin 6

 

May 21, 2015 Bloomberg Brief Bitcoin 7

 

 

VOICES

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VOICES

Wedbush's Luria Says Bitcoin Has to Be More Mature for Broad, Institutional Use

, managing director for financialGil Luria

technology research at , Wedbush Securities

says the current version of the core bitcoin

operating system, released in May, is good for the

"sandlot and the lab," but is not ready yet for

broad, institutional use. Luria spoke with

Bloomberg Brief contributor Steven Lord. His

remarks were edited and condensed.

Q: How is the bitcoin ecosystemdeveloping?A: Bitcoin will eventually have a numberof key applications. Cross-borderremittance and payment services areobvious places where the technology canradically reduce friction, and we will see alot of rapid development in that space.Ditto for micropayments, which allowminuscule payment amounts to be sentvia social media and lead to some bigchanges in terms of how subscriptionbased publishers are monetizing theircontent. More strategically, the provisionof banking-like services to underbankedpopulations around the world is going toget a lot of attention due to the sheerscale of both the savings possible and thecustomer base.

It’s important to note that right now,bitcoin looks like it’s all about payments,but it will ultimately also change the wayassets are owned, tracked and traded.Slow, expensive legacy processes insecurities trading, real estatetransactions, legal contracts, etc. will bethe areas of largest disruption. People arejust starting to imagine these applications,but they’re coming. And don’t thinkinnovation will only come from bitcoinstartups — the legacy service providersare not asleep. They will undoubtedlycome up with their own ways to utilizedigital currency and the blockchain.

Q: Is there interest from Wall Street atthe moment?

Just like with bitcoin in general,A:interest is growing at the grass roots.Institutional investors are starting to getinvolved on the trading side, and a lot ofbanks understand the potential. Many areactively exploring ways in which they canbenefit. At the moment, though, we’re still

 

constrained by the lack of regulatoryclarity. Regulatory frameworks areneeded that specifically spell out whatcan and can’t be done. Until then, the bigWall Street firms won't engage in size.Also, remember that most global financialinstitutions don’t view the technology asready for prime time. It isn’t proven atscale and in a broad context.

We just got version 0.10.2 of the bitcoincore protocol in May — nobody likes todeploy version 0.10.2 of anything. It’sgood for the sandlot and the lab, but forreally broad, institutional use, bitcoin hasto be more mature.

Q: What do you see for the future ofbitcoin?

The potential exists forA:blockchain-esque technology to disrupt awhole range of financial services. Rightnow, transactions only occur throughtrusted third parties. Bitcoin eventuallyoffers open, decentralized, trustless andsecure infrastructure, which will radicallyreduce cost and increase efficiency. TheInternet has removed middlemen andbottlenecks all over the place, but not yetfor money. I think that’s going to change.

Q: Is ApplePay a bitcoin competitor? ApplePay is a front-end innovation thatA:

makes it significantly easier for people touse a smartphone to interact with theexisting payments infrastructure. It’sgreat, in that regard. But it does nothingfor the back end, which is the expensivepart. If anything, ApplePay entrenches thelegacy payments system. Bitcoin’s realrevolution is on the back end. I don’treally see them as competitors, but as

 

complements to one another. There is noreason they can’t coexist.

Q: What's your take on bitcoin'snon-refundability?

It’s an advantage, not a disadvantage.A:It is much easier to go from a system thatdoesn’t offer refunds to one that does.The legacy system essentially forces allmerchants to systemically absorb thecosts of refunds. Down the road, I thinkdigital currency payment processors willoffer refunds as a feature, and merchantscan decide whether to add them or not. Itwill become a competitive advantage, justlike it became an advantage to offer freeshipping.

Q: Is regulation coming for bitcoin?It’s inevitable. But what’s moreA:

important is that regulation is appliedevenly and consistently. That’s the bestoutcome. It’s not going to be a panacea,though. Banks, money transmitters,payment processors, etc. have beeninvolved in immeasurable fraud, hacksand legal issues, and they’re among themost regulated companies on the planet.Just having regulations doesn’t guaranteethey’re followed.

An interesting aspect about bitcoin isthat it will actually make it harder for badactors to hide. Bad guys do bad things incash all the time, and when they do, it’sgone. As we’ve seen with both the SilkRoad seizure (and the DEA corruptionthat went with it), every transaction inbitcoin is tracked and, eventually,traceable. It seems counterintuitive, butusing bitcoin actually makes it mucheasier to catch the bad guys.

Education: Bachelor’s Degree in Economics, Hebrew University;MBA from Columbia University

Equity research, Sanford C. Bernstein; Deloitte ConsultingCareer:Industry expertise: Crypto-currencies, payment systems, telecomWhy cover bitcoin? I’ve been covering payments companies for thelast 10 years, and was introduced to bitcoin in 2013. I read theoriginal paper, which speaks to problems in current paymentnetworks and ways to solve them. That resonated with me, and Istarted doing some research. At the same time, interest began risingfrom our institutional clients, so we steadily became more involved.

May 21, 2015 Bloomberg Brief Bitcoin 9

 

RESEARCH  COMPILED BY ANNE RILEY, BLOOMBERG BRIEF EDITOR

May 21, 2015 Bloomberg Brief Bitcoin 10

RESEARCH  COMPILED BY ANNE RILEY, BLOOMBERG BRIEF EDITOR

As Mobile Banking Becomes Less Foreign, Bitcoin May Gain Traction"The way we pay is changing." That's

the opening line of Goldman Sachs'srecent report on the future of finance, andwith far more millennials today carryingsmartphones than checkbooks, thatshouldn't come as a surprise to anyone.

According to the report by analystsJames Schneider and S.K. Prasad Borra,the percentage of banked smartphone ortablet owners who said they haveperformed at least one mobilemoney-related transaction in the previousmonth grew sharply across all age groupsin the U.S. between the fourth quarter of2011 and the second quarter of 2014.The survey data, which comes fromAlixPartners, not surprisingly shows theyoungest generations to be the mostactive when it comes to online banking.

"This suggests to us that the adoption[of] technologies — even within agecohorts — is rapidly evolving and is farfrom static," the analysts wrote in theGoldman Sachs report, entitled "TheFuture of Finance, Part 2: Redefining 'TheWay We Pay' in the Next Decade."

As online and mobile banking evolves,bitcoin and other online currencies couldgain more traction.

Merchant acceptance of bitcoin is still inits "infancy," the Goldman analysts wrote,but a growing number of merchants haveexpressed an interest in accepting bitcoinand other cryptocurrencies in the future.According to a survey conducted byGoldman Sachs and the ElectronicTransactions Association (ETA), 23percent of merchant acquirers orindependent sales organizationssurveyed have plans to start acceptingbitcoin within the next two years.

"A number of other major retailers havebeen testing bitcoin payment in specificareas of their business, including Dell,which is accepting bitcoin for digital goodspurchases. Despite optimism among

some merchants, there has been littleevidence of strong sales traction amongconsumers," they wrote in the report,

published on March 10, noting that mostmerchant bitcoin activity has beenconcentrated in the U.S. and Europe.

 

INSIGHT: MINING  BY STEVEN LORD

Money-Related Transactions Move Toward Mobile

Acceptance of Bitcoin Expected to Pick Up in Mid-Term 

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INSIGHT: MINING  BY STEVEN LORD

Bitcoin Mining Industry Developing as Difficulty Increases 

Unlike fiat currency systems, inflation of bitcoin’s supply is fixedat a very predictable rate by the mining process, which currentlygives a reward of 25 new bitcoins for each new block solved, anda finite total supply of 21 million.

Blocks are solved about every 10 minutes and the rewardhalves every 210,000 blocks (approximately every four years),meaning the supply expansion can be calculated with someaccuracy.

To date, about 14.2 million XBT have been mined since bitcoinwas launched in 2009; the last one will likely be mined sometimein 2140.

  

The proportion of bitcoin mining being accomplished by smalleroperators has steadily declined since the start of last year. Anumber of industrial-scale operations, including GHash,DiscusFish and AntMiner, have increasingly become the dominant players in the business of creating new bitcoins.

Despite its theoretically distributed nature, the concentration ofmining power among a handful of firms has raised centralizationconcerns, as has the advent of so-called cloud mining, whichrents mining capacity out on the web for a fee.

Meanwhile, the proportion of blocks solved by unknown minershas remained relatively constant at 10 percent to 15 percent.

  

Bitcoin mining relies on a self-adjusting system that varies thedifficulty of solving a transaction block according to how muchaggregate computing power, worldwide, is utilized in the effort.

Rapid growth in the scale and sophistication of mining activityhas resulted in an increase in bitcoin’s hash rate, the number ofcalculations per second across the bitcoin network. As designed,this has been accompanied by a similar rise in mining difficulty.

However, the rate of increase has slowed as the economics ofmining have tightened; difficulty dropped for the first time inDecember 2014 as mining power exited the ecosystem.

VOICES

Just Over 14M Bitcoins Have Been Mined

Percentage of Bitcoin Mined by Major Pools

Speed of Bitcoin Hash Rate Increase Slows

May 21, 2015 Bloomberg Brief Bitcoin 12

VOICES

Strong Regulation, Global Standards Are Solution to Bitcoin Risks, Says Williams

, a risk management expert andMark T. Williams

lecturer at Boston University, told Bloomberg

Brief's Melissa Karsh that there are many risks

surrounding bitcoin that have yet to be addressed.

Until there's stronger regulation and oversight, and

the pseudo-anonymous nature goes away, the

virtual currency remains a major macroeconomic

risk, he said. His remarks were edited and

condensed.  

Q: What's your stance on bitcoin? A: It has always been that with thisopportunity comes substantial new riskinto the economy from a macroperspective. This is an experiment beingdone outside of the controlledenvironment of a laboratory. As a result,there need to be controls around it, whichmeans stronger regulation. There aremany risks still to be addressed.

Q: What are those specific risks?A: The most obvious is the risk thatcryptocurrencies, as currentlyconstructed, continue to be the designercurrency of choice for the criminallyinclined. That's why the recent high-profileFinancial Crimes Enforcement Network(FinCEN) action against Ripple Labs wasimportant in policing the onramps used toexploit the legitimate financial system.However, FinCEN cannot police theglobe.

Other risks include the fact that bitcoinis a nationless currency. It's not controlledand regulated by any one entity, so it'shard to protect vulnerable consumers.The pseudo-anonymous nature of bitcoinalso exposes consumers to risk of theftwith little chance of recovery if privatekeys are taken.

Also, it's a voluntary currency, so it onlyhas value in the marketplace as long aspeople accept it. There's always a riskthat bitcoin can go from its current valueto being virtually worthless. We've alreadyseen a drop of more than 75 percentsince its November 2013 market high.That price risk hasn't declined, which is aproblem. If a currency can fluctuate by 10or 20 percent in a given day, then there'sless incentive to own or use it. When youhave these extreme price movements, italso reduces the number of merchantswilling to take such extreme market risk.

 

In 2014, the Internal Revenue Serviceruled that bitcoin was not legal tender andshould be taxed like property. That's asignificant blow to the use of bitcoin fortransactional purposes because if youbuy it at a low cost, you would have topay tax for using it. Bitcoin also has thepotential to be a sovereign attack.Sovereign nations around the globe havea monopoly on money creation and usethis power as a means to help manageeconomic well-being for their citizens.Nation-state treasuries print currency butthe vital role of currency managementneeded to spur economic growth isreserved for central bankers. If notcontrolled and tightly regulated, bitcoinhas the potential to undermine thelongstanding bond between sovereignsand their currency.

Last, bitcoin trades like a high-riskvirtual commodity and is more risky thanthe U.S. dollar.

Q: What is the solution? Regulation that protects consumersA:

and our global financial market —reducing the chances of use for financialterrorism, money laundering, drugrunning, sex trafficking and tax evasion,etc. There need to be high industrystandards set globally. For instance,whether transacting on an exchange inCyprus or San Diego, California, thereneeds to be assurance that controls are inplace and market integrity is strong.There also needs to be greater marketprice stability.

Regulation can encourage wider use ofvirtual currencies as safeguards andfinancial protections are in place. Rightnow, it appears that the financial cost ofusing bitcoin is greater than the benefit.With the 2014 collapse of Mt. Gox andadding up other fraudulent events,

consumers have lost almost $1billion. Since the November 2013 marketpeak, the total market value of bitcoins incirculation has also dropped by roughly$8 billion.

Q: So what's been the benefit? The economic benefit would be if weA:

can reduce frictional costs globally in howwe transact business. Virtual currenciesdo have a place as long as there'sregulation, strong oversight and thepseudo-anonymous nature goes away.For instance, if the Federal Reservestepped in and made a Fed coin withgood controls around it — a safety net forconsumers of sorts — and did away withthe anonymous nature, then that coinwould be trusted, used and be morewidely adopted. Virtual currencies havesuch an opportunity here, but it's a shortwindow. If the bitcoin community is willingto acknowledge that regulation isinevitable, and embrace it, it will be ableto increase the chance for wider bitcoinadoption.

Q: What about bitcoin 2.0 projects?A: There's two components — bitcoin theengine and bitcoin the delivery system.The delivery system is like the rails thetrain rides on, and even if they are sturdy,if the engine isn’t stable, it doesn't matterhow great the rails are: The systemdoesn't work. Unless price stability isachieved, the 2.0 discussion can’t be fullyrealized. What use is the blockchain ifconsumers don't feel safe using theaccess coin? At a recent conference inWashington, D.C., claims were made thatvirtual currencies could save the thirdworld. But, are we helping or hurtingimpoverished citizens if they could loseup to 20 percent of their wealth in a singleday?

Education: BSBA in Finance from the University of Delaware and aMBA from Boston University.

Since 2002, has been on the Finance & Economics FacultyCareer:at Boston University. Prior to teaching, worked as a senior tradingfloor executive, a bank trust officer and as a bank examiner for theFederal Reserve Bank.Industry expertise: Risk management in the energy trading andbanking industry, and derivative matters in the capital markets.

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REGULATION: AGENCIES

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REGULATION: AGENCIES

Switzerland Looks to Money Laundering; U.S. Targets Virtual Cash; CFTC on Demand

Switzerland’s financial market regulatorsays bitcoin needs to be treated as aserious medium for illicit activity likemoney laundering in a sign of thewidening acceptance of the digitalpayment system. Bitcoin’s ability to beused anonymously and internationallyincreases the risk it could play a role interrorist financing, Finma, as the regulatoris known, said in a February report ondraft of its revised decree on moneylaundering. Finma has been cautious inits approach to bitcoin. The Swissregulator in June asked Swiss exchange

to suspend operations ofBitcoin Suisseits network of automated teller machinespending inquiries about its operations. Finma held a two-month consultationperiod that wrapped up last month andwill incorporate that feedback into therevision of its Anti-Money LaunderingOrdinance.

— Hugo Miller and Jeffrey Vogeli

U.S. authorities effectively tightenedtheir grip on virtual currencies, reaching asettlement with a San Francisco-basedstart-up that regulators accused ofnegotiating a quarter-million-dollar dealwith a convicted explosives dealer.

agreed to pay $700,000Ripple Labs Inc.to settle allegations of poormoney-laundering controls with the U.S.Justice Department, the Internal RevenueService and Financial CrimesEnforcement Network, or FinCEN.

The May 5 settlement is the first civilenforcement action against a virtualcurrency exchanger, FinCEN said in astatement. It enforces rules that FinCENlaid out in 2013. Ripple sold its XRP, thesecond-largest virtual currency, eventhough it hadn’t registered with FinCEN,the Justice Department said in astatement. Ripple failed to maintainappropriate anti-money launderingcontrols under federal banking laws, theDOJ said. Ripple spokeswoman MonicaLong said the company is pleased toresolve this matter, adding that it hasn’twillfully engaged in criminal activity and

Finma

FinCEN, DOJ, IRS

cooperated with investigators whilebolstering compliance efforts in a “WildWest” industry. “An early company in anemerging, undefined fintech category,Ripple Labs was one of the first toproactively build out a compliance andrisk program,” Long said.

The ruling underscores the costs suchstartup companies seeking to carve out apiece of the cryptocurrency market maybear — in the form of potentialenforcement actions, or in complianceand legal costs. Ripple Labs“acknowledged that digital currencyproviders have an obligation not only torefrain from illegal activity, but also toensure they aren’t profiting by creatingproducts that allow would-be criminals toavoid detection,” said U.S. AttorneyMelinda Haag of the Northern District ofCalifornia. “We hope that this sets anindustry standard.”

In late 2013, the company negotiated a$250,000 transaction with an individualwho had prior felony convictions fordealing in explosive devices and hadbeen sentenced to prison, the DOJ said ina statement, adding the company hadn’tfollowed its own “know your customer”requirements. That individual was aRipple Labs investor, the statement offacts said. Ripple was co-founded in 2012by Internet entrepreneur Jed McCaleb, acompany blog said. McCaleb also startedMt. Gox. As part of the settlement, Ripplewill have external audits through 2020and beef up its AML controls and trainingprogram. A subsidiary of the firm, XRP IILLC, was cited for failing to file suspiciousactivity reports and for lax moneylaundering controls.

— Keri Geiger and Greg Farrell

In March 2013, FinCEN issuedguidance classifying as money servicesbusinesses both exchangers — personsengaged as a business in the exchangeof virtual currency for real currency, fundsor other virtual currency — and administrators — persons engaged as a business in putting into circulation avirtual currency and having the authorityto withdraw it from circulation, requiring

some virtual currency companies toregister with the agency.

— Stephen Joyce, Bloomberg BNA  

The IRS on March 25, 2014 issuedNotice 2014-21, which in part stated thesale or exchange of convertible virtualcurrency and the use of convertible virtualcurrency to pay for goods or serviceshave tax consequences that may result ina tax liability.

— Stephen Joyce, Bloomberg BNA

Financial industry regulators havelargely been on the periphery regardingbitcoin reforms, though the U.S.Commodity Futures Trade Commission,or CFTC, has started to look more closelyat the demand for derivative productsbased on the digital currency. CFTCCommissioner Mark Wetjen said at a fallconference that the agency does haveauthority under the Commodity ExchangeAct to regulate virtual currencies,although it hasn't to date. "I believe wehave the authority because bitcoin, by arational reading of our statute, qualifies asa commodity under the definition of acommodity under the CommodityExchange Act," Wetjen said at theconference. This does not mean,however, that the agency would haveoversight over bitcoin exchanges that donot offer or trade in derivative contracts.

In April, Wetjen said in testimony thatbitcoin-like technologies have thepotential to further reduce market risk ifthey are more widely embraced."Bitcoin-like protocols or distributed publicledger technologies could provide andenhance various settlement and othertrustee-like services provided byregistered entities in the derivativesmarkets, where monies and collateral arefrequently transferred and settledthroughout a trading day," he said inprepared remarks. "These technologieswork to provide a record of transactionsand changes of ownership, and can beused to validate any type of transaction —including the more familiar concept ofexchanging cash or currencies, as well asother types of assets or collateral, suchas stocks, bonds, and securities. Withthese technologies, this can be donewithout the use of banks or otherintermediaries."

— Steven Lord and Melissa Karsh

CFTC

REGULATION: STATES  BY STEPHEN JOYCE, BLOOMBERG BNA

May 21, 2015 Bloomberg Brief Bitcoin 15

REGULATION: STATES  BY STEPHEN JOYCE, BLOOMBERG BNA

For the first time, a U.S. bank regulatorgranted a charter to a trust companyoperating an exchange for bitcoin.

The New York State Department ofFinancial Services (NYDFS) May 7announced it granted a state charter to

, a global exchangeitBit Trust Co. LLCwhere institutions and retail customersmay buy and sell bitcoin using U.S.dollars. The company counts formerfederal regulators on its board and said itwill provide customers with federalinsurance for their accounts.

The precise benefits of the charter weredebated among financial serviceslawyers. At issue is whether the charterexempts or provides reciprocal waiversfrom existing money transmitter andmoney services licensing requirementsthat currently exist in a majority of states.Obtaining the charter might also exemptitBit from registration obligations requiredby the Treasury Department's FinancialCrimes Enforcement Network (FinCEN).

In public disclosures itBit promotes itselfas a bitcoin exchange that meets highregulatory, service and securitystandards. Its board of directors includesSheila Bair, a former Federal DepositInsurance Corp. chairman; Bill Bradley, aformer Democratic senator from NewJersey; and Robert Herz, a formerFinancial Accounting Standards Boardchairman. It counts RRE Ventures,Canaan Partners and Liberty CityVentures as venture-capital companiesparticipating in its first capitalizationround, during which itBit said it raised $25million. A key element of its structure isthat it will accept U.S. dollars from U.S.customers and place those dollars in aninsured depository, giving customersFDIC insurance protection.

In a May 7 statement, NYDFS said itreviewed itBit's anti-money laundering,capitalization, consumer protection andcybersecurity standards as part of itsassessment of itBit's charter application.ItBit will be required to meet thoseobligations applied to operators of a trustcompany under New York law, it said.

“We have sought to move quickly butcarefully to put in place rules of the roadto protect consumers and provide greaterregulatory certainty for virtual currencyentrepreneurs,” said NYDFS

N.Y. Grants First Charter toBitcoin Firm; Waiver Mulled

Superintendent Benjamin Lawsky, whowill step down in June as New York’s topbank regulator. “Indeed, we believe thatregulation will ultimately be important tothe long-term health and development ofthe virtual currency industry.”  

While the granting of the charter maytechnically establish itBit as a type of NewYork banking entity, the charter does notallow itBit to accept deposits and holdthem or make loans to customers,Latham & Watkins LLP partner AlanAvery said. ItBit also won't be considereda bank for purposes of the federal BankHolding Company Act, he said.

“Indeed, we believethat regulation will

ultimately be importantto the long-term health

and development ofthe virtual currency

industry.”— BENJAMIN LAWSKY  

In a May 7 e-mail, itBit spokeswomanDorothy Jean Chang asserted the charterdoes exempt the company from FinCENand state money transmitter licenserequirements. “Money transmitters aresubject to FinCEN regulations, but itBit isnot because it's regulated by the NewYork Department of Financial Servicesand meets much more rigorousstandards,” she wrote. The trust will alsonot be required to obtain the envisionedBitLicense because it meets thoserigorous standards, she wrote.

ItBit's legal view was not whollyaccepted by some lawyers. “I do notbelieve it is correct to say that a trustcompany charter granted by the NewYork DFS allows an entity to provideservices to residents of other states.Unlike retail banks, there is no reciprocityfor state chartered trust companies underthe Nationwide Cooperative Agreementfor Supervision and Examination ofMulti-State Trust Institutions (1999),” Paul

Hastings LLP partner and electronicpayments specialist Chris Daniel said inan e-mail. “While itBit may have engagedin this exercise already, it will require astate-by-state approach to determinewhether other states agree that a trustcompany is the right regulated structureto engage in commercial cryptocurrencyexchange activity in their state."

FinCEN spokesman Stephen Hudakdeclined to comment without knowing thefull facts and circumstances of the matter.

The charter announcement was madein the runup to the release of an eagerlyanticipated New York Department ofFinancial Services final regulation that willcreate a first-in-the-nation BitLicenserequiring companies engaged in certainactivities related to virtual, or digital,currencies to register with NYDFS.

Those activities are defined in theproposed regulation as receiving virtualcurrency for transmission or transmittingvirtual currency with some exceptions;storing, holding or maintaining custody orcontrol of virtual currency on behalf ofothers; buying and selling virtual currencyas a customer business; performingexchange services as a customerbusiness; and controlling, administeringor issuing a virtual currency.

Outgoing NYDFS SuperintendentBenjamin Lawsky told reporters April 21the BitLicense regulation will likely bereleased no later than May 31.

In February 2014 the Conference ofState Bank Supervisors formed anEmerging Payments Task Force toexamine the intersection betweenelectronic payment systems and the roleof state financial regulators. The CSBSDec. 16 issued a draft model stateregulatory framework including languagethat states could use when drafting rulesregarding consumer protection, licensing,market stability, anti-money launderingand cybersecurity for state-licensedvirtual currency firms. A spokeswomansaid previously that the framework will befinalized by the end of the year. Membersof the task force include state regulatorsfrom California, Florida, Georgia,Massachusetts, New York, Tennessee,Texas, Utah and Washington state.

BitLicense to Be Finished,Issued by End of May

REGULATION: ANONYMITY  COMMENTARY BY STEVEN LORD

May 21, 2015 Bloomberg Brief Bitcoin 16

REGULATION: ANONYMITY  COMMENTARY BY STEVEN LORD

Anti-Money-Laundering Rules Creating Arms Race Between Anonymity, TransparencyThere's an arms race of sorts between

those trying to de-anonymize bitcoin andthose trying to enhance anonymity,spurred by anti-money-laundering andknow-your-customer requirements,increased regulation, and theidentification of individuals in a number ofhigh-profile criminal cases. Some usershave started going to extraordinarylengths to obscure their identities evenmore than what is already possible withthe blockchain, which is the public,distributed and decentralized ledger inwhich every bitcoin transaction isrecorded.

One common technique users haveemployed to obscure their identities isthrough the use of tumblers or mixers, thethird-party services that breaktransactions up into many smaller ones orexchange one set of bitcoin for another ofthe exact same value less a fee,essentially laundering the coins inquestion. However, using such servicesmeans the user has less control over thebitcoin transaction and has to place trustin an unknown third party. Tumblers andmixers also have difficulty handling largeamounts of bitcoins, so they tend to workbetter with smaller transaction amounts.Also, they have been decoded by usingsophisticated techniques to link bitcoinpublic keys — the alphanumeric string ofnumbers and letters that identifies thesender or recipient in a bitcoin transaction— with real people.

The ability to circumvent the bankingsystem’s anti-money laundering and knowyour customer rules, known as AML/KYC,by having a bitcoin address has been anatural draw for all manner of illicitactivities, from online black marketsselling illegal drugs to a large number ofthefts, frauds and hacks. Bitcoinsupporters say its use in illegal activitiesshould be considered a separate anddistinct issue from the digital currency

itself, just as it is with the dollar, euro orprecious metals.

Many in the community cite the 2013takedown of online black market SilkRoad as the moment bitcoin becamevisible on the radar of regulators aroundthe world. The bust has resulted in twoconvictions and the auction of tens ofthousands of bitcoins seized by the U.S.government.

Yet it is important to understand thedifference between privacy andanonymity. With the former, details of apurchase or sale, i.e., the amount, theproduct, or the date, are kept confidential.With the latter, the identity of thepurchaser or seller is kept confidential, orin bitcoin’s case, not known in the firstplace.

By design, the bitcoin protocol offersanonymity. Bitcoin can be earned bymining or private transaction, and held incold storage entirely offline, with the onlyidentifying information associated with thebitcoin address being the private key.Tracking subsequent transactions can bedifficult, since the blockchain doesn’trecord identities.

But in practice, the majority of usersnow interact with the digital currency viaan online wallet or exchange service,such as Xapo, Blockchain.info or BitPay.At that point, any anonymity they gainedby using bitcoin is out the window, sincethe information they provided whencreating accounts links them to theirbitcoin balances, as does their computerusage. This is where efforts to establishrobust AML/KYC regulations arestrongest — no one is going to changethe inherent anonymity offered by thebitcoin protocol, but for businesses thatinterface between it and the customer,rules will apply.

“There is no retreating from the fact welive in AML/KYC world,” said James Jalil,digital currency practice head at law firm

Thompson Hine, in an interview in March.“Despite all the technological advances ofdigital currencies, there is no way we goback to the days of bearer bonds,” whichcan be redeemed by anyone holding thesecurities and were declared virtuallyillegal in the U.S. in 1982.

“Plus, anytime bitcoin or a bitcoin usertouches the fiat currency system, therewill be AML/KYC obligations,” Jalil said.This means that any time you buy or sellbitcoin using a bank account or creditcard, your identity is going to be linkedwith that transaction.  

Moreover, several techniques havebeen developed, some more precise thanothers, to associate particular addressesand transactions with particularindividuals or businesses. It’s not easy,but it is not impossible. The ledger itself isperfectly transparent; every transactionthat takes place is visible, time stampedand searchable, making it easy to mapwhat is happening across the bitcoinecosystem.

Also, bitcoin exists online, so at somelevel every interaction with the blockchainrequires Internet access, and thus istheoretically identifiable via IP address tothe bitcoin nodes — a source ofcomputing power for the network thatauthenticates transactions — processingthe transaction. Through a triangulationprocess using multiple nodes, it ispossible to narrow down which was theoriginating one, and thus a place for thetraditional tools of law enforcement —subpoenas and the power to compel — tostart.

"Ultimately, law enforcement has what itneeds," J. Dax Hansen, a partner at lawfirm Perkins Coie LLP, said in aninterview. "In fact, this conversation mayeventually flip from bitcoin's anonymity towhether it is actually private enough."

 

VOICES

May 21, 2015 Bloomberg Brief Bitcoin 17

VOICES

BitGo's Belshe Says Security Platform Has Twofold Litmus Test for Transactions

, co-founder and CEO of , aMike Belshe BitGo

venture-backed security-as-a-service platform that

powers enterprise-level secure bitcoin wallets,

says a core principle at the company is that it

doesn't hold enough private keys to make a

transaction, so that if the company disappears, the

customers still have their money. Belshe spoke

with Bloomberg Brief contributor Steven Lord. His

remarks have been edited and condensed.  

Q: How did you first get the idea forbitcoin storage?A: I began looking into bitcoin two and ahalf years ago, and I started out skeptical.But the more I researched, the more Ibegan realizing this was real, so I beganbuying bitcoin, convinced my friends tobuy bitcoin, etc. Pretty soon, we allrealized that we didn’t have a decentlysecure way to store it.

I was involved in Google Chrome earlyon, and security is a big deal at Google,so it was very much on my daily radar. Iwas afraid of having all this money on mylaptop, so my research led to the idea thatmulti-signature authentication could solvesome of our concerns.

Q: Security is often described as thebitcoin Achilles' heel. Is this true?

It's important to point out that whenA: bitcoin first started, it was worth zero.How much security should be applied tosomething that isn’t worth anything?Failures on the security side camebecause the early core developers simplydidn’t worry about it. Then, suddenly,bitcoin was worth something, but thesecurity was lacking because no one hadthought it would matter. Secondly, thecore technology absolutely works. All thehacks and losses you’ve heard abouthave involved human error andnegligence, not the technology itself. Itturns out that humans are just not verygood at keeping secrets. We routinelyforget passwords, lose thumb drives,

 

share credentials, etc. We need a lot ofprocess and backup to handle secretinformation, and even then, we screw itup.

Bitcoin is so compelling because itessentially empowers people to be theirown bank. But that’s both good and bad,since we’re so terrible at security, and noone is there to blame or absorb thelosses. That’s why security has to be asgood as possible.

Q: How does BitGo approach thisissue?

We started with a simple question:A:What if we could secure digital currencyagainst theft? So we started applying thebest security principles already in place tobitcoin, with the goal of eliminating anysingle point of failure. We reasoned that ifwe were able to accomplish that, we’dend up with something better than cash.We started with multidevice technologythat required two machines to access theblockchain, and then moved to multi-userand multi-signature. Our goal is to ensureno single entity has access to enoughkeys to sign a transaction. It getscomplicated, with multiple levels ofwallets with multiple keys, but each levelmakes it exponentially harder for the badguys.

Our main product is our platform API,which is about securing online, real-timetransactions. The best method used to becold storage, but that is unwieldy. Wewanted to make bitcoin secure andusable, so we started with our own web

 

wallet, with cutting edge security, plusmulti-signature technology, plus policyoptions. A lot of breaches in the bitcoinspace to date have involved companiesholding assets on behalf of customers, sothe API is also great for exchanges,remittance providers, payment processors— anyone holding funds on a customer’sbehalf.

Q: Can you give an example? Earlier this year, a major bitcoinA:

exchange suffered a breach and reachedout to us for help. It turned out that allthey needed to do on their end waschange one line of source code to get afully secured, multi-signature, hot walletonto their platform.

Q: Is Wall Street already utilizingmulti-signature technology?A: Yes. We have a number of customersdoing segregated accounts on theblockchain. Instead of having to go to abitcoin exchange and trade there, theycan create a multi-signature wallet,develop policies, give one key to theexchange, one to BitGo, and keep one forthemselves. No single party has all theinformation necessary to transact at alltimes. To compromise it, you’d have tohack at least two of the three. A coreprinciple is that we do not hold enoughprivate keys to make a transaction. If wedisappear, you still have your money. Wehave a twofold litmus test — we can’ttransact without you, and you cantransact without us.

Education: BS, Computer Science, California Polytechnic Software engineer, Google; Development manager,Career:

Microsoft; Co-founder, Lookout Software. At Google, was one of thefirst 10 members of Google Chrome, and invented SPDY, nowknown as HTTP/2.0.Industry expertise: Coding, networking, security protocols

 

INSIGHT: SWAPS & TRADING BY STEVEN LORD

Source: Twitter

May 21, 2015 Bloomberg Brief Bitcoin 18

INSIGHT: SWAPS & TRADING BY STEVEN LORD

XBT/USD Swap Rates Show Bitcoin Volatility; Trade Volume Heavily Concentrated 

Swaps allow traders to gain exposure to bitcoin without havingto actually own it, but the nascent market remains relativelyilliquid and expensive.

Rates for USD/XBT swaps on Bitfinex have been very volatile,ranging from more than 100 percent twice in the past 18 monthsto under 10 percent during the first quarter. Although a generaltrend lower is visible and notional values are heading up again,the market remains very small and the cost of such contractsextremely high.   

  

XBT/USD swap rates have also been volatile since the start oflast year, but bitcoin’s price swoon since the end of 2014 hasresulted in a fairly steady downward push in rates.

Notional outstanding, meanwhile, has remained in the15,000-20,000 XBT range, suggesting traders are staying shortthe digital currency at fairly consistent levels.

The difference in rates between XBT/USD swaps and itscounterpart USD/XBT partly illustrates the cost and difficultiesassociated with effectively borrowing bitcoin in order to short it.

  

USD bitcoin trade volume for the year to date through mid-Mayis heavily concentrated among a few exchanges.

Most are located outside the U.S., with the top three — HongKong-based BitFinex, China-based OKCoin and U.K.-basedBitstamp — responsible for more than 72 percent of volume.

U.S.-based Coinbase, meanwhile, launched an exchange inJanuary 2015 and has rapidly grown to account for more than 7percent of USD trading volume in bitcoin.

USD/XBT Swaps Trend Lower, Notionals Up

Traders Remain Short Bitcoin Amid Volatility

Volume Concentrated at Few Exchanges

May 21, 2015 Bloomberg Brief Bitcoin 19

 

May 21, 2015 Bloomberg Brief Bitcoin 20

 

DERIVATIVES  

May 21, 2015 Bloomberg Brief Bitcoin 21

DERIVATIVES  Bitcoin Derivatives Begin to Emerge, But Liquidity Remains ThinBY STEVEN LORD

Bitcoin earned the title of bestperforming currency in 2013 and worstperforming just one year later. With thatkind of volatility, a growing number ofopportunistic market participants fromSilicon Valley to Wall Street are racing tobring institutional-scale derivatives tobitcoin trading.

“Traders have a natural affinity forsomething that is imperfectly priced,unregulated, thinly traded, and volatile,”said Dan Gallancy, CEO of SolidXPartners, one such financial servicescompany pushing into the nascentindustry. “But until leveraged instrumentsexist to offload some of the risk, they’rereluctant to get seriously involved.”

To date, the development has beenfocused in two areas. First, somecompanies have started to develop swapand non-deliverable forward contracts, orNDFs, similar to those already heavilytraded by institutional investors. They

generally settle in cash and createsynthetic exposure to bitcoin without theneed for an investor to own the digitalcurrency directly. Some players in thisarea include SolidX, Hedgy and Tera Exchange, among others.

The second area of developmentinvolves options. LedgerX, for example,filed for U.S. Commodity Futures TradingCommission approval in December asboth a swap-execution facility and aderivatives clearing exchange with thegoal of becoming bitcoin’s first fullyregulated options exchange. If approved,it will offer 100 percent collateralized,physically settled options in an order-bookformat.

“An order book mechanism is familiar totraders,” LedgerX CEO Paul Chou said inan interview. “We’ve spoken to a lot ofpeople — miners, processors, investors— and the need is there.”

Interest in bitcoin derivatives is notlimited to the U.S. In London, former

Goldman Sachs Group Inc. and BNPParibas SA executives have set upCrypto Facilities, which offers futurescontracts on bitcoin, whileSingapore-registered Coinarch's offeringsinclude a custom out-of-the-money putoption that functions as a type of reverseconvertible.

As more companies look to get involvedin bitcoin derivatives, some worry whetherthe underlying bitcoin market is robustenough yet to support them. For instance,limited price discovery and concentratedbitcoin positions could result in a swapsmarket that is still very volatile andextremely expensive.

“Contracts will come, but we haveenough liquidity challenges in spottrading,” Mike Moro, chief operatingofficer at Genesis Trading, said.“Everyone wants these advanced tradingtools, like we’re used to in other assetclasses. But it took years for them todevelop in other markets. It’s not going tohappen right away.”

    

EXCHANGE-TRADED NOTES

May 21, 2015 Bloomberg Brief Bitcoin 22

 

EXCHANGE-TRADED NOTES

Swedish Firm Lists First Exchange-Traded Note Tracking BitcoinBY YAKOB PETERSEIL

A Swedish firm says it has become theworld’s first to offer an exchange-tradednote (ETN) tied to bitcoin.

XBT Provider AB listed 200 millionSwedish krona ($24 million) of BitcoinTracker One securities on the NasdaqOMX exchange in Stockholm on May 18.The ETNs track the price in U.S. dollarsof a unit of bitcoin.

While bitcoin attracted a wave ofnegative publicity due to thefts and thebankruptcy of Mt. Gox, a leadingexchange, major financial companies arebacking the virtual currency. In April,Goldman Sachs Group Inc. participated ina $50 million fundraising round in bitcoinstart-up .,Circle Internet Financial Ltdand the New York Stock Exchange hasinvested in a trading platform for thecurrency.

XBT is seeing demand from “privateinvestors and institutions that are curiousabout bitcoin, but still think it’scomplicated to invest with bitcoinexchanges,” , theJohan Wattenstrom

company’s head of trading, said in aninterview prior to the listing. XBT willcharge a 2.5 percent annual fee for thesecurities, he said, and sells them indenominations of 10 krona, which is lessthan the price of a liter of Pepsi in theNordic capital.

The notes track the average price of aunit of bitcoin in U.S. dollars using datafrom three exchanges, then converts itinto Swedish krona. Wattenstrom said thefirm must completely hedge its bitcoinexposure by buying units of the currencyand is “not allowed to have market risk,”though repayment on the ETNs dependson the creditworthiness of XBT, as with allsuch products.

XBT is part of , which KnCGroup ABWattenstrom called one of the largestbitcoin miners in the world.

One challenge of holding bitcoins iskeeping the currency safe from hackers.The firm can keep “a small part” of itsholdings on bitcoin exchanges, accordingto Wattenstrom, but at least 90 percentwill be in a secure location accessible

only by using private keys held by certainshareholders and company executives inseparate bank vaults.

Issuing bitcoin-tracking products as anETN is cheaper and quicker than doing soas an exchange-traded fund (ETF),Wattenstrom said. and Tyler Cameron

, who claimed MarkWinklevossZuckerberg stole their idea for asocial-networking website to startFacebook Inc., have proposed a bitcoinETF that has been under review by theU.S. Securities and ExchangeCommission since 2013.

The lack of a regulated market forbitcoin is behind volatility in its price, theWinklevoss twins said at a conference inJanuary.

Samuel Lee, an ETF analyst at in Chicago, said theMorningstar Inc.

new ETN could be useful not only foravoiding the hassles of storing bitcoins,but also as a way of shorting the virtualcurrency.

LEVERAGE  COMMENTARY BY STEVEN LORD

May 21, 2015 Bloomberg Brief Bitcoin 23

 

LEVERAGE  COMMENTARY BY STEVEN LORD

Drop in Correlation Between Price and Leverage Raises Margin Call ConcernData from the largest

dollar-denominated bitcoin exchangesuggest the traditional relationshipbetween bitcoin’s price and the amount ofleverage outstanding has shifted, at leasttemporarily.

The bitcoin spot rate against the U.S.dollar and the total long leverageoutstanding were highly correlatedthroughout most of the first quarter. Therelationship is so tight that recentmovements in bitcoin are thought to bedriven largely by changes in leverage,which in turn feeds through to the totalnotional value of bitcoin being bought,and, thus, liquidity. Some 70 percent oftotal USD bitcoin trading that takes placeon-exchange does so via serviceproviders that offer leverage to theirclients.

Accordingly, sharp rises in bitcoin’sprice have often been accompanied bycorresponding increases in leverage, andvice versa — with decreases in priceoccasionally heightened by margin calls.Over the last few weeks of the year’s firstquarter, though, this relationship brokedown. The two measures diverged, withthe USD spot price of bitcoin fallingsharply, while total long leverageoutstanding remained uncharacteristicallyelevated. According to TradeBlock, totallong leverage at Bitfinex climbed by

nearly 20 percent since mid March,despite a dropping bitcoin price.

If past is prologue, the relationship mayrevert to its previous state in due course.In the meantime, the potential for

significant automatic margin calls — andthus increased selling — on leveragedbitcoin positions will continue to increaseshould the price of bitcoin fall more andleverage remain high.

VOICES

XBT Price Continues to Decline as Leveraged Longs Increase

Source: TradeBlock

Since the start of last year, bitcoin price movements have been generally in line with swings inthe amount of gross long XBT leverage in the system as measured by USD swaps. Thissuggests that the leveraged buying (or the lack thereof) has been partly responsible for bitcoin’sinfamous volatility, helping push the price up but also generating automatic margin calls onunderwater positions. However, since mid-March 2015, this normally correlated relationship hasdiverged, with the price of XBT dropping despite a steady increase in leveraged longs. 

May 21, 2015 Bloomberg Brief Bitcoin 24

VOICES

Coin Center's Brito Says Utility Will Be the Best Barometer of Bitcoin Success

, executive director of ,Jerry Brito Coin Center

says the U.S. has done "remarkably well" at

finding a balance between preserving freedom of

action to develop bitcoin technology while also

upholding laws on theft, fraud and money

laundering, though it potentially lags on

regulations surrounding money transmission. Coin

Center, which includes Marc Andreessen of

Netscape and Andreessen Horowitz and Union

Square Ventures' Fred Wilson among its advisory

board members, is a non-profit research and

advocacy center focused on the public policy

issues facing cryptocurrency technologies. Brito

spoke with Bloomberg Brief contributor Steven

Lord. His remarks were edited and condensed.  

Q: What's your goal with Coin Center?A: Three things: education, policyresearch and advocacy. Education is themost basic function, but also the mostimportant. It involves briefings, creation ofresource materials, etc. At least on aweekly basis, we have someCongressional committee staff member oragency officer asking us to explainbitcoin. Our goal is to make sure thetechnology is understood, so that ifregulatory frameworks are necessary,policy makers can create rulesappropriate to the problem they’re tryingto address. That was the problem with thefirst draft of the Bitlicense —  thetechnology was just not well understood.

Policy research entails exploring novelquestions as they emerge. For instance,who has custody of bitcoins in a walletwith multi-signature technology? It’s afascinating question. So we do the legalresearch, write position papers andcomment in proceedings to help answerthese kinds of cutting-edge questions. Finally, although we accomplish a lot ofadvocacy through the first two activities,we are registered lobbyists, so we cansuggest a lawmaker vote this way or that.We’re not a trade association, so we can’tadvocate for a particular company ortechnology, but we are there to help makesure, to the extent possible, no regulationinfringes on the right to innovate.

Q: How do you see regulationdeveloping?

 

A: People serious about digitalcurrencies, even the core developers,have always known that their use incertain ways would be regulated. To us,the more interesting question is notwhether there should be regulation, butwhether we can get it right. Can wepreserve freedom of action to develop thistechnology while also upholding laws inplace against theft, fraud, moneylaundering and so on?

Q: Where does the U.S. stand when itcomes to finding that balance?

Remarkably well, in spite ofA:everything. We’re way ahead on tacklingsome of the thornier issues. The earlyrules are not perfect, but so far they’repretty reasonable. The failure of Mt. Goxprecipitated much of what we now seebecause it highlighted the need to dealwith bad actors and comply with rulesalready on the books.

Where the U.S. potentially lags is inmoney transmission regulations becausethey are handled at the state level. It’s thebiggest drawback to U.S. regulationbecause it is very complex, repetitive andcostly. This industry is overwhelminglydominated by venture and angel-fundedstartups, so getting legal counsel in everystate will be prohibitive. One regulator,one license is better; eventually, federalpre-emption will be the way to go.

Q: What do you make of the corruptionin the Silk Road case?

On the one hand, it shows how federalA:authorities were able to piece togetherbitcoin transactions to get to an identity.On the other hand, Silk Road shows that

digital currencies pose a new, but notinsurmountable, challenge for lawenforcement. It’s not any different thanother new innovations — criminals willuse a new technology first, and then thegood guys have to catch up. Thegovernment didn't ban the car becausebank robbers used them first; we taughtcops how to drive and gave them carswith bigger engines.

Q: What's next for you? We conduct a monthly survey aimed atA:

discovering consumer attitudes, which willdrive policymaker attitudes. Right now,we’re doing it on a monthly basis, but thenumbers are not changing much. Afterone year of data, we will see whether togo quarterly.

The vast majority of individuals stillhaven't heard about bitcoin. Thecomparisons to Transmission ControlProtocol/Internet Protocol (TCP/IP) arevalid; most people who use the Internetevery day have no idea what TCP/IP is orhow it works. We can easily envision aworld where bitcoin is extremelysuccessful, but most of those that interactwith it can’t tell you what it does.

Q: What will be the best barometer ofsuccess?A: Utility. The chance exists to turn old,sturdy, expensive, slow business modelsinto rapid, cheap and nimble ones, andallow for things that were not possiblebefore, like micropayments, the internet ofthings, etc. For us, how well thistechnology is utilized will be the best wayto tell if it succeeded.

Education: BA, Florida International University; JD, George Mason Adjunct Professor of Law, George Mason; Director,Career:

Technology Policy Program, Mercatus Center; Director ofOperations, America's Future Foundation's Manager of MediaRelations, Cato Institute.Other activities: Wrote a pamphlet called "Bitcoin: A Primer forPolicymakers," released in 2013; Host of "Surprisingly Free," a

weekly half-hour podcast.Why bitcoin? "I came across bitcoin in 2011 and was immediately taken by itselegance. However, I also realized there were going to be a lot of regulatory issues. So Idid some research and realized that at least among policymakers, little was known."

INSIGHT: BANKRUPTCIES

May 21, 2015 Bloomberg Brief Bitcoin 25

INSIGHT: BANKRUPTCIES

Mt. Gox, Cointerra Top the List of Bitcoin Bankruptcy Filers by Liabilities  U.S. and non-U.S. businesses within

the bitcoin world have sought bankruptcyprotection in the U.S. court systemthrough three different bankruptcy types:Chapter 7, Chapter 11 and Chapter 15petitions.

The largest was the March 2014Chapter 15 filing of , whereMt. Goxcreditors were owed as much as $100million. According to court documents, theTokyo-based bitcoin exchange haltedwithdrawals by customers on Feb. 7,2014 after the company became subjectto a massive theft or disappearance ofbitcoins being held on behalf of its

customers and itself. More recently, Mt.Gox affiliate . — alsoTibanne Co. Ltdknown as Taro Awataguchi in flings —filed a Chapter 15 petition in New York'ssouthern district in order to protect U.S.assets from creditors.

To date, there have been two Chapter 7cases — Cointerra Inc. and HashFast Technologies — which call for aliquidation of the debtor's assets.Cointerra, a bitcoin mining company thatgave no reason for its filing, had thesecond-largest petition with assets anddebt of $10 million to $50 million each. InJune 2014, mining startup HashFast was

converted to a Chapter 11, joining CLI and the industry's most recentHoldings

filer, the .World Bitcoin AssociationBoth listed assets of $0 to $500,000,according to the filings. World BitcoinAssociation said in an affidavit that itspetition for court protection wasprecipitated by a dispute with its landlord,while CLI Holdings, another bitcoin miner,said in court documents that it could notgenerate a positive cash flow from itsmining operations.

      — Aleksandrs Rozens, Bloomberg

Brief Editor

 

A Look at the Largest Bitcoin-Related Filings So Far

DEBTOR DATE OF FILING COURT JUDGEDEBTOR HOME

STATE/COUNTRYASSETS  LIABILITIES

BANKRUPTCYFILING TYPE

DEBTORCOUNSEL

Mt. Gox Co. Ltd   3/9/2014   N.D. TexasStacey G.Jernigan  

Tokyo  $10 million -$50 million 

$50 million -$100 million 

Chapter 15  Baker &McKenzie  

Cointerra Inc.   1/24/2015   W.D. Texas H.ChristopherMott  

Austin, Texas  $10 million -$50 million 

$10 million -$50 million  

Chapter 7  Andrews &Kurth LLP  

Taro Awataguchi (TibanneCo. Ltd aka KK Tibanne) 

2/3/2015   S.D. New York  Robert E.Gerber  

Tokyo  $1 million -$10 million

$1 million -$10 million  

Chapter 15Reid Collins &Tsai  

HashFast Technologies 5/9/2014 (involuntaryCh. 7), 6/9/2014(converted to Ch. 11)

N.D. California  DennisMontali  

San Francisco  $1 million -$10 million  

$50,000-$100,000  

Chapter 11(OriginallyChapter 7)

Katten MuchinRosenman LLP

CLI Holdings (DBAAlydian Inc.)  

11/1/2013   W.D. WashingtonKarenOverstreet 

BainbridgeIsland, Washington

$0-$50,000$1 million -$10 million  

Chapter 11  KellerRohrback LLP

World Bitcoin Association 3/16/2015 S.D. New YorkRobert E.Gerber

New York $0-$50,000$100,000-$500,000

Chapter 11Shafferman &Feldman LLP

Source: Bloomberg LP, bankruptcy filings

Commentary: Future Bitcoin Bankruptcies May Not Have U.S. RootsCOMMENTARY BY BILL ROCHELLE

If more bankruptcies hit in the bitcoinsector, it's unlikely to be a boon forunderemployed U.S. bankruptcyprofessionals for several reasons.

First, a bitcoin operator has noparticular need to be located in the U.S.Indeed, there may be good reason forlocating in a lightly regulated, far-awaycountry.

Second, and perhaps more important,bitcoin companies may not have much inthe way of valuable assets.

Some bitcoin miners and repositories

may find themselves insolvent. Some,especially the miners, may simply dry upand blow away, without going through thecourt-supervised bankruptcy process.

Some miners have large sums tied upin massive computers, but a computer fora dead business has a defined marketvalue that won't go far to cover a debt ifit's large. There won't be valuabletrademarks, and competitors have theirown software.

If the miner had truly novel software andthe best supercomputers, it probablywouldn't be bankrupt in the first place.

In the case of bankruptcy by a bitcoinrepository, there won't be much in theway of assets if customers' bitcoins wereheld in trust and properly accounted for.

Bankruptcy would mostly be anexercise in parceling out bitcoins tocustomers, although there could besignificant litigation to decide who getshow much if there is a shortfall.

And if any bitcoin bankruptcies turn outto be Ponzi schemes, they would be themost interesting for the lawyers — butnightmares for everyone else.

 

May 21, 2015 Bloomberg Brief Bitcoin 26

 

COMMENTARY  BY NOAH SMITH, BLOOMBERG VIEW

May 21, 2015 Bloomberg Brief Bitcoin 27

COMMENTARY  BY NOAH SMITH, BLOOMBERG VIEW

Bitcoin Must Die as Investment to Become a Currency

Bitcoins become more useful as a currency the

more their price drops, according to , Noah Smith

an assistant professor of finance at Stony Brook

University and a freelance writer for a number of

business publications, including Bloomberg View.

He maintains a personal blog, called .Noahpinion

“Bitcoin is collapsing,” BoingBoingrecently tweeted. “Will Bitcoin everrebound?” wonders CNN. “Bitcoin isheaded to the ash heap,” USA Todayproclaims.

But what all this weeping, wailing, andgnashing of teeth fails to grasp is thatbitcoin isn't supposed to be aninvestment-grade financial asset. It’ssupposed to be a medium of exchange.Surprisingly few people understand thedifference.

The Washington Post’s Matt O’Brien isone of the few who does:

"If Bitcoin were a currency, it'd be theworst-performing one in the world, worseeven than the Russian ruble…But Bitcoinisn't a currency. It's a Ponzi scheme forredistributing wealth from one libertarianto another. At least, that’s all it is rightnow."

O’Brien is correct. The reason forbitcoin’s wild price volatility is that manypeople — not just O’Brien’s “libertarians,”but many others — fail to understand thedifference between money and riskylong-term assets.

Long-term assets are things like stock.As the human race invents more ways tocreate value, and as corporations findmore ways to capture that value in theform of profit, the price of stock goes up.By buying stock and holding it, you get toshare in that value. In return, you lowerthe cost of capital for the companies — ineffect, you lend them money, and whenthe stock price goes up (or the stock paysdividends), you get paid back.

But stock isn't money. If you don’tbelieve me, go to the store and try to usea share of General Electric to buy a loafof bread. Eventually, security will gently

escort you from the premises.Money is a medium of exchange. It’s

what you use to buy stuff. There can bemultiple kinds of money that existalongside each other — for example, insome countries, you can pay for things inthe local currency or in U.S. dollars.

But what money doesn’t usually do isincrease in value over time. Sometimes itdoes, a little bit — for example, in the longdeflation of the 1800s. Usually, though,money slowly decreases in value,because of inflation. The central banktries to keep these decreases slow andsteady, so money isn’t risky.

"The sooner peoplegive up the hope that

bitcoin will skyrocket inprice, the sooner theywill be willing to spend

bitcoins in everydaylife, the way they now

spend dollars."

So if money loses value slowly, why dopeople keep any money in their checkingaccounts? Because they need it to buystuff. If you want assets that will tend togo up over time, you buy stocks, bonds orreal estate.

At least, if you’re sensible, that’s whatyou do. If you’re a gambler, you mightconsider something along these lines:

“At some point, people are going toswitch to using a different kind of money. Ibet I can predict that switch, and get inahead of the game. I’ll buy up a bunch ofthe future money, and when peopleswitch to using that, I’ll be sitting on awhole pile of cash!”

That’s the implicit thought process ofthe people who buy bitcoins as aspeculative investment. It’s also theimplicit thought process of gold bugs.“Gold is money,” gold bug websitesstubbornly repeat. But it isn’t. You can’tbuy stuff with gold. David Andolfatto, vicepresident of the Federal Reserve Bank ofSt. Louis, explains this very well. Bitcoinis a bit more currency-like, but mostthings still can’t be bought with bitcoins.

What gold bugs hope — almostcertainly in vain — is that people willswitch to using gold as money in thefuture. What bitcoin speculators hope —possibly correctly, possibly incorrectly —is that people will switch to using bitcoinsas money in the future. They’re notfunding any sort of productive activity,they’re just making risky speculative betsabout future currency regimes.

But speculative bets on bitcoin don’tactually help it become a true currency.More likely, they hurt it. There’s a rule ineconomics called Gresham’s law, whichis that when you have two currencies,people tend to hoard the one with greatermaterial value and spend the one withless material value.

If people think bitcoin has value as aspeculative asset, they will hoard it, andbuy their groceries with greenbacksinstead — after all, they expect bitcoin’sprice to go up, and the price of thegreenback to go down. This makes itmore difficult for bitcoin to establish itselfas a medium of exchange, because noone wants to actually spend them!

So I suspect that the people who haveinvested in bitcoin-related companies andtechnologies are not too upset whenbitcoin prices crash. The sooner peoplegive up the hope that bitcoin willskyrocket in price, the sooner they will bewilling to spend bitcoins in everyday life,the way they now spend dollars. Thequicker bitcoin as an investment dies, thequicker bitcoins as currency can come tolife.

(This was originally published on Jan. 21, 2015.)

 

CENTRAL BANKS  COMMENTARY BY STEVEN LORD

May 21, 2015 Bloomberg Brief Bitcoin 28

CENTRAL BANKS  COMMENTARY BY STEVEN LORD

Central Banks Remain Split on Digital CurrencyThe world’s central banks are still

struggling to understand their role, if any,in the digital currency landscape. Whilethey're viewed as potentially having somejurisdiction in the arena, most centralbanks have been quick to back away.

Federal Reserve Chair Janet Yellen hasnoted that the U.S. central bank doesn’thave much of a role to play when itcomes to regulating bitcoin. “It’s importantto understand that this is a paymentinnovation that’s happening outside thebanking industry,” Yellen said in early2014 following the Mt. Gox bankruptcy.“The Federal Reserve simply does nothave the authorization to regulate bitcoinin any way.”

By definition, bitcoin and other digitalcurrencies exist outside the traditionalmonetary systems of any central bank,which has led to confusion about exactlyhow a central bank should respond to it.The growth and persistence of the bitcoinecosystem has kept it on the radar, andalthough ducking the question ofregulatory authority, most major centralbanks now view the technology with atleast guarded interest. The result hasbeen a hodgepodge of interpretations andreports from various national andsupra-national monetary stewards.

Underlying this discussion is a stridentdebate among regulators and users alikeabout whether bitcoin qualifies as money.A common refrain from central bankssuch as the European Central Bank andthe Bank of England is that digitalcurrencies cannot be legitimately countedas “money” due to comparatively lowlevels of acceptance.

Moreover, the fact that manyparticipants are seemingly holdingbitcoins with an eye toward priceappreciation is not lost on central banks.They correctly point out that somethingused as a medium of exchange is rarelysimultaneously held as an asset forappreciation value. Goods are purchasedwith money, not investments.

Adherents make the case that, at leastin the case of bitcoin, the six commonlyheld characteristics of money are fulfilled.

Bitcoin is scarce, transportable, durable,divisible, uniform and acceptable.

In addition, the Fed defines the mainfunctions of money to be as a store ofvalue, a unit of account and a medium ofexchange. Bitcoin satisfies all three, albeitfrom an admittedly minuscule baserelative to current fiat currencies. “Thereare three basic functions of money,” saidWences Cesares, co-founder of Xapo.“Saving, paying and pricing. Bitcoin doesall three.”

To date, information from central bankshas primarily consisted of consumerwarnings about the lack of refund rights,volatility and fraud in the digital currency

  “The FederalReserve simply does

not have theauthorization to

regulate bitcoin in anyway.”

— JANET YELLEN

ecosystem. Several have studied whetherdigital currencies represent a threat totheir respective monetary systems, nothow and to what extent they should beregulated.

Perhaps unsurprisingly, many havestudied digital currencies from theperspective of how they would function asnational currency. In this context,concerns have focused on whetherbitcoin’s fixed money supply would lead toprice deflation and the inability tomanipulate the money supply in responseto shifts in demand. Extrapolating out toan unlikely future, some have concludedthat, if widely adopted, digital currencieswould severely impair a central bank’s

ability to influence monetary systems.This year, both the ECB and BOE have

covered digital currencies and thepotential role for central banks in reports.Each explored the advantages that digitalcurrency and blockchain technology mightbring, while highlighting the risks theypose. The ECB released a highlyskeptical on virtual currencies inreportFebruary, noting the "several drawbacksand disadvantages for users, i.e. lack oftransparency, clarity and continuity; highdependency on IT and on networks;anonymity of the actors involved; andhigh volatility." It also acknowledged thatbenefits may exist in terms of lowertransaction costs, borderless flows, rapidsettlement and privacy.

The BOE considered digital currenciesin a section of a One Bank ResearchAgenda in February ondiscussion paperthe bank's response to technological,institutional, societal and environmentalchange. The section noted the promise ofsuch systems' distributed ledgertechnology. “Digital currencies, potentiallycombined with mobile technology, mayreshape the mechanisms for makingsecure payments, allowing transactions tobe made directly between participants,”the BOE’s report said. “This haspotentially profound implications for afinancial system whose paymentsmechanism depends on bank depositsthat need to be created through credit.”

Central bank interest in bitcoin hasn’tgone unnoticed by the private sector.International Business Machines (IBM) isreportedly developing an extension ofbitcoin and blockchain technologies thatcould be applied to traditional fiatcurrencies, creating a distributed, openledger of a specific country’s currencythat would make payments cheap, nearlyinstantaneous and without middlemen.

The effort, while still in the very earlystages, suggests prospective adaptationof a blockchain-esque structure thatconnects central bank control over themonetary system with the potentialadvantages of digital currency.

 

REFERENCE RATES  COMMENTARY BY STEVEN LORD

May 21, 2015 Bloomberg Brief Bitcoin 29

REFERENCE RATES  COMMENTARY BY STEVEN LORD

Creation of a Single Reference Rate Is Complicated by Characteristics, BenchmarksThe growing interest in bitcoin as a

financial asset has spawned a largenumber of competing reference rates forthe digital currency. Unlike mostinstruments traded on Wall Street, thereis no globally accepted spot rate forbitcoin. Instead, a fractured network ofexchanges all over the world has evolved,each with its own inside market. Theresult has been a confusing collection of“best” prices that can vary tremendouslybetween exchanges.

At the same time, interest insophisticated derivatives designed tomanage bitcoin price risk, which dependon reliable and stable reference rates,has expanded. Yet the uniquecharacteristics of digital currency make itdifficult to create a consolidated “tape” ofbitcoin trades on which everyone agrees.Large spreads between differentexchanges, combined with low liquidityand little visibility about off-market, OTCtrades that increasingly dominateinstitutional involvement in bitcoin tradingresult in incomplete and often competingpictures of the true cash price.

Moreover, exchange-specific problems,such as the bankruptcy of Tokyo-basedMt. Gox in February 2014 or Bitstamp’ssecurity breach in January, can causeposted prices to diverge quickly, freeze ordisappear entirely, skewing any index thatrelies on them. Liquidity is still thinenough that a determined effort to pushprices at a particular exchange would notbe prohibitively expensive, particularly ifunderpinning a large derivative contract.

Several data providers have developedindex products that seek to address theseissues. Most utilize a volume-weightedaverage of several exchanges that mustmeet screening characteristics in order tobe included. Media site Coindesklaunched its Bitcoin Price Index inmid-2013, and describes it as a “standardretail price reference” representing anaverage across global exchangesmeeting specific criteria regardinginternational availability, volumeminimums, bid-offer spreads, andbitcoin-to-fiat transaction speeds.

TradeBlock’s XBX Index takes a similarapproach, tracking global bitcoin liquidityfrom a range of carefully screened

  exchanges and constantly monitoringspreads to identify exchange-specificpricing anomalies, which are thendiscounted in real time.

"The result," according to TradeBlock’sGreg Schvey, "is a tamper-resistant,institutional-quality reference rate for theUSD-denominated price of bitcoin, idealfor use with any instrument using bitcoinas an underlying asset." XBX serves asthe reference rate for the BitcoinInvestment Trust, the first publicly tradedbitcoin investment vehicle, as well as avariety of products on other derivativeplatforms that license TradeBlock's index.

Tera Exchange has created the TeraBitIndex, which also employs a robust set ofquantitative measures to generate areliable and precise spot benchmark. LikeXBX, Tera’s index is a weighted averageof prices from a set of qualifiedexchanges, the data from which arecontinually subjected to a proprietary setof filters to weed out anomalous data. Todate, the TeraBit Index is the onlyreference rate to have passed regulatory

muster, satisfying Commodity FuturesTrading Commission scrutiny that it wasnot susceptible to price manipulation andcould thus form the backbone of Tera’sregulated Swaps Execution Facility.

Finally, Pantera Capital’s BitIndexquantitatively measures the growth ofbitcoin’s technological power, adoptionand activity to gauge growth in theecosystem as a whole. The indexspecifically avoids price, which thecompany says is too easily manipulatedor distorted to be useful as an indicator. Ittracks seven measures: developerinterest, merchant adoption, Wikipediaviews, hashrate, Google searches, walletgrowth and transaction volume. Panteraweights these factors on its opinion oftheir importance, with developer interest,user adoption, and merchant adoptionseen as the three most important leadingindicators. When viewed from thisperspective, the steep volatility in priceover the past year has maskedsurprisingly steady growth in bitcoin’s keymeasures.

Bitcoin Spreads Narrowing on Liquidity, Rates, Stability

Bitcoin trading is fractured across a number of global exchanges, each with their own insidemarket, available liquidity and tools like margin, CFDs and high-speed algorithms. Differences, orspreads, exist between the prices offered on various exchanges. At times, these spreads havewidened considerably, although gradually increasing liquidity, the availability of establishedreference rates, and improved exchange stability are slowly bringing them in. 

May 21, 2015 Bloomberg Brief Bitcoin 30

 

VOICES

May 21, 2015 Bloomberg Brief Bitcoin 31

VOICES

DCG's Silbert Says He's Focusing on Bitcoin Startups in Africa, the Middle East, India

, founder and CEO of the Barry Silbert Digital

, says he's been focusing onCurrency Group

startups in places like India, the Middle East and

Africa, where he sees bitcoin taking off. DCG has

backed more than 50 bitcoin startups and created

the Bitcoin Investment Trust, the first publicly

traded bitcoin investment vehicle. Silbert, who

spoke to Bloomberg Brief contributor Steven Lord,

says digital currencies, including bitcoin, will have

as much impact on society as the Internet. His

remarks have been edited and condensed.  

Q: How and when did you first get intobitcoin?A: Around the time of the first pricebubble in mid-2011, when the price wentto $10-$12, and I started getting reallyexcited about it by late spring of 2012.That’s when I started buying. I hadrecently read Charles Hugh Smith’s book"An Unconventional Guide to Investing inTroubled Times," so I was really drawn tobitcoin because it has many of gold’straits but also has practical uses. Ienvisioned a world where you couldactually have a global digital currency.

Honestly, I didn’t understand orappreciate the technological breakthroughat the time. But I’m a former investmentbanker, so I’d missed plenty of wiredeadlines, struggled to send moneyoverseas, etc. It didn’t take me long torealize bitcoin was a game changer.

Q: How do you see the bitcoinecosystem developing?

Fundamentally, you still have to look atA: this as a binary bet. But every day thatgoes by without bitcoin dying, the odds ofthe better outcome increase. Digitalcurrencies will have at least as muchimpact on society as the Internet did.They revolutionize how goods andservices can be purchased, and howbusiness can be transacted, anywhere inthe world.

However, none of the great thingsunder development — payment rails,global remittances, smart contracts, etc.— are going to be feasible if we stay at amonetary base of $3-$4 billion and dailyvolume of $100 million. People will get excited about bitcoin when they

 

believe its price will rise, which will create a flywheel effect of increased adoption,velocity, trading etc. Bitcoin can live up to

its promise, but it will only be possible ifthe price and liquidity are a lot higher thanthey are today.

Q: Bitcoin Investment Trust recentlybecame the first publicly traded bitcoinfund (GBTC). How was that process?A: We formed the Bitcoin InvestmentTrust (BIT) in 2013 as a private Delawaregrantor trust only available to accreditedinvestors. The process to move to thepublic market was unique; it tookadvantage of a rule that allows existingholders of a trust to sell into a secondarymarket after holding their specific sharesfor one year, as long as certain disclosureand trading requirements are met. Thealternative was to pursue a full listing withthe U.S. Securities and ExchangeCommission, which as evidenced by theWinklevoss effort, is a bit of a black hole.

We’ve teamed up with OTC Markets,quoting GBTC shares on their top-tiermarketplace, OTCQX, and MerrimanCapital as the initial market maker anddesignated adviser for disclosure. Toprovide liquidity to existing BIT investors,shareholders may elect to sell into thepublic market, free of restriction, andthose shares are eligible to be purchasedby any individual or entity. The result is a way for investors to gain exposure to the

price movement of bitcoin in their regular securities accounts, even their IRAs,

without the challenges of buying, storing and safekeeping. At the same time, we

have an ongoing private placement happening. It creates new BIT shares at

net asset value (NAV), but with theattendant lockup restrictions. We think the

public shares will trade at a premium to the trust’s NAV, which creates a natural

arbitrage.

Q: Does GBTC give the appearance ofliquidity to a pretty illiquid asset?

This does put a relatively liquid overlayA:onto a relatively illiquid asset, but we thinkGBTC is unlikely to be more liquid thanbitcoin itself, given the size of the market.Our model for GBTC was the SPDR GoldTrust (GLD). When GLD launched in 2004, it made investing into gold by themasses possible. That's what we're tryingto do here. Before you ask, the trust’sfinancials are audited annually by Ernst &Young LLP, to allay concerns about ourholdings.

Q: What's next for GBTC and DCG?A: Our near-term focus is on creating theaftermarket, signing up new authorizedparticipants, working with RIAs,wirehouses, etc. so they know they canuse GBTC as an instrument to gainexposure to bitcoin. We fully intend touplist GBTC when possible, andeventually we want to get options tradingon it. It will take time, though — we ownabout 1 percent of the outstanding bitcoin,so it’s not a very deep market yet.

DCG is making investments in thebitcoin ecosystem. I’ve been focusing alot lately on startups in countries where Ithink bitcoin will really take off, like inIndia, Africa, and the Middle East. I’minterested in the companies building theearly infrastructure that will make bitcoinadoption possible in these places.

Education: BBA, Emory University Founder & CEO, Digital Currency Group; Founder,Career:

SecondMarket Inc.; Founder Bitcoin Investment Trust. DCG is acombination of the Bitcoin Opportunity Corp., which holds our earlystage investment portfolio, with two businesses that were formerlyunder SecondMarket — Grayscale, which develops products, suchas the Bitcoin Investment Trust, that facilitate access to digitalcurrency investing, and Genesis Trading, which conducts digitalcurrency trading and brokerage business.Industry expertise: Digital currencies, illiquid securities, ventureinvestingSource: Bloomberg/

Andrew Harrer

May 21, 2015 Bloomberg Brief Bitcoin 32

 

VOICES

May 21, 2015 Bloomberg Brief Bitcoin 33

VOICES

Coins.ph CEO Says Bitcoin Is to Remittances What Skype Was to Overseas Calls

, co-founder and CEO ofRon Hose

Philippines-headquartered , a remittanceCoins.ph

company, says bitcoin can lower the cost and time

it takes to finalize remittance transfers and

payments in emerging markets along the lines of

how Skype lowered the cost of calling overseas.

Hose spoke with Bloomberg Brief contributor

Steven Lord. His remarks have been edited and

condensed.  

Q: Why does bitcoin appeal toemerging markets?A: The first thing you notice when youcome to a developing market is thateverything is done in cash. Money issaved in a mattress, if at all, so what littlefinancial infrastructure there exists tendsto be very costly, slow and inefficient. It’stoo expensive to establish large, efficientbanking networks because there is nosavings and the amounts are so small.Bitcoin is seen as a payment novelty indeveloped countries, but here, theadvantages it has over traditionalmethods could solve large, daily problemsfor millions of people.

Q: Is addressing the unbanked asmuch of a focal point as the remittancemarket?

They’re intertwined. It’s hard toA: exaggerate just how unbanked places likethe Philippines are. More Filipinos haveFacebook than bank accounts. Only 3percent have credit cards. That meansonly three people out of a hundredlanding on an e-commerce website havean immediate way to pay for what theybuy. Everything is done cash on delivery(COD). It’s the same story in the rest ofAsia — more than half the Asianpopulation is unbanked, and only 5percent have credit cards. Yet thesepeople are consuming services all thetime, and their relatives are sending cashhome from all over the place. Theaverage Filipino remittance is $250 andcosts 8 percent, or $20, a pretty highnumber considering the average monthlysalary here is only $280. Imagine paying8 percent of your monthly salary just tohave access to your money.

 

Q: Where does bitcoin come into play regarding remittances?

Bitcoin is the digital currencyA:equivalent of WhatsApp for cash. It’saccessible from anywhere, it’s borderless,has low friction and few middlemen.Costs are low and utility is high. It cantheoretically be used going from anycurrency to any currency, anywhere,quickly and securely. A person in thePhilippines might wait all day in line atWestern Union to get that $250 fromoverseas. Using digital currency, it takesminutes. The difference is like night andday.

Q: What's your goal in this market? We’ve built an extensive network forA:

transacting in a cash-in/cash-out fashion.The customer puts cash into a partnerATM or convenience store, we exchangeit into bitcoin, and deliver cash, in theform of cardless ATM withdrawals, mobilemoney, bill pay, etc., on the other end.Once money is in the system, it can bemaneuvered freely. We use bitcoin as avehicle and the blockchain as amechanism. Our customers are notexposed to bitcoin itself. They don’t carevery much about the underlyingtechnology — all they see is that atransaction that used to take hours ordays and cost a fortune now takes anaverage of five seconds and is cheap. Forpeople in developing countries, it’s agame changer.  Our mission is to improve financialinclusion in emerging markets, and ourcompany is built around the goal ofimproving lives through bitcointechnology. All of the products wedevelop stem from this same main goal.

Think of how Skype lowered the cost ofcalling overseas a decade ago — bitcoincan have the same effect on theremittance market.  

Q: What's next? We’ve recently plugged into theA:

existing global ecosystem via apartnership with Coinbase. We’veintegrated their API so that Coinbasecustomers in 24 countries can use ourcash-to-cash remittance service to sendmoney to the Philippines. In themeantime, we’re expanding ATM andsimilar networks in popular remittanceorigins like Hong Kong to build out thenetwork of input locations, and areworking on adding to our network of 450ATMs and more than 5,000 cash pickuplocations here in the Philippines. We’vealso inked an exciting partnership withBitwage in which Filipinos working for U.S. firms, for instance in BPO, can bepaid in U.S. funds into a U.S. bankaccount, but through the blockchain andour two services, collect the money herein either Philippine pesos, preloaded cashcards, mobile wallets, or bank deposits.And it all happens quickly, cheaply andsecurely.

Q: Are there any other countries thatyou're eyeing for expansion?A: We’re already growing at a healthydouble-digit clip, and have to bring whatwe’re doing to other Asian countries thatshare similar characteristics as thePhilippines — Indonesia and Vietnam, forinstance. Right now, we’re about 20employees, with half developers and anoperations group in Thailand.

Education: Master's Degree in Computer Science, CornellUniversity

Founding Partner, Innovation Endeavors; Co-founderCareer:TokBox, acquired in 2012 by TelefonicaIndustry expertise: Information technology, digital currency, venturecapital

EVENTS CALENDAR COMPILED BY STEVEN LORD

May 21, 2015 Bloomberg Brief Bitcoin 34

DATE EVENT LOCATION

June 9-10 PayExpo 2015 London, U.K.

June 10-11 iBitcoin Expo Shanghai, China

June 11 BLOCKCHA1N: The Blockchain Forum Paris, France

June 12 Controlling Crypto-Currencies Birmingham, U.K.

June 15-16 Money Conference Belfast, U.K.

June 22-23 CE Week/CoinAgenda New York, NY

July 8 Wired Money London, U.K.

July 10-11 Inside Bitcoins Chicago Chicago, IL

June 24-25 Internet Finance Innovation CEO & Bitcoin Summit Shanghai, China

July 28 American Banker's Digital Currencies + the Blockchain New York, NY

Aug. 13 Coin Congress San Francisco San Francisco, CA

Aug. 31- Sept. 2 Mobile Payment Conference Chicago, IL

Sept. 1 Inside Bitcoins London London, UK

Sept. 9-11 ATM & Mobile Innovation Summit Washington, D.C.

Sept. 10 Consensus 2015 New York, NY

Oct. 25-28 Money 20/20 Las Vegas, NV

Oct. 28-30 CoinAgenda/BitAngels Global Conference Las Vegas, NV

Nov.  3-5   Mobile Money & Digital Payments     Istanbul, Turkey  

Nov. 9 MTBIT: Bitcoin & Remittances Miami, FL

Nov. 16-18 Inside Bitcoins San Diego San Diego, CA

Dec. 10-11 Inside Bitcoins Seoul Seoul, South Korea

Jan. 19-21, 2016 Mobile Money & Digital Payments (Asia) Jakarta, Indonesia

April 4-7, 2016 Money 20/20 Europe Copenhagen, Denmark

April 5-10, 2016 Coinfest 2016 Global

April 10-12, 2016 Inside Bitcoins New York New York, NY

 

EVENTS CALENDAR COMPILED BY STEVEN LORD

Bloomberg Brief: BitcoinBloomberg Brief

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May 21, 2015 Bloomberg Brief Bitcoin 35