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Innovations in Trading and Technology

26 December 2014

2014 TOP STORIES: Bitcoin: 4 Steps Before Wall Street Buys In

The internet-based protocol behind Bitcoin has the power to disrupt and transform the fintech industry, and the crypto-currency's recent endorsements from well-respected investors provide a critical first step toward legitimacy.

This article originally was published on Jan. 7, 2014.

Let me begin with a confession: I’ve been a Bitcoin hater for the better part of two years. I was turned off by the questionable profiles of its early advocates. To say that Bitcoin began at the fringe would be an understatement—with its anarchist, tax-evading backers and a notorious rise through Silk Road, the currency seemed more like a criminal plaything than a potentially legitimate alternative to the Euro or US Dollar.

From those rocky beginnings, however, Bitcoin acceptance came a long way in 2013. The media thoroughly covered its meteoric rise in market value as a currency, but the bigger story is that high-profile investors have placed significant bets on Bitcoin-related businesses this year, including Li-Ka Shing, Union Square Ventures, and Andreessen-Horowitz. Given their involvement, Bitcoin demands a serious look.

[Related: “2013 TOP STORIES: Debunking 11 Bitcoin Myths”]

The more I learn about BTC, the more I’m convinced that these investors are making a smart move. I’ve overcome my repugnance to Bitcoin as an anonymous chit to avoid declaring income or enabling the drug trades. Now I clearly see how the Bitcoin protocol – combining a public, distributed ledger utilizing advances in open-source software, cryptography, P2P processing and digital signatures – is capable of straightening out our current labyrinth of inconsistent regulation, inefficient payment processing and legacy back-office practices. Think of it like Linux – an open source backbone for financial services; or even better, the API for programmable cash transactions. (Fred Wilson gives an overall perspective of its importance at 18:00 in this talk, as does Naval Ravikant here.)

The internet-based protocol behind Bitcoin is a gift to a fintech industry in dire need of disruption, and its recent endorsements from well-respected investors provide a critical first step toward legitimacy. Will BTC emerge the single winner in the digital currency market? I’m not sold yet. I can see a scenario in which there are many versions of these currencies, just as there are multiple versions of Android software out there, all linked by a common open-sourced parent.

Regardless, the process improvements that Bitcoin has set in motion seem here to stay, and many will benefit. The beneficiaries may start with the unbanked in Africa, then drift upward into global mobile wallets and lower fees for merchants, but the disruption I’m rooting for (and which the readers of TabbFORUM probably care most about) is at the institutional investing level. Bitcoin has the opportunity to disrupt the entire food chain: settlement and clearinghouses (yes, DTCC, CLS, ICE, LCH, Euroclear – we’re talking about you), exchanges (not just for public securities, but also private ones served by Second Market, et al.), FX trading … This list goes on. It’s not about the currency – it’s about the software as an agent for disintermediation.

So let’s get to it: What are the key steps Bitcoin needs to take before eating away at the top of the pyramid? We see four that stand out:

1. Clear Regulation: The early opinions seem positive among some jurisdictions (see Ben Bernanke’s letter to Congress and the November Senate hearing), but negative where currency is currently most controlled (China, India, etc.). As Mark Smith (CEO of AtlasATS, and former COO at LavaFX) pointed out in this interview, similar fears of foggy legal standing and jurisdiction questions originally put a damper on the early days of retail electronic FX trading. As we now know, a thriving market quickly emerged in spite of original jitters. The bottom line: Early signs from regulators are more promising than I initially expected, but we still have a long way to go. CFTC: Bitcoin most likely falls in your lap, whether as a commodity, currency, or derivative. Take a stand!

2a. Grownups Running the Show (on the Inside): Bitcoin needs more direct participation from people in the financial world who know what they’re doing. The largest Bitcoin exchange, Mt Gox, was shut down for weeks for improper registration, freezing people’s assets. This kind of risk is a threat to growth and needs to be curbed by more credible service. Want anecdotal evidence that Mt Gox isn’t ready for primetime? As I learned from Mark Smith, Mt Gox is an acronym for “Magic TheGathering Online eXchange.” Yes ... the exchange was originally proposed for teenagers trading their fantasy game playing cards. I can't see Prudential Insurance, Vanguard or the Monetary Authority of Singapore trusting their assets with these kids. Those of you running Bitcoin exchanges, dump the rhetoric, go hire some pros from SWIFT, the major credit card companies, central banks, the FSA, etc.

2b. Endorsements from Big Establishments (Externally): As many know, the word credit derives from “Credere,” which is Latin for “to believe.” To get broad buy-in of its legitimacy, Bitcoin needs some sponsorship by big players. Some well-known VCs have jumped in, but we need one or two mammoth banks like JP Morgan or Deutsche Bank to come onboard; not shady entities based out of the Caymans. It’s a safe bet that few, if any, large global players are nimble enough to get in on the ground floor and nurture a venture, but they are smart enough to buy something once volume becomes serious. I’m waiting for the first $200 mm investment by a global top-10 broker-dealer or bank – then it’s gold rush time for the infrastructure play. My fearless prediction: Expect the New York Fintech Innovation Lab(backed by a Who’s Who of the banking establishment) to announce one or more Bitcoin-themed startups in its 2014 class as the big boys aim to take a closer look.

3. Synchronous netting and DVP: As of now, BTC is sent asynchronously, in one-way transactions. That may be fine for money remittances, but not for securities markets. (By the way, it’s time to short Western Union, whose expensive pricing just became unsustainable.) Either the open-source is modified to allow for Delivery vs. Payment (“DVP”), which is doable within the scripting process, or other means are found to enable certain trades to be flagged for automatic escrow to achieve de facto DVP. When a DVP and security registration can be automated via a decentralized P2P process, Bitcoin takes the banking world by storm.

4. Identity: Finally, to become institutional, Bitcoin requires optional and verifiable identity opt-ins. Identity for securities settlement instructions is going to be known in advance before diving into anonymous-looking alphanumeric strings of private and public keys. (An exception may be made for dark pool transactions.) My guess is that institutional “wallets” (read: custody accounts for Bitcoin) may have some identifiable and consistent beginning, then unique and cryptographic back ends.

It’s hard to go against 30 years of habit, but this old dog has converted from Krugmanesque Bitcoin hating to being optimistic about virtual currencies. It will be time for new tricks soon, but Bitcoin needs to check a few boxes before it’s ready for primetime. Have I left out anything?

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6 Comments to "2014 TOP STORIES: Bitcoin: 4 Steps Before Wall Street Buys In":
  • Missing

    08 January 2014

    Another interesting long term perspective here.

    I have the same opinion!!!

    I'd like very much an article about the future implication of bitcoin usage and how it can replace a lot of wall street mechanisms, and how it will impact financial world!

  • Comment_main-thumb-3378195-200-eeqk8jvi8vsk38mxx85ssngsoii7elay

    08 January 2014


    Well said and I agree that Bitcoin has the capability of becoming a panacea for global payment processing by simply becoming an intermediary for transactions. So if everything you laid out occurs (save for regulation, that always lags) I can see that happening rather quickly. My opinion though, is that in order for this to happen Bitcoin would have to stop being used like a“real currency”. To be clear, as it is now, it's very unstable, prone to far too much volatility, and easily manipulated. So while it may be cool to buy a pizza or an iPhone with Bitcoin, that's really not the best use. The way to solve this is not regulating out it's use as a currency, but just letting it play itself out and the coolness of using Bitcoin as currency will fade away.  

  • Missing

    08 January 2014

    I too have long been and still am a bit skeptic.  I think the most important way to view bitcoin is not as a currency, but as a payment system.  In order for a new payment system to succeed, it needs to gain a critical mass large enough to overcome competing payment methods.   What does bitcoin solve better than existing payment systems?  Proponents claim that it will reduce costs below that of the existing methods, and indeed there is lots of room for cost reduction.  However, once the appropriate amount of consumer protection, anti-money laundering and other necessary regulation is added in, costs will be comparable to other innovations in the payment space like Square.  

    As bitcoin hits its theoretical limit, miners will have to be compensated for processing transactions.  Already, one has to pay a few cents for faster processing.  Add the invevitable transactions costs on top of the instability of bitcoin, and I don't see the bulk of merchants clamoring for payments in an unstable currency that the merchants will have to sell immediately, incurring FX charges and currency risk.   Of course, the anarcho-fringe types who lament the suppression of Silk Road will still like bitcoin so it will probably stick around the fringes for quite some time. 

    As a techie I admit that the technology is cool.  However, is it more cost effective than other competing technologies?  At its heart, the massive competition among miners provides multiple redundancy for processing transactions, but does it provide too much in a socially wasteful manner?   The same open-architecture technology can be used to transfer digital forms of existing currencies as well without the instability of bitcoin itself.    That is the real disruptive threat to the Mastercard/Visa duopoly.

    Western Union is super expensive because of the human involvement at both ends of the payment, as it deals with unbanked humans on both ends of a transaction.   More savvy migrants in the US deposit cash in a US bank account and then send an ATM card to their relatives in the home country who can get cash out of ATMs in the home country.   This is much cheaper than Western Union, even with the ATM fees and currency conversion costs.    

  • Missing

    08 January 2014

    Since I posted this, a terrific non-technical blogpost came out describing better how scripting works, and the effect it can have on banking and transactions.

    Written far better than I did.  And if you're in the mood for shock, awe and grins, check out the reaction to the idea of regulation and institutional investors getting acquainted with Bitcoin on Reddit:

  • Comment_stringio

    08 January 2014

    Identity would be very simple to solve - without any changes to BTC software. A certificate issuer (a-la VeriSign) could issue digital certificates that merely certify that a given wallet identifier belongs to a certain legal entity. Allow revocation for additional protection - and done.

    I think the biggest issue with BTC is the time taken for a conformation - too long. I would think a requirement of a cryptoccy is sub-second transactions.

  • Comment_rose_25-wallpaper-3840x2160

    15 January 2014

    As any new digital currency system matures and the platform is used by more commercial players, the digital currency will lose most of it's original beneficial features. Personally, I would think that if the big banks and Wall St. wanted to participate in a digital currency system they would simply create a new one that they could own and control. Clear regulations are at least two years away.

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