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?