17 January 2014

The Bitcoin conundrum

This news was first published on Dialogue Online.

Bitcoin’s two challenges for the long term are, first, that it doesn’t exist, and secondly, that it isn’t taken seriously enough where it matters. It is a tradable open-source crypto-currency with a five-year track record of volatility, and it is a low-cost, near-instant remittance mechanism for purchased, unitised electronic value. It doesn’t exist in the sense that if a bank was to seek, let’s say, a partnership with Bitcoin – who would the bank call? The Bitcoin Foundation is not a commercial entity, nor indeed is it the Bitcoin equivalent of a central bank. “There’s nobody there, no company,” says Zilvinas Bareisis, senior analyst at Celent, the financial research analysts.

Serious money

Bitcoin is taken seriously in Germany, where sales tax is imposed on Bitcoin transactions, and in China, where financial institutions are prohibited from handling any virtual currencies at all. Two companies, Robocoin and Lamassu, provide Bitcoin ATMs. The former’s machine seems designed to facilitate access to and cash exchange of Bitcoin, while Lamassu’s promises “fiat to Bitcoin in 15 seconds”. But there is a broader issue here than accessibility via ATM, pragmatic tax policy, or indeed the kind of profile that leads to an outright ban. Ty Danco, CEO and co-founder of BuysideFX, a solutions broker targeting institutional investors, summed it up in a recent blog post: “Bitcoin needs more direct participation from people in the financial world who know what they’re doing… Those of you running Bitcoin exchanges – dump the rhetoric, go hire some pros.”

Bitcoin isn’t a bank-led initiative. It operates “with no central authority or banks” (says www.bitcoin.org); it has been popular with criminals (it was used on the ‘silk road’ online black market), and its users include people who, for example, put out press releases when they succeed in buying pizzas with Bitcoins (a story picked up by many mainstream media outlets). In this light, Bitcoin appears to be a durable novelty that has run for five years without attracting those “pros” to its team. But the bigger issue, for the long term, is that there is no easy answer to the ‘Why Bitcoin?’ question.

Critical mass

JP Morgan Chase’s patent application number 20130317984, published November 2013 and widely analysed online, describes a “method and system for processing internet payments using the electronic funds transfer network.” This suggests banks can do what Bitcoin does, without Bitcoin, if they so choose. Patrick Murck, general counsel at the Bitcoin Foundation, argues for a commonality of interest between banks and Bitcoin and suggests that the next step is for a mutually beneficial meeting of minds: the ‘mature organisations’ of the banking world and the pizza-eating entrepreneurs of Bitcoin could usefully work together. Nice idea, and there’s an obvious precedent: Innotribe at Sibos Dubai last year (where Murck also spoke) gave a clear indication of the innovative value that can be added when “suits sit down with jeans” (to take a phrase from Salesforce chief scientist JP Rangaswami’s closing-plenary summary of the week).

But there are other ‘jeans’ out there, and Bitcoin has a problematic history. Banks do seem to be interested – Bank of America Merrill Lynch published a research paper on Bitcoin in December; Wells Fargo recently convened a summit to discuss it – but the focus tends to be on virtual currencies in general and the regulatory/practical challenges they raise. True, Bitcoin does have significant take-up, as Murck points out, and this may represent a critical mass that banks cannot ignore. “If you consider the number of users that Bitcoin has worldwide, and the transactions that it enables, I would say that yes, it has definitely reached critical mass,” says Jordan Kelley, CEO, Robocoin. But a critical mass has to go through some form of KYC process if it is to interact with the established, regulated global financial infrastructure. “A lot of banks will struggle to deal with Bitcoin directly in the foreseeable future,” says Bareisis.

Genuine use cases

Let’s not be too negative. In its five years of existence, Bitcoin has cracked the remittance business, after all. Julie Conroy, research director for Aite Group’s retail banking practice, says: “There are genuine use cases for Bitcoin. It’s useful for cross-border remittances, for e-commerce payments, for use in countries that don’t have a stable currency of their own.” It’s also e-portable, and given the global penetration of mobile telephony, thereby potentially capable of reaching the unbanked. It’s a potential solution for some of the very long-standing, as well as some of the very new, challenges facing the banking industry.

“Bitcoin is the poster child for potentially viable digital currencies,” says Conroy, making the points that Bitcoin supply is finite – like gold, it has scarcity on its side – and that its volatility could be expected to reduce if it becomes mainstream. “To get there, Bitcoin has to play nicely within the norms of our regulatory structure,” says Conroy. But it has to start doing that before banks start building their own alternatives.