Charlie Munger: "I think it's rat poison."
Warren Buffett: "Put it down as undecided -"
Bill Gates: "[Bitcoin] is a techno tour de force, but that's an area where governments are going to maintain a dominant role."
Warren Buffett: "I think either Charlie or Bill is right."
The investing world is sharply divided on the subject of Bitcoin (BITCOIN). On December 5th, David Woo of Bank of America (NYSE:BAC) initiated coverage on BTC with the release of a 14-page research report, pegging the value of the Bitcoin protocol at $15 billion with a commodity status similar to Silver (NYSEARCA:SLV).
PayPal's (NASDAQ:EBAY) president David Marcus told attendees at a conference in Paris that Bitcoin would revolutionize the world of money and that PayPal might be interested in accepting the digital currency as a legitimate method of payment once the regulatory picture was clearer and volatility was reduced.
I don't think it is a currency. It's a store of value, a distributed ledger. It's a great place to put assets, especially in places like Argentina with 40 percent inflation, where $1 today is worth 60 cents in a year, and a government's currency does not hold value. It's also a good investment vehicle if you have an appetite for risk. But it won't be a currency until volatility slows down. Whenever the regulatory framework is clearer, and the volatility comes down, then we'll consider it.
Silicon Valley vs. Wall Street
Bitcoin is on track to become the most popular new technology among Silicon Valley VCs, with Thursday's $25 million bid from Marc Andreessen (via Andreessen Horowitz), Paul Graham (via Ycombinator) and Fred Wilson (via Union Square Ventures) on Bitcoin super-exchange Coinbase leading the charge. On the other hand is the former Fed Chief Alan Greenspan, who dismissed Bitcoin as a bubble without "intrinsic value" in a recent interview. In the U.S., Bitcoin is stuck in a regulatory twilight zone engineered by FinCen. UK officials slapped the VAT on it, only to reverse that decision once the protocol was explained to them in better detail. Russia has given virtual currencies a big bear hug. Norway wants to apply cap gains and sales taxes. Germany has recognized BTC as a unit of account, while the European Union, Australia and New Zealand have issued warnings on the risk of holding cryptocurrency and China appears to be making a 180-degree turn away from its former policy of tolerance.
VISA and Beyond
Banking is rapidly becoming something that you do rather than a place that you go. Never before have consumers had such a wide variety of money transmission options. Few of these innovations have favored the incumbents.
Take VISA (NYSE:V), for example: The multinational financial services giant currently has 2.2 billion cards in circulation, 14,600 institutional clients, tens of millions participating merchants and 2 million ATMs in over 200 countries and territories.
Despite these formidable advantages, VISA's primary vehicle for money transmission, the credit card, was never designed for the Internet. When used for online shopping, the frictionless experience of swiping a credit card is transformed into a cumbersome process analogous to filling out a check by hand. Today, millions of people transfer mobile payments instantaneously using services like PayPal and Square without looking at a credit card or thinking about their bank.
The most significant weakness of the Bitcoin economy today is not volatility or security, but the fact that it's tethered to the dollar. This has allowed Bitcoin to increase its merchant adoption exponentially without pegging the currency to a physical commodity or government guarantee at the price of dependency on the interlocking institutions of fiat-based economies for both entering and exiting the system, effectively allowing governments and financial institutions alike the power to indirectly influence the velocity of money throughout the Bitcoin sub-economy through threats of sanctions.
Most people forget how similar PayPal's origins and prior regulatory tribulations are to Bitcoin and its present difficulties. PayPal (originally called Confinnity) was initially conceived as a Libertarian vision of an extra-governmental form of currency. Like Bitcoin, PayPal was touted as a way to help the "un-banked" Third World escape penury, not by avoiding fees but by allowing citizens of countries with historically insecure currencies like Russia, India and Mexico to convert their savings to more secure currencies like GBP, JPY and USD instantaneously. Like Bitcoin, PayPal was used for fraud and money laundering by hackers, sophisticated scam artists and international mobsters and attacked by the media, politicians, and the banks.
Ultimately, the fact that PayPal's ambitions were reined in by FinCen and the company itself sold to its primary competitor eBay is an ominous precedent for crypto movement. It remains to be seen whether Bitcoin remains an open and government unaffiliated protocol or is crushed and reshaped by FinCen. In the words of Bradley Jansen, director of the Center for Financial Privacy and Human Rights:
I think the lesson from the 90s was that you either become what FinCen wants you to be or you're not going to be.
Joining us at Seeking Alpha today to discuss the implications of the BAC report and evolution of the Bitcoin community are Erik Vorhees, co-founder and CEO of Coinapult, former Director of Marketing at BitInstant and former co-owner of SatoshiDice and a leading voice within the Bitcoin community; venture capitalist Ryan Selkis, a former venture capital associate and current Bitcoin entrepreneur; Trace Mayer, fellow SA Contributor and seed investor in BitPay and Armory; Aaron Lasher, early adopter and Editor in Chief of the Bitcoin blog Real Virtual Currency and Tyler Satre, a Moderator of the /r/Bitcoin subreddit.
K.S. Bitcoin recently received a signal endorsement from Wall Street in the form of a 14 page note from David Woo of Bank of America arguing that Bitcoin could be "a significant store of value with a reputation close to silver" with a fair value of 1300 USD per coin. What's your read on the situation? Can a digital currency compete with silver or gold as an asset class?
E.V. Bitcoin is valuable for many of the same reasons as the metals. It is a form of money that cannot be corrupted by governments. It is an alternative to fiat currency. So Bitcoin will share some market with gold and silver, but they are also excellent complements - one being digital and brand new/experimental, and the other being physical and traditional/time-tested. I don't think the competition is so much gold vs. Bitcoin, but rather fiat vs. non-fiat (Bitcoin and gold).
R.S. Woo is well-respected, and he wrote a very positive note. Moreover, he appeared to be one of the first people on Wall Street to take anything more than a superficial look at Bitcoin, the platform. The fair value of a Bitcoin is anyone's guess, but the comparison to silver and gold seems appropriate. The vast majority of investors are already investing in Bitcoin as if it is a long-term store of value, albeit one that will experience significant near-term volatility.
T.M. I don't think the Bank of America/Merrill Lynch analysts have a clue about where the fair value of Bitcoin should be. I've been a major thought leader regarding Bitcoin ecosystem for years and even I do not come anywhere close to fully understanding it because it is so complex and evolving so rapidly. No one does. Our lead developer at Armory is one of the top five Bitcoin wallet experts in the world. Recently, I sent him a transaction and he asked 'What did you do and how did you do it?' There are so many different factors involved: mathematics, cryptography, statistics, computer science, thermodynamics, the foresight of how economics would guide human action to evolve the protocol, network topography, entropy generation, triple-entry bookkeeping and the list goes on and on. Tens of millions of man-hours have been poured into this by some of the most brilliant individuals on the planet, and as a result, Bitcoin has evolved far beyond the comprehension of any single human mind.
Consequently, attempting to assess a fair market value on something where such asymmetric knowledge exists is a fool's errand because Bitcoin can be so many things to so many people and solve so many different market needs in so many different ways that I believe there will never be an objective fair market value but instead only the subjective value each market participant places on it for their own individual use. What is the fair market value of TCP/IP, SMTP or HTTP?
Regarding comparisons to commodity money like gold, Bitcoin is as much or more tangible than gold because it is constructed from and limited in amount by the laws of mathematics, which are purer than atoms. As a safe haven Bitcoin, when properly secured with something like Armory, is much more resistant to seizure-ship than gold or other corporeal tangible assets. The great innovation of Bitcoin is the first material implementation of a triple entry bookkeeping system that is secured by computer processing power that dwarfs the combined processing power of the 500 largest supercomputers in the world. Given the laws of chemistry, thermodynamics and mathematics as currently constituted and understood it is easy, for those who can comprehend those laws, to see why Bitcoin could outcompete gold as a superior safe haven from inflation and seizure-ship.
A.L. As a store of value, Bitcoin is very similar to gold. In some ways it's even better. I agree with Trace on that one. What Bitcoin lacks is a track record to convince people that it's going to be around in the next 1, 2, or 10 years. Gold will certainly be around, and will always play a dominant role as a store of value. The longer that Bitcoin chugs along without any major technical issues, the more likely that it will compete with gold for savers' dollars.
I'm a little skeptical of anybody who claims to have an idea of what a fair valuation of Bitcoin might be, particularly if they are new to the party. That said, if I recall correctly the value of all extant silver is somewhere in the hundreds of billions of dollars - and Bitcoin does have the potential to serve a similar purpose as an alternative store of value. BofA concluded that $1,300 (roughly twice we are today) is a fair price, which in my opinion is low.
There really isn't much room for Bitcoin to live in the middle - if it fails to hit peak velocity for massive uptake within a certain period of time, perhaps 5-8 years, then it probably never will.
T.S. Only time will tell if Bitcoin is able to complete with silver or gold as an asset class. Many people never thought the internet would be used for things like shopping, but that's a huge market now. I see the Bank of America report as good news because it's a first step towards laying the "Bitcoin has no intrinsic value" meme to rest.
K.S. Can you give us a sense of how the Bitcoin community has developed over the last two and a half years?
T.S. One of the biggest changes I've noticed is in the technical abilities of the users. When I first got into Bitcoin in May of 2011, it was still mostly limited to IT people. Now it's starting to spread to a wider audience. There also seems to be a lot more excitement and willingness to develop services to help move Bitcoin forward. Two years ago, everyone seemed a lot more reluctant to dive in.
A.L. The most obvious difference is that the user base has exploded. It's gone from a group, which was predominantly male, perhaps 20-40 years old, with some type of computer science, or math background - tinkerers I would call them - to a broader group of people who are open to trying new technologies, and have an above-average financial IQ. In the beginning, it was just crypto-geeks, sending handfuls of Bitcoins back and forth for the fun of it. Then came the famous "10,000 Bitcoin pizza," which was the first publicized use of Bitcoin to purchase something real.
I had my own "pizza" moment in 2012 when a friend of mine who lived in Sweden couldn't cash a check I wrote him as a wedding gift. If I remember correctly, the conversation went something like this:
"I have a solution, if you are willing to hear me out."
"Sure. What do you have in mind?"
"Well, I've been involved with this new internet currency called Bitcoin… it's really volatile and nobody knows if it will be successful in the long-term, but I could use it to send you your wedding gift, instantly, across the ocean, and with negligible transaction costs. If you don't want to hold it, you can probably find somebody to sell it to for krona."
He was hesitant at first, but after I told him more about Bitcoin, he thought the idea was cool and, after all, it was a gift. So I sent him some Bitcoins. At the same time, I owed another friend $250 for expenses incurred during a recent bachelor party. I also offered him Bitcoin as a remittance but he declined, preferring a good old fashioned check in the mail.
Today, one of my friends has $250 in USD, and the other one has $15,000 in Bitcoin.
E.V. It's gotten bigger! The community has grown tremendously, from a niche of ideologically-motivated computer developers to a more broad base of libertarian types and social activists. Now, within the last few months, we're seeing Bitcoin become more mainstream. Bitcoin is a useful tool for lots of people and purposes, so it's natural that the core userbase will be diluted as it expands. Certainly, many of us "Bitcoiners" consider this more than just a cool technology - it is a movement, a philosophical and economic experiment with grand consequences. For some of us, Bitcoin is a way to move money easily. For others, Bitcoin represents the actual separation of money and state. And there's everything in between. The Bitcoin community is not homogeneous and it is becoming as diverse and multi-faceted as the internet itself.
R.S. I'm a relative newcomer, but the community has already changed significantly. I first became aware of Bitcoin late last year, but I didn't dig in until the Silk Road shutdown this fall. It's almost sacrilegious to talk about any regulation of Bitcoin being a good thing, but the fed's seizure of Silk Road assets turned on a lot of people (including me) to the idea that Bitcoin could be a serious mainstream innovation. I think Bitcoin will only realize its potential once most of the dangerous and illegal transactions are weeded out. Silk Road's demise was a good start, and it brought more entrepreneurs to the Bitcoin table.
The biggest change for me (in three months) hasn't been within the community per se, but in the people now supporting the community. Germany and the U.S. have all given their cautious but positive approval of Bitcoin, and you have powerful people like Ben Bernanke, world-class entrepreneurs like Jeremy Allaire, and name-brand investors like Marc Andreessen, Fred Wilson and Paul Graham talking about digital currencies and the Bitcoin protocol as the next major tech revolution. I think we may have gone from the "innovator" to "early adopter" phase of Bitcoin's adoption curve this fall.
I just got back from the Inside Bitcoins conference in Vegas. Even though there were over 600 attendees, you couldn't turn around without bumping into a Bitcoin expert of some sort--entrepreneurs, investors, specialized lawyers, bloggers, etc. And even the senior-most people in the room were unusually accessible.
K.S. You've recently proposed a way to hedge against Bitcoin's volatility. I know that the head of The Bitcoin Foundation, Patrick Murck, was extremely enthusiastic regarding your proposal, saying "this needs to happen." What is this new project?
R.S. Along with a few other serial entrepreneurs, I recently formed Inscrypto, which is an entity that will eliminate some of the risks associated with holding Bitcoin. We are just getting started, but the general idea is to create an insurance deposit system worthy of the Bitcoin community: decentralized, privately funded, and free. We plan to integrate with the best and most popular Bitcoin wallet providers, like Coinbase, so that the user experience is seamless. And we'll rely on professional investors to provide the capital to underwrite the underlying fiat value of new consumer Bitcoin deposits.
So, for example, if a Coinbase wallet holder (individual or merchant) wanted to minimize exposure to Bitcoin's price swings by 80%, a BDIC hedge fund investor would cover 80% of any losses while capturing 80% of any gains in the currency. In this way, we could help hedge funds essentially trade Bitcoin on margin...without actually holding the digital currency. At the same time, we would minimize volatility for Bitcoin's non-speculators. We think that once the volatility issue is addressed, more mainstream consumers will take interest in the benefits of Bitcoin, the payment system.
BDIC will be expensive and tricky to build, and we still need to add horsepower to our team, but we think there is tremendous demand for this type of solution. We expect that demand will attract high-quality talent within the community.
K.S. Mr. Mayer, you're currently invested in two of the most popular Bitcoin products. I know with BitPay, you got in even before Peter Thiel, and now Armory. Can products like BitPay and Armory really compete with established money transfer companies like PayPal and Western Union?
T.M. Yes, BitPay and Armory are already competing with established money transfer companies. For example, BitPay's November transaction value was up 390% over October's and up over 6,000% from November 2012. The growth rate is astonishing.
K.S. Gentlemen, thank you for taking the time to speak with the members of Seeking Alpha.
The Bitcoin protocol presents a novel financial concept: An open-sourced, decentralized, crowd-funded global payment system. That system, though still in its infancy, is now being perceived as a credible threat not only by traditional transaction processors like VISA, but by banks and governments as well.
Fortunately, online financial service companies like PayPal are ideally positioned for adaptation to the virtual currency paradigm. They will still make their spread against Bitcoin, just like they do with CCs and ACH. Credit card companies and traditional wire service providers will have a much harder slog, as many merchants will balk at 3% fees and chargebacks if a secure, fast, widely used and cheaper alternative existed. On the other hand, if Bitcoin exchanges were barred from operating by FinCen, the long-term investment case for established payment processors would be re-enforced, albeit at the expense of innovation and the elimination of potentially highly lucrative future markets.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.