Coinbase founders Fred Ehrsam, left, and Brian Armstrong in their San Francisco headquarters
46 BLOOMBERG MARKETS NOVEMBER 2014 47 JPMorgan Chase & Co. show how the old forms of payment and transfer are ripe for replacement, bitcoin believers say. Coinbase is a bitcoin blue chip. Arm- strong and Ehrsam have scored money and support from Y Combinator, the hy- RIAN ARMSTRONG the largest bitcoin exchange in the world, perselective startup booster in Silicon Val- and Fred Ehrsam certainly look like the collapsed, and suddenly 850,000 bitcoins, ley. New York–based Union Square kind of guys who could help bitcoin re- worth $500 million at the time, were just … Ventures led a $5 million investment in cover from its wild years. gone. (Two hundred thousand of the miss- May 2013, and Marc Andreessen’s Menlo They are tall and textbook fit, and as ing bitcoins later turned up.) Before and Park, California–based venture capital poised as Swiss bankers—Vulcan Swiss since, there have been numerous bitcoin firm, Andreessen Horowitz LLC, anchored bankers. Armstrong, 31 and a former soft- heists, blamed on hackers, and more than a $25 million B round in December. ware engineer at Airbnb Inc., shaves his a few bitcoin losses—people literally lose Andreessen may be more stoked about head. Ehrsam, 26 and a former foreign-ex- their bitcoins by misplacing the code that bitcoin than anyone else in techdom. change trader at Goldman Sachs Group proves ownership. If you do that, there’s He says it fills a void in the Internet that Inc., keeps his hair short and very much no reset, no more than if you drop a $100 has existed since he and his friend Eric in place. When they discuss bitcoin, they bill through a sewer grate. Bina invented the first widely used Web rarely smile. Do not try to make them laugh. “Right now, it’s just about making peo- browser in the 1990s: a protocol for pay- Their seriousness is understandable. ple feel safe and secure,” Ehrsam says in ments. He always imagined that some- Armstrong and Ehrsam are the founders an interview at Coinbase’s headquarters. one would figure out how to send money of a startup called Coinbase Inc., whose Coinbase looks like a startup, with rows of as easily as data. (Bloomberg LP, the par- mission is to convince everyone that bit- industrial-sized Apple computers on Ikea ent of Bloomberg News and Bloomberg coin isn’t an Internet scam or a libertarian tables, except that it’s on the 26th floor of Markets, is an investor in Andreessen plot against the government or a digital a building in San Francisco’s financial Horowitz.) version of goldbuggery, as various skeptics have it. Rather, it’s the best thing to hap- pen to money since the Lydians started minting coins sometime in the seventh century B.C. Coinbase isn’t a bank—technically, it’s a brokerage—but in important respects it behaves like one. Customers open ac- counts, through which they buy bitcoins for dollars. Coinbase holds the bitcoins. Customers spend them using a computer or a smartphone application. Coinbase district, nestled among the very banks bit- Like many West Coast entrepreneurs, makes money by charging a 1 percent fee coin lovers love to hate. Armstrong and Ehrsam relish cutting for exchanging dollars and bitcoins. All Bitcoin is worth a makeover, Armstrong out financial middlemen and have a spe- other transactions are free. and Ehrsam say, because the currency cial scorn for credit card companies. In Coinbase’s aim is to take a curio cur- solves so many problems that come with Armstrong’s view, they entice customers rency that exists only as bits on the In- putting old technology, in particular credit with airline miles, then fleece merchants ternet and turn it into a coin of the cards, on the Internet. When consumers with fees. “This is the way they’re inno- realm—every realm, because part of the use bitcoins, merchants pay fees that are vating, playing these games,” he says. appeal of bitcoin is that it can cross bor- a fraction of what credit card companies Such fees add up to a big opportunity ders as easily as e-mail. get. Users can shop online without giv- for bitcoin. Credit card and debit fees in It’s a big job. Reputation is everything ing their names, never mind credit card the U.S. totaled $72 billion in 2013, says Gil when it comes to currency, and bitcoin’s information—which, yes, explains Silk Luria, an analyst at Wedbush Securities has taken some hits. Road but also allows noncriminals to claw Inc. in Los Angeles. Much of that could In 2013, the FBI busted Silk Road, an on- back some privacy. As for security, the bit- vanish if bitcoin catches on, he says. line drug market that ran on bitcoins. In coin system has thwarted every attack Bitcoin arrived in the world on Hal- February 2014, Tokyo-based Mt. Gox, once thus far. Recent hacks of Target Corp. and loween 2008 in the form of a nine-page
48 BLOOMBERG MARKETS NOVEMBER 2014 BITCOIN’S EXTRAORDINARY VOLATILITY CAN ONLY SOMETIMES, AND ONLY SORT OF, BE EXPLAINED BY EVENTS.
Bitcoin 3/18/13 10/1/13 11/18/13 11/29/13 12/5/13 12/12/13 2/24/14 Price Bitcoin, seen by Silk Road, an At a U.S. Senate Bitcoin price China’s central Coinbase Mt. Gox, some as a haven, online bazaar for hearing, Depart- peaks at $1,137. bank bars raises the world’s $1,200 rallies after Cyprus illegal drugs that ment of Justice financial $25 million. largest closes the island runs on bitcoins, officials appear institutions from bitcoin nation’s banks to is shut down. willing to regulate handling bitcoin exchange, prevent depositors bitcoin rather than transactions. closes. 1,000 from fleeing. try to shut it down.
800
600
400 6/12 Coinbase founded 200
0
6/1 2012 2013 2014 9/18
Source: Bloomberg
white paper called “Bitcoin: A Peer-to- dollar twice if you gave it to two people at checking and solving is called mining Peer Electronic Cash System,” authored the same time. bitcoins. In the beginning, people were by Satoshi Nakamoto, a person or group Nakamoto found a solution. No bit- able to mine bitcoins on desktop comput- of people who remains anonymous. coin transaction is legitimate unless it ers. Now, it takes huge rigs built on spe- Nakamoto unleashed the bitcoin software, comports with all of the preceding trans- cial chips and running in places, such as all of it public, in January 2009. The sys- actions for each bitcoin involved. Every Iceland, where the electricity needed to tem allowed for the creation of 21 million transaction for every bitcoin is available power the machines is cheap. bitcoins, total, with the last ones to be re- to every computer that joins the peer-to- That magical ledger is called the block- leased in 2140. peer network that runs the bitcoin sys- chain, and there is no word more excit- Bitcoin lets commerce happen without tem. Buy a watch on Overstock.com, one ing to Silicon Valley venture capitalists an overarching authority, be it a bank that of the biggest retailers to take bitcoins, these days. Andreessen and others say clears transactions or even a central bank and the system goes to work, checking the the blockchain could be used to keep that controls the money supply. It works common ledger for past transactions that track of not just money but anything that because each bitcoin is really just a slot in prove you have the money. The purchase needs third-party verification, such as real a huge, peer-to-peer online ledger—mil- isn’t done until all the computers on the estate contracts or stock trades. It might lions of slots, really, because each bitcoin, network agree. even track voting and guarantee one worth $417 as of Sept. 18, is infinitely divis- Why does anyone devote any time to ballot per person. On a website called ible. The smallest unit so far, eight places checking transactions? Because program- Proofofexistence.com, it’s possible to turn a beyond the decimal point, is called a mers earn new bitcoins for the work—if document like a lease, or even a novel, into Satoshi. It was worth about 0.0004 cent as their computers also find, by trial and er- a hash—a code generated by an algorithm— of Sept. 18. ror, the solution to a complex equation and load it into the bitcoin blockchain, Electronic currencies had been pro- that the bitcoin system automatically proving that it existed at a certain time. posed before, but no one could figure out makes harder as more computing power Alec Ross, until last year the senior ad- the double-spending problem: You can’t goes to work on it. This hurdle is designed viser for innovation at the U.S. State De- spend the dollar in your friend’s pocket, to prevent a rogue programmer from hi- partment and now a consultant, says he but you could spend the same electronic jacking the system. Taken together, the loves blockchain technology, but he isn’t
50 BLOOMBERG MARKETS NOVEMBER 2014 Adam Draper wants to fund 100 bitcoin- related companies at his accelerator, Boost VC.
convinced about bitcoin. One basic prob- Airbnb to handle payments from around Inc., which Amazon.com Inc. bought in lem: “The unit is ridiculous,” he says. the world. Then he discovered the Naka- August for $970 million. At $417 per bitcoin, it’s too big. Just be- moto white paper and was dazzled. Here Armstrong won a spot in the 12-week cause it’s divisible into tiny pieces doesn’t was a currency that could fly across bor- Y Combinator session that began in April mean people will be comfortable with tiny ders via an e-mail. Proficient in a babel 2012. Fred Wilson from Union Square Ven- pieces. “It’s an important innovation in of computer languages, he built a digital tures was there doing office hours and met computer science,” Ross says. “I just don’t wallet to hold bitcoins on Android phones. Armstrong. Until then, Wilson says, all the think it’s necessarily going to supplant Already, the idea was to make bitcoin ac- bitcoin guys seemed like ideologues: con- the euro.” cessible, to mainstream it. spiracy theorists keen to escape what they Armstrong was an early adopter of bit- He thought there was a company in this. see as the tyranny of institutions such as coin technology. After growing up in San He applied to Y Combinator. The found- the U.S. Federal Reserve. “He didn’t have Jose, California, he graduated from Rice ers of Airbnb and Reddit Inc. went through a hard-core libertarian bent,” Wilson says. University with bachelor’s degrees in eco- Y Combinator, as did Justin Kan, founder “He was focused on solving pragmatic nomics and computer science and a mas- of the gaming platform Twitch Interactive problems with bitcoin.” ter’s in computer science, all in 2005. He worked in information technology for De- loitte & Touche LLP and then returned full time to a company he had founded in college, called UniversityTutor.com. He joined Airbnb, the online lodging com- pany, in 2011, and set to work building the company’s anti-fraud system. While there, he saw how hard it was for
52 BLOOMBERG MARKETS NOVEMBER 2014 Armstrong finished Y Combinator also to develop a specialty. “We looked at caffeine-seeking coders. They talked amid that June, formally launched Coinbase drones,” he says. “They’re cool, but there the clicking of keyboards. After hearing Arm- and went looking for money. He called are two use cases: One is taco delivery, and strong out, Draper invested his own money on Adam Draper, son of venture capital- the other is national security.” in Coinbase and six months later decided to ist Tim Draper. Adam was in the midst Draper had heard about bitcoin. Its have Boost focus on embryonic bitcoin com- of starting Boost VC, a Y Combinator– promise became apparent, he says, after panies. He wants to fund 100 of them. like accelerator in San Mateo, California. he met Armstrong at Red Rock Coffee in The first big challenge Armstrong ad- He wanted to invest across categories but Mountain View, California, a hangout for dressed was how to buy bitcoins easily.
DOLLARS, EUROS AND POUNDS ARE to help popularize the cryptocur- to be money transmitting and in- easy to visualize: They’re physical ob- rency—but he, too, grappled with its in- formed him that he lacked the neces- jects. Being digital, bitcoins aren’t tan- tangibility. “No one is going to get this if sary license. Since then, Caldwell has gible—which has become a boon for I can’t show them something,” Caldwell sold only aluminum promo coins via George Frey. “I’ve sort of cornered the remembers thinking. So in September his website, Casascius.com. A bag of market on bitcoin photos,” says the 2011, he began making physical coins as 500 costs 0.39 bitcoin—about $163 as Provo, Utah–based photographer. vessels. Inside of each, he embedded a of Sept. 18. All told, Caldwell minted Indeed, dozens of media outlets, in- piece of paper that contained a bitcoin about 60,000 Casascius bitcoins. Bit- cluding Bloomberg News, have pub- private key, which he protected with a coin enthusiasts consider them col- lished Frey’s pictures. The image used tamper-resistant hologram sticker. As lectibles—especially the earliest ones, here—dated April 26, 2013—happens for the word casascius, it was half acro- which have fetched as much as $2,500 to rank as the most popular bitcoin nym (derived from the phrase “call a each on EBay because of a typo in the photograph on Gettyimages.com. But spade a spade”), half Latin-sounding hologram. if a bitcoin isn’t a physical object, what suffix (“cius”). Not that much of this matters to exactly are we looking at in Frey’s As of Nov. 27, 2013, however, Cald- Frey, whose photos continue to be photographs? well no longer includes digital bit- downloaded via Getty. Frey says he’s They’re called Casascius bitcoins, coins in his physical bitcoins. A letter made more than $10,000 off the im- and they were minted, in a variety of from the U.S. Treasury Department’s ages, which he shot at Caldwell’s metals, by software engineer Mike Financial Crimes Enforcement Net- home. Unlike Caldwell, he accepts Caldwell at his home in Sandy, Utah. An work, or FinCEN, stopped him in his only U.S. currency for his work.
GEORGE FREY/GETTY IMAGES FREY/GETTY GEORGE early bitcoin adopter, Caldwell wanted tracks: FinCEN considered his activity JOEL WEBER
NOVEMBER 2014 BLOOMBERG MARKETS 53 Back then, buyers and sellers gathered in parks or bars to trade cash for bits. Oth- ers wired money to brokers, often abroad, and hoped. It was hard to turn dollars, or any other currency, into bitcoins. Armstrong solved that by gaining access to the Automated Clearing House, or ACH, the electronic rails on which certain finan- cial transactions run in the U.S. Employers use ACH to deposit checks in employee ac- transfer money from a U.S. bank account then everything else he could discover counts, for example. To get on, a company to Coinbase and buy bitcoins. No muss, about bitcoin. “You could find nobody needs a bank to sponsor it. Bitcoin com- no fuss. Circle Internet Financial Ltd., a in person who could explain how bitcoin panies struggle, Armstrong says, because Boston-based bitcoin brokerage, also of- worked,” he says. He came across Arm- banks worry that with bitcoin, you can’t fers ACH transfers. strong’s work on the Internet. They corre- know your customer and prevent money In New York, Ehrsam had fallen un- sponded, and Ehrsam started buying and laundering, two things regulators require. der Nakamoto’s spell. It happened when selling bitcoins, sometimes on his phone Armstrong scored a banking relation- a friend from Duke University, where Ehr- from the bathroom at Goldman Sachs. “We ship with Silicon Valley Bank in October sam had studied computer science, pulled traded it for fun and some profit,” he says. 2012. A month later, customers could up the white paper. Ehrsam read that and Ehrsam flew to San Francisco and met
Juan Pineda and Tim Olson, and de- signer Warren Paul Anderson. Hedgy is building a system to hedge bitcoins via the blockchain, bitcoin’s beating heart CHRISTIAN MARTIN AND LEONARD register it with the U.S. Commodity Fu- and what even skeptics call its greatest Nuara go to a lot of bitcoin conferences, tures Trading Commission. strength. and, at 49 and 55, respectively, they in- Now, a merchant looking to lock in The blockchain is an online ledger variably feel old. “Everyone else is 25 today’s bitcoin price can use Tera’s that tracks all bitcoin transactions. It and good-looking,” Nuara says. system to find a buyer willing to pay can also be used to prove the existence The graybeards are trying to help that price in 30 days or 60. So far, the of contracts at certain times and terms. bitcoin grow up. Their company, Tera- buyers—usually bitcoin-focused hedge Bitcoin sales arranged by Hedgy and Exchange LLC, runs the first regulated funds or other speculators—are will- set for a future date will be encoded in trading platform where people can ing to go out about four months. Be- the blockchain. Both sides of a trade shed some of the risk of owning yond that, the currency is too volatile. will put 20 percent of the value of the bitcoins. In the first eight months of 2014, it contract in escrow—again in the And there’s a lot of risk to owning bit- ranged from $376.90 to $914.51. “I don’t blockchain. coins. Imagine your business accepts it, expect anyone to be making markets in As the bitcoin price moves in either and on Friday, Feb. 21, you made a big bitcoin out two years anytime soon,” direction, the blockchain will make a sale. You didn’t sell your bitcoins for Martin says. payment from escrow to the other party dollars that same day. On Monday, you Martin and Nuara are old school. automatically. No party will be able to found the value of your bitcoins had Martin spent 20 years at Merrill Lynch remove that collateral. plunged 20 percent during the & Co. and its parent, Bank of America TeraExchange’s platform is up and weekend. Corp. Nuara, a lawyer, worked at Green- running. Hedgy is looking for venture That’s why Martin and Nuara are berg Traurig LLP. capital. Old and new solutions to the bringing an old-fashioned idea to the Some of the young guns are hot to same problem: how to take some of the hip new currency: hedging. They hedge, too. Early this year, Matt Slater, risk out of owning a strange new asset worked for seven months to develop a 23, co-founded a company called Hedgy with plenty of promise. U.S. dollar-bitcoin swap contract and Inc. with former Apple Inc. engineers ANTHONY EFFINGER
54 BLOOMBERG MARKETS NOVEMBER 2014 Armstrong at The Creamery, a coffee shop and Ehrsam are pitching them. So far, it out of view,” she says. “With bitcoin, popular with techies because it’s near the they’ve convinced computer maker Dell there is no way for the average consumer Caltrain station, where people arrive from Inc., travel company Expedia Inc. and to protect themselves.” Silicon Valley for meetings in the city. software maker Intuit Inc. to take bit- Coinbase addresses that by keeping ev- Both were a little guarded, Ehrsam recalls. coins and to open merchant accounts on erything in house. Coinbase users never “I could tell that the mental horsepower Coinbase. even see their private keys. They just have was there,” Armstrong says. “We decided The system will have to prove secure, accounts with passwords, and those pass- to work on something for a week.” too, for the general public to get on board. words are backed up with ever-changing They hit it off, and Ehrsam joined Coin- Bitcoin “manages to function in a very ad- codes sent to their phones. Coinbase, in base in November 2012, taking the title of versarial environment,” says Paul Kocher, turn, puts many of the bitcoins it holds in co-founder. Back then, some 15,000 peo- ple had wallets on Coinbase, and they bought and sold about $1 million in bit- coins a month, Armstrong says. He and Ehrsam ran the thing by themselves out of a two-bedroom apartment in San Fran- cisco. At the time, one bitcoin sold for about $13. People still used a whole one to buy a pizza, if they could find a shop that accepted it. The price of a bitcoin rose for most of president and chief scientist at Cryptog- what the company refers to as cold stor- 2013, peaking at $1,137 on Nov. 29. By year’s raphy Research, a part of semiconductor age. It splits individual private keys, writes end, Coinbase had more than 600,000 us- designer Rambus Inc. By that, he means them onto USB drives and prints them on ers, and it got a further $25 million from that everyone wants to attack it, because paper, and puts everything in vaults and venture capitalists, with Andreessen it’s money. safety deposit boxes at various locations. Horowitz putting in the biggest chunk. Bitcoin uses something called public-key No one person can retrieve the codes. “We The success of bitcoin, and Coinbase, cryptography, which requires two keys, don’t want someone to come in here, kid- will depend in part on whether big mer- each a string of numbers and letters. One nap Fred and me and get a quorum of chants start accepting it. Armstrong is public and identifies the sender or recip- these keys,” Armstrong says. ient in a bitcoin transaction. The other key Many bitcoin lovers, Ehrsam and Arm- is private and is used to verify, or sign, the strong included, make endless compari- transaction. Unlike a Facebook password, sons between e-mail and bitcoin. One sends the private key can’t be retrieved with an data, the other money. People freaked out e-mail if it’s lost. Once it’s gone, it’s gone. about the security of e-mail in the begin- Tracking Bitcoin Bitcoin seems as futuristic as a light sa- ning, and today they send all manner of You can use the Virtual Currency Monitor ber until it comes to keeping hold of the private information electronically because (VCCY) function to track bitcoin prices. private key. Then it seems as ancient and it’s proved easy to use and secure, provided Type VCCY
56 BLOOMBERG MARKETS NOVEMBER 2014