We have been studying and investing in the Bitcoin space for a couple of years now and have posted actively about our thoughts on Bitcoin since then. We first met the Blockchain team at the inaugural Bitcoin Foundation conference in San Jose in early 2013 where we were one of very few VCs in attendance. Since then we have continued to meet with the team regularly, including at this year’s Bitcoin Foundation conference in Amsterdam, and making a field trip out to the company’s founding headquarters in York, England. Through that time we have come to hone our thesis on Bitcoin and build our enthusiasm for Blockchain. This investment is by far the largest one that we have made in the Bitcoin space.
Right now, a lot of attention is being paid to the Bitcoin price which has been steadily drifting downwards since it peaked in December 2013. We think that this focus on short term price fluctuations is misguided. Bitcoin is a long game that will be played out over a decade or more. In a success case, Bitcoin will become a payment mechanism as widely accepted as Paypal or American Express, and a major world currency. This has the potential to massively disrupt the financial services sector. Widespread Bitcoin adoption will enable various other applications of its distributed ledger, including smart contracts and more.
All that being said, it is still early days for Bitcoin. We expect much to change over the coming years. In as fluid an environment as this one, the value lies in the strategic high ground. We believe that in the Bitcoin ecosystem, the wallet is the strategic high ground. Wallets own the relationship with the consumer and every transaction begins and ends with a wallet. Unsurprisingly, this is the area that has attracted the most VC Investment, including Coinbase ($6M Series A and $25M Series B), Xapo ($20M Series A and $20M Series A1) and Circle ($9M Series A and $17M Series B).
Blockchain is the largest Bitcoin wallet, with about 2.3M wallet accounts at the time of writing (see growth chart above) relative to the 1.7M wallet accounts at Coinbase at the time of writing. Although Xapo and Circle have not publicly discussed how many accounts they have, given that they have only publicly launched in the last few months, it is likely that Blockchain has more Bitcoin wallets than Coinbase, Xapo and Circle combined. Blockchain is also growing more rapidly, having added 500k new accounts since mid July, during which time Coinbase added 300k new accounts. Blockchain’s market leadership was a key reason for our decision to invest.
The other key reason for our decision to invest in Blockchain is its user-controlled architecture, which contrasts to a custodial architecture.
Custodial wallet companies take custody of customer funds, much like a bank does. They take actions on your behalf. One of the key advantages of an online custodial wallet is ease of use – online custodial wallets map onto users’ current mental models of a bank. These wallets can simplify buying and selling Bitcoin by acting on your behalf, obscuring the complexity of actually using Bitcoin.
The downside of an online custodial wallet is that the wallet company literally controls your account and makes transactions on your behalf. This creates a potential security risk. If, either through a hacker’s attack or internal action, a bad actor gains entry into the wallet’s internal systems, they are able to steal money from all the users accounts. This is the way that every failed Bitcoin wallet or exchange (including Mt Gox) has been compromised.
The best online custodial wallets mitigate this risk through various mechanisms including cold storage, physical and IT security, multi-sig accounts and insurance, but it is impossible to completely eliminate the risk that a sufficiently determined and patient attacker who has access to internal systems can compromise all accounts. The more successful a wallet becomes, the greater the prize available to a successful attacker, with the same level of work to breach the system.
The original Bitcoin wallets were client wallets and were all user-controlled. User-controlled wallets never have control over customer funds, so they look more like software than like a financial institution. An analogy might be an online safe to which only the customer has the key. Client wallets run the risk of loss if the computer or phone where the client is installed is lost or stolen.
Blockchain is an online, user-controlled wallet. It runs in the cloud, so it does not expose a user to risk of Bitcion loss if a computer or phone is lost.
The downside of user-controlled wallets is that they cannot help a user if they forget their password, in the same way that a safe manufacturer cannot help a customer if they forget their safe combination. Also, because user-controlled wallets cannot transact on behalf of their users, they need to work through third parties to help users buy and sell bitcoin.
However, a user-controlled wallet is a less attractive target for theft/hacking. Instead of breaching a single internal “master system”, an attacker would need to compromise each individual wallet, one at a time, without knowing in advance which wallets are empty and which have high balances. Under this model, the amount of work an attacker has to do scales with the number of accounts, making it a less attractive target for attack.
So to sum it up, our investment thesis is as follows:
- Bitcoin has the opportunity to be a big disruptor in financial services.
- Wallet companies will occupy a central position in the Bitcoin ecosystem since they own the relationship with the consumer. This is the area that has attracted the most VC investment.
- Blockchain is the biggest wallet company and is currently growing faster than the #2 player.
- Blockchain’s user-controlled architecture will prove to be more valuable over time, leading it to maintain and increase its leadership position.
We have spent the last two years carefully studying Bitcoin and have spent time with most of the companies in the space. We have met many excellent management teams and made a few other investments in the space, but with Blockchain we are writing our biggest check so far. We are very excited about working with the team to help Blockchain realize its full potential, and to help Bitcoin realize its full potential!