Many commentators immediately asked, is Bitcoin next?

It seems like the answer is “no”.

The LA Times, writing about the Liberty Reserve Press conference, notes

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U.S. officials were careful to say Tuesday that they were not targeting digital currency systems — so long as they comply with the law.

“If they do so, they have nothing to fear from Treasury,” said David Cohen, the U.S. Treasury’s under secretary for terrorism and financial intelligence.

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Cohen’s full quote is, “In recent years virtual currencies have become a popular method of transferring funds because of the ability to conduct transactions any time, from any location with internet access. I want to make clear that today’s action does not mean that we are trying to eliminate virtual currencies. To the contrary, mobile and internet based financial technology, including virtual currencies hold great promise to empower consumers, encourage the development of innovative financial products, and expand access to financial services. In fact FinCEN issued guidance in March 2013 to bring clarity and regulatory certainty for businesses and individuals engaged in money transmitting services and offering virtual currencies. This guidance explains that under FinCEN’s rules, administrators or exchanges of virtual currencies have registration requirements, and a broad range of effective anti-money laundering record keeping and reporting responsibilities. Those offering virtual currencies must comply with these regulatory requirements, and if they do so, they have nothing to fear from Treasury.”

Furthermore, in a Q&A about DigitalCurrency with American Banker, Jennifer Shasky Calvery, the director of Fincen, says about the Liberty Reserve action:

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I think that action was against one financial institution and one type of financial service. That’s what a criminal case is, that’s what a regulatory action is. It goes against a particular violator. I would be hesitant ever to paint a broad brush because of one criminal action against an entire industry. I don’t think that’s fair to an industry in any situation, let alone this one.

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And later about digital currencies in general:

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What I do think, though, is that digital currencies are exciting because of the innovation around it. I think it shows the great innovation that’s going on in the financial services industry these days, whether it’s a digital currency or whether it’s using other types of technology to improve and extend financial services to those that are unbanked or to make things more efficient or to be able to do things in a different way that has a customer base. That innovation is a great thing. But the fact is that being a financial institution comes with certain responsibilities.

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As I’ve said before, compliance with FinCEN guidance and other regulation is one of the three key elements for building trust in the Bitcoin ecosystem. The other two are having trustworthy people and organizations around your company (including management, directors, advisers, investors, lawyers and bankers) and developing a history of strong security, of withstanding attacks from hackers. With these three elements in place a company in the Bitcoin ecosystem can build trust with users and establish a leadership position.

This may well lead to the slow demise of Mt. Gox. Is this happens it won’t be the first time a Bitcoin exchange has shut down. A recent study showed that 45% of Bitcoin exchanges have closed. Notes Ars Technica:

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Computer scientists Tyler Moore (from the Southern Methodist University, Dallas) and Nicolas Christin (of Carnegie Mellon University) found 40 exchanges on the Web that offered a service changing bitcoins into other fiat currencies or back again. Of those 40, 18 have gone out of business—13 closing without warning, and five closing after suffering security breaches that forced them to close. Four other exchanges have suffered serious attacks but remain open…

An extra risk for customers is losing their money from exchanges closing. Of the 18 closed exchanges, there was evidence that only six reimbursed their customers. Five did not, while there was not evidence enough to make a judgement regarding the remaining seven.

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Hacks are one major killer of exchanges, with regulatory action or the fear of regulatory action (leading to the withdrawal of a banking relationship) being another.

And of course, exchanges are only one source of the total set of losses of Bitcoin through theft, hacks and fraud.

None of this is good for the Bitcoin ecosystem. There is little reason for trust in Bitcoin companies. Although Bitcoin is designed to facilitate transactions between untrusted parties, it is likely that trusted parties will have to arise for Bitcoin acceptance to become widespread. So what is needed to create trusted Bitcoin companies?

One proxy for trust is the set of people and organizations around a company. You are judged by the company that you keep. Companies like Coinbase, Opencoin* and Dwolla are smart to raise money from top tier VC firms as some of the credibility of the investors rubs off on the companies that they invest in. (I realize that this is quite a self serving statement since I am a VC looking to invest in interesting Bitcoin companies). But just as important in building credibility is the experience and reputation of the management team, of the board members, and of the legal representation and banking relationships that a company forms. Reputation is transitive.

Another driver of trust is a companies willingness to accept and embrace regulation in a country with strong rule of law. Bitcoin companies based in the US, the UK, the EU, Japan and other similar countries are more likely to be trusted than companies operating out of countries with weaker legal systems. But it isn’t enough to simply be based in a country with a strong rule of law, companies will need to accept and fully comply with relevant rules and laws to combat money laundering, terrorist financing and so on. Getting the appropriate money transmittal licenses that Mt Gox failed to do, and that FinCEN’s guidance clearly indicated would be necessary, is a good first step.  This will take time and money, but should not put any undue limitations on legitimate companies trying to build Bitcoin into a broadly accepted payment mechanism.

A third driver of trust is developing a history of withstanding attacks from hackers. This takes time by definition, so new startups will need to develop this history. Hackers and fraudsters attach targets that are worth attacking, so in their earliest days new startups will not likely come under too much pressure. But success will attract more attention, and startups need to develop robust defenses, including physical security, network security and well trained and loyal employees to deflect attacks on multiple levels. No company is immune to a successful attack, but many Bitcoin companies have simply not put the resources against security that are necessary, and instead are only reactive to attacks that have been seen already. Mt Gox is rumored to have only three engineers, and only a portion of their time can be spent on security. It is not entirely surprising that they have failed under attack on multiple occasions.

These steps will take time, money and work to build trust on all three levels. But becoming a trusted company in the Bitcoin ecosystem will likely have signficant benefits with both customers and regulators.

What do you think can help build trust in the Bitcoin ecosystem?

* Lightspeed is an investor in Opencoin

At Lightspeed, we are very proud of what the team has achieved in short 15 months since inception. As the founding investor board member I have witnessed first hand an enterprise innovation at Instagram speed. PernixData’s innovative Flash Virtualization Platform (FVP) disrupts the storage market by enabling virtualized datacenters to take advantage of decoupled storage performance from raw capacity. With PernixData’s FVP, companies no longer need to purchase capacity from storage vendors when they need performance. This radical design promises to not only solve the storage performance problem, but also ensures that enterprises can scale out their performance as easily as they scale their compute and memory, without any need to change applications or storage infrastructure.

With more than 30 employees and growing, PernixData has over 50 customers in its beta program globally and is preparing for a public release of the product in the next few months. We believe that customers and partners have been waiting for a solution such as FVP, which positions PernixData to capitalize on a huge opportunity in the enterprise storage market.

If you found this post interesting follow me on Twitter @bipulsinha

It’s no secret that that I see the opportunity for Bitcoin to disrupt multi-billion-dollar markets and dramatically cut transaction costs for people around the world.  We are in the early stages of innovation in this ecosystem, and Lightspeed wants to encourage that innovation

So today, I am thrilled to announce that Lightspeed Venture Partners will anchor the newly created Boost BitCoin Fund. This fund will provide all of the Bitcoin related startups in the next Boost VC incubator class with guaranteed capital.  Joining us an investors in the fund are Rothenberg Ventures, the Bitcoin Opportunity Fund and Ben Davenport.

Boost is a Bay Area accelerator founded by Adam Draper that is currently focused on Bitcoin. Adam is as passionate about Bitcoin as we are.  We are pleased to be working with him to provide some of the most promising early-stage startups in this market with the support and funding they need.

Lightspeed has made several investments in Bitcoin companies already and plan to continue funding companies in the Bitcoin ecosystem as an area of continued focus.

Follow us on Twitter @lightspeedvp @jeremysliew

Check out my article in Network World for a look at the evolution of the SDN market, where we are today and what it means for entrepreneurs http://bit.ly/13eAUMc

Follow me on Twitter @arifj

I think that this is a good thing.

I do not believe that the US Government is out to stop Bitcoin. Some in the Bitcoin community may call me naive. But I believe that the arms of the US Government are primarily interested in their stated functions, not in some grand conspiracy to stop Bitcoin from becoming an alternative currency and payments system. And I think that those stated functions are typically good for society, and good for Bitcoin.

For example, FinCEN is set up to fight money laundering, and to a lesser extent, terrorist financing. I think most people would agree that these are worthwhile aims.

The CFTC’s mission it to “protect the public from fraud, manipulation, abusive practices and systematic risk in commodity future and options markets”. That sounds like a worthwhile aim as well. And the Bitcoin ecosystem has seen plenty of fraud, manipulation, abusive practices and systematic risk in the past. If some degree of regulation can help make Bitcoin a cleaner, safer and better lit place to do business, that can not but help to make Bitcoin a more acceptable alternative for a broader cross section of the public.

The biggest long term driver of value in the Bitcoin ecosystem is its use in transactions. And the biggest driver of widespread use of Bitcoin in transactions will be Zero(ish) transaction costs. But before the public is willing to accept Bitcoin, they need to trust it. And that trust in Bitcoin is largely absent in the broader public right now.

There are many elements that can drive trust. But whether you like it or not, governmental oversight is one of them.

Two of the early drivers of Bitcoin adoption were its decentralized nature, and its anonymity. Governmental oversight will mean sacrificing both of these characteristics. Many of the early adopters of Bitcoin won’t like this. But I think it is necessary if Bitcoin is to achieve widespread use.

Regulation of course carries many dangers. Bitcoin has a PR problem right now. It is thought of either as a wild speculative commodity, or an enabler for illegal or unsavory activities. If the Bitcoin ecosystem does not improve its reputation by rapidly enabling and showcasing a number of positive usecases (perhaps saving the newspaper industry, or ending hyperinflation in a developing world country), then the risk of over-reaching regulation, is high. I worry even more about over-reaching legislation or prosecution driven by ambitious politicians or state AGs, looking for an easy target to beat up on. But that is on us as an industry. We need to enable and celebrate positive usecases, and quickly, for Bitcoin to survive and thrive.

So what do you think? Am I naive, am I a tool of the government overlords, or is more regulation an inevitable part of the path towards widespread Bitcoin adoption?

The US is a relatively stable and strong economy, with good rule of law, good financial technology, low inflation and financial institutions that most people have faith in (although many Bitcoin enthusiasts would beg to differ). But these happy circumstances do not hold in every country in the world. And when these circumstances do not hold, the appeal for Bitcoin is stronger.

Some attributed one of the recent rises in Bitcoin price to worries in Cyprus and Spain about the fragility of their banking systems. There is a good documentary about Bitcoin in Argentina that highlights similar concerns, in that case driven by the economy and inflation.

Inflation, and hyperinflation, is one possible driver of Bitcoin adoption in a country. When holding the local fiat currency entails losing value by the day, citizens will seek alternatives. In Zimbabwe, hyperinflation drove the US Dollar became the de facto local currency even while foreign currency trading was illegal. So there is existence proof that high inflation can drive a whole country to adopt another currency, one that is completely disassociated from the central government. Despite Bitcoin’s volatility, it may serve as a better store of value than a rapidly inflating local currency.

High transaction costs are another possible driver of Bitcoin adoption. This can be especially severe when most transactions are small. Africa presents another example of adoption of a digital currency, or at least a digital form of payments. M-PESA, a payments system enabled on mobile phones, now constitutes 31% of Kenya’s GDP.

As the developing world leapfrogs to mobile, I think that it is likely that we will find some developing countries with the right combination of high inflation, high mobile phone penetration, high transaction costs and weak financial institutions to foster fast Bitcoin adoption. What do you think?

Everyone is going online. Readers were willing to pay for content when it is printed on paper but they want it for free online. Advertisers pay less for online ads than they do for ones in print. Unfortunately, it is only getting worse. Mobile ad units are cheaper and more ineffective than online units, putting even more pressure on newspaper revenues. In the US, newspaper revenues in 2012 were half what they were in 2000.

But it doesn’t get any cheaper to run a quality newsroom – estimated at around $50-100M a year for a single, high quality national newspaper covering regional, national and international news.

Newspapers have responded by erecting paywalls in front of their content. Says, the Economist:

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The number of American newspapers with some sort of paywall has at least doubled this year. More than a quarter of newspapers now have one, and most big groups that do not have plans to charge for digital access. This is a global trend: newspapers in Brazil, Germany and elsewhere are fed up with giving away their articles for nothing on the internet.

Charging for content online used to be the privilege of the lucky few, such as the Financial Times and Wall Street Journal, offering market-sensitive information readers would pay for. General newspapers opposed charging because they feared their traffic would drop—and their fragile digital ad revenues would fall rather than rise….

Newspapers have been heartened by evidence that pay systems can work. In the industry’s most closely watched experiment to date the New York Times adopted a paid-access model in March 2011. It chose a pay “meter”, which is more porous than a hard “wall”, and allows readers to view a certain number of articles each month before having to pay. The advantage of this is that search engines and social media can still direct casual readers to a newspaper’s site. Traffic typically drops by only around 20%, according to J.P. Morgan, an investment bank. This means online advertising revenue can be mostly preserved while readers are required to open their wallets. In October the New York Times and International Herald Tribune, its global sister, had nearly 600,000 paid digital subscribers. …

It is also too early to tell exactly how successful paywalls will be. They may not work at national newspapers without any real comparative advantage in news, or at newspapers in competitive districts where other papers are giving away content free. The Washington Post, which has had a tough time, has opposed a paywall so far, presumably because it worries it will not woo enough paying readers.

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Newspapers have been forced to use paywalls to offer a subscription product because the cost of payments has been too high to be able to charge a penny or two to read a single article. But even a penny to read an article can be the equivalent of a $10 CPM, which is pretty rich for the online world. Would more users be willing to pay to read just what they want, versus being turned off by more expensive subscriptions?  Freemium certainly seems to have won out over subscription in the gaming industry.

Newspapers haven’t had the ability to try true micropayments to see if this could also work for them. The structure of payments costs has simply been too high. By making it possible for a newspaper to charge pennies to read a page, instead of several dollars for a monthly subscription, they may see a dramatic lift in the proportion of readers that they can charge. Whether it is a supplement or replacement for subscription paywalls, it can only add to revenue as it improves the ability to price discriminate.

One of the areas that Bitcoin could revolutionize payments is in micropayments. Since it costs roughly 30c plus 2% for a credit card transaction when the card is not present, it has been impossible to set prices at a few cents for anything. Bitcoin has zero transaction costs. It would have no problem in handling a 1c transaction, or even lower. This could be a huge boon for newspapers, and for online content more broadly.

What do you think, could Bitcoin help newspapers roll out “pay by the drink” payments systems?

One such company, Natera, is a good example of a startup that has brought together doctors, geneticists, statisticians, data scientists and software engineers to leverage both big data and genetics for the improvement pre-natal health.

By combining the power of big data computation and algorithms with world-class genomic science, Natera provides expectant mothers and doctors with information that can improve their chances of having a healthy child.

Natera announced today that it closed $54.6 million in financing to support expansion and continued global rollout of its non-invasive pre-natal test, Panorama™. This new test leverages the power of science and big data to discover chromosomal abnormalities through analysis of a drop of blood from the mother-to-be, eliminating the risk associated with older techniques like amniocentesis and ionic villus sampling, which can lead to complications such as miscarriage. Panorama holds the possibility of reducing and ultimately obviating the need for many of today’s high-risk pre-natal procedures.

From the very beginning of our partnership with Natera, we’ve recognized that they’re poised to completely disrupt the pre-natal genetic testing market while positively benefitting expectant mothers and doctors. The opportunity for Natera to improve lives through cutting edge computer science and big data is a bold proposition, and one that touches many of us personally. In the past, doctors have had to wait until the second or third trimester to conduct many pre-natal tests. By this time, the risk is much higher and the options are far more limited. Natera is completely changing that model by enabling physicians to uncover highly accurate clinical information and data through a simple blood draw as early as six weeks into a pregnancy.

Lightspeed would like to congratulate the entire Natera team on their bold vision and tremendous success to date. We look forward to our ongoing shared journey as Natera continues to transform the way the world conducts pre-natal genetic testing with the combined power of science and big data.

Follow Ravi on Twitter @RMTacct

Mt. Gox understands this. In an FAQ in response to the DDOS attacks on April 24th, the company said:

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“Mt. Gox has been working overtime since February to build a new trading engine which

will be implemented by the end of June. Additionally, since early March we have been

building a new IT infrastructure which will be completed by the end of May.”

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This is pretty exciting news. Here we are at the end of April, so a new trading platform that could potentially support much higher volumes and more robust to hackers attacks may be only weeks away.

But there are many disgruntled Bitcoin traders who are approaching the limits of their patience with Gox’s poor performance, poor service and restrictive limitations on transfer of funds. Will they wait a few weeks for a fix, especially if we see continued outages? It not, the window is short before they look for a new alternative.

One possible future holds that in the next couple of weeks, Gox suffers another  major attack and goes dowm for a protracted period of time. Some group of traders grows impatient and moves en mass to another exchange, creating a new nexus for liquidity. Although there are a number of startup Bitcoin exchanges, the only ones that could reasonable handle the volume in the next few weeks are likely the ones already up and running, btc-e and BitStamp.

Another potential vulnerability might be if Gox comes under investigation by FinCEN or some other regulatory body. In a recent interview on Let’s Talk Bitcoin, Bradley Jansen of Freebanking.org (start listening at 17,14) says:

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“Jensen: “I have heard through the grapevine that FinCEN has prosecutions in the works for Bitcoin broadly speaking.  My guess, based on the timing of the guidance, and what I had heard previously from the rumor mill about the prosecutions, is that FinCEN put out the guidance sort of ex post facto to justify the prosecutions that they’re about to launch.”

I don’t know Jansen, but from his writing he does not come off as someone who is completely impartial; he is an ex regulatory aide to Ron Paul and can definitely be described as “anti governmental control”. But if what he reports is right, then it is reasonable to assume that FinCEN might target Gox. Just due to its market share and longevity, there is a pretty good chance that if any financial crimes have been committed with Bitcoin (and there have been many), that Gox has touched that tainted Bitcoin in some way.

If Gox gets targeted by FinCEN, then this would open the door for a new exchange to capture share. In fact a new exchange with no prior trading history, and hence no risk of prior financial crimes, may be advantaged as it can start from scratch with squeaky clean AML and KYC practices, money transmittal licenses and so on.

But if Gox keeps its liquidity through the period of instability before it can ship a new trading platform, and it is not targeted by FinCEN, then life gets a lot harder for new exchanges. They would need to extract liquidity from a well functioning Gox, a much harder proposition than taking on Gox today. This is not an impossible task as Gox is essentially a “single item” exchange, which is much more vulnerable to loss of market share than an exchange that trades in many different items. But a new exchange will require a well thought through strategy to take liquidity away from Gox. It can’t just rely on a better product.

I’d love to hear what readers think about these scenarios, other scenarios, and possible strategies to extract liquidity from Gox.