Bitcoin Gets Big Bets From Tech Industry

People in Silicon Valley like to say it’s not about the money; it’s about changing the world. But with Bitcoin, it’s about changing the money to change the world.

Dot-com pioneers and fresh-faced 20-somethings alike are founding companies to help transact the virtual currency. A nationwide network has formed for angel investors keen on backing such startups. And the Winklevoss twins of Facebook fame plan a Bitcoin investment fund.

But what is “virtual currency,” anyway? And are those chasing Bitcoin headed for a gold rush, or fool’s gold?

Nick Holland, a Javelin Strategy analyst in Boston, is among those who believe math-based currencies like Bitcoin, which enable transactions from one user to another without official oversight or high fees, could upset the centuries-old tradition of paper money – much as user-generated Wikipedia all but replaced the venerable Encyclopaedia Britannica.

Bitcoin was created in 2008 by a programmer (or group) using the pseudonym Satoshi Nakamoto. Nakamoto envisioned a peer-to-peer computing network of interconnected users that could oversee the creation of a digital currency independent of any central authority, then regulate its trade.

Nakamoto capped the number of bitcoins that could exist at 21 million. And to keep the market from being flooded, Nakamoto set up a system in which new bitcoins could only be minted, or “mined,” by solving complex mathematical puzzles.

Once a miner believes he or she has solved one of those puzzles, a message goes out to the entire network. If other users agree with the solution, new bitcoins are added to a public ledger that keeps track of the number in existence; that number currently stands at just over 11.4 million.

The Nakamoto system varies the difficulty of each puzzle so that, on average, a new block gets mined every 10 minutes, keeping the supply predictable. For his trouble, the successful miner then pockets a bit of the new Bitcoin, which he can sell or trade with other users.

The phenomenon was largely restricted to hardcore geeks until last spring’s financial crisis in Cyprus. With the Mediterranean nation’s government unable to guarantee bank deposits, some investors liquidated their savings into Bitcoin by linking their bank accounts to Bitcoin transfer services.

“That was kind of the catalytic event that pushed Bitcoin into the forefront,” Holland said. It also helped create a frenzied run-up in the price, from around $14 per coin to more than $230; as of Friday afternoon, it was trading around $95 on the various online exchanges that have sprung up to let users buy and sell the currency.

Bitcoin skeptics, to be sure, abound. California finance officials in June sent the Washington, D.C.-based Bitcoin Foundation a cease-and-desist letter asking if the group was conducting money transfers without a license. Officials with the foundation, which was formed in September, say they’re simply in the business of developing certification guidelines for Bitcoin companies.

That such guidelines have yet to be formed reflects one of the chief concerns regarding the technology: its Wild West atmosphere.

During Bitcoin 2013 – held in San Jose in May and billed as the currency’s first major U.S. summit – an organization called Bitcoin Not Bombs urged nonprofits to adopt the virtual payment system, trumpeting that it “cannot be manipulated by any government, bank, organization or individual.”

The libertarian aspect may appeal to Silicon Valley’s ethos. But it also led Homeland Security officials in May to briefly seize some assets of Tokyo-based Mt. Gox, the largest Bitcoin exchange, for not complying with money-laundering laws.

Critics note that transactions in the currency are anonymous, which has enabled the sale of illicit weapons and drugs. And because the coins are stored in online “wallets,” there have been reported instances of hackers wiping out a user’s holdings.

Many Bitcoin backers concede that adult supervision may be required if it is to gain broader use and trust.

“All these exchanges have realized, ‘I have something really valuable here. I’d better follow the regulations,’ ” said Alex Ferrara, a tech investor with Bessemer Venture Partners in New York. Though he’s waiting to bet on any startups in the space, he believes that “for Bitcoin, going legit will be a good thing.”

Another sign of that mainstreaming effort came in April, when the Winklevoss brothers announced they’d amassed about 1 percent of all bitcoins in circulation. They’re now seeking federal approval to let investors buy into that hoard via shares in a public investment fund.

While it’s unclear whether regulators will sign off on the untested concept, Bitcoin is increasingly finding favor with merchants that range from blogging site Reddit to watch manufacturer Raketa. Earlier this year, two hackers in Los Angeles unveiled PizzaForCoins.com, which lets people use bitcoins to buy pies from nearby Pizza Hut and Domino’s locations.

“Bitcoin will make a dent in society when more normal transactions occur that would have occurred with dollars or credit cards,” said Garry Tan, a partner at Mountain View, Calif. startup foundry Y Combinator. He’s an adviser to Coinbase, a San Francisco startup that holds the record for the most venture capital pumped into a Bitcoin company (more than $6 million at last count).

Ferrara, the venture capitalist, thinks that day is still far off, noting that turning bitcoins into cash requires a transfer service such as BitInstant, which charges high fees, or a go-between like Coinbase, which limits how much users can transact unless they provide reams of information to comply with banking laws.

Still, Ferrara is bullish on the technology’s disruptive potential, which he said evokes that of Skype.

Michael Terpin, co-founder of the new BitAngels investment network, hearkens back even further to the last time he saw promise like Bitcoin’s. Terpin attended the San Jose conference in May, and noticed that it was held in the same room as the first Internet World trade show.

“I got the same kind of evangelism and hopes for incredible growth as I got in 1994, when I found little 10-by-10 booths for Yahoo and Lycos,” he said.

Regarding Bitcoin, he said, “Now the question is, can they maintain that growth – and surmount the regulatory issues?”

Bitcoin By the Barrel:

Here are just some of the many startups that have arisen to help people use the virtual currency Bitcoin.

• BitInstant (New York): Platform for instantaneous Bitcoin transfers.
• Bitpay (Atlanta): Lets customers of businesses ranging from software-makers to auto dealerships make payments in Bitcoin, then transfers cash to those merchants.
• Coinbase (San Francisco): Makes a “virtual wallet” that lets users buy bitcoins and pay for goods and services with it.
• CoinLab (Seattle): Backed by Silicon Valley investor Tim Draper. Recently tried teaming with leading Bitcoin exchange Mt. Gox, based in Tokyo; the partners, however, are now in court.
• Lamassu (New Hampshire): Has developed an ATM to instantly turn dollar bills into bitcoins.
• OpenCoin (San Francisco): Co-founded by E-Loan’s Chris Larsen, it has created a payment system to transact various currencies, including dollars, Bitcoin and a new alternative, Ripple.
• Tradehill (San Francisco): Runs a Bitcoin exchange that competes with Bitstamp, BTC-E and Mt. Gox, among others.

SOURCE: San Jose Mercury News research