December 7, 2013
The extent to which Bitcoin could survive and grow without government approval was on display in Buenos Aires, at the first conference hosted by Bitcoin Argentina. The group had been founded by Wences Casares’s old friend Diego along with a partner he had met at a Bitcoin Meetup earlier in the year. For the conference the men had booked a big hotel in downtown Buenos Aires and managed to sell four hundred tickets, with about 40 percent going to foreigners like Roger Ver, Erik Voorhees, and Charlie Shrem.
The ticket-buying process itself had put a spotlight on one of the most promising Bitcoin startups to emerge from Argentina and one of the first companies anywhere using the network to legally provide a service that wasn’t possible with the traditional financial system.
In Argentina, credit card transactions with foreigners, like the sale of conference tickets to Americans, normally took a long and expensive route before paying out in Argentina. The American customer’s credit card company would deduct around $2.50 from the $100 ticket price to send the money to Diego’s Argentinian bank. From there, the Argentinian bank would generally charge another 3 percent for the foreign exchange, leaving $94.50. The big hit, though, happened when the Argentinian bank turned the dollars into pesos. If Diego converted the $94.50 with a money changer on the street he could have gotten the unofficial rate of around 9.7 pesos for each dollar, leaving him with 915 pesos. But the bank exchanged the money at the official exchange rate set by the government—6.3 pesos at the time of the conference—giving him, instead, 595 pesos. On top of that, Diego’s bank wouldn’t give him those pesos until twenty days after the customer purchased the ticket.
The Argentinian Bitcoin startup, BitPagos, provided a clever way around this expensive morass. BitPagos took the $100 credit card payment in the United States and charged a 5 percent fee. But instead of transferring the remaining $95 to an Argentinian bank, BitPagos used the dollars to buy Bitcoins in the United States. BitPagos then transferred the Bitcoins directly to Diego. He could either keep the Bitcoins or exchange them for pesos at the unofficial exchange rate, thus ending up with around 920 pesos, instead of 595. And rather than taking twenty days, BitPagos gave him his Bitcoins in two days.
BitPagos had been started earlier in the year by two young Argentinians, a man and a woman, who had been running a consulting company and struggling to take payments from foreign customers. In addition to collecting ticket payments for the foundation, the new company was getting traction with hotels that took money from foreign tourists and didn’t want to pay the cost of getting those payments into pesos. By the time of the conference, BitPagos had already signed up around thirty hotels. Most of these hoteliers didn’t care about the ideas behind a decentralized currency; they were just happy to find a way around the expensive tollbooths that littered the Argentinian financial system. As an added bonus, they could end up with money in Bitcoins rather than the rapidly depreciating peso.
This was an eminently practical use of Bitcoin to deal with the inflationary mess in Argentina, but it was so practical that it actually swung around into the domain of the ideological ambitions that Satoshi Nakamoto and the Cypherpunks had imagined. The Argentinian hoteliers might not have been libertarians, but they would have easily understood Satoshi’s early writing about Bitcoin, which explained that “the root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust.” Mismanagement of currencies was a part of daily life in Argentina.
The conference in Argentina attracted many of the more ideologically minded Bitcoin followers from around the world. The old team from BitInstant gathered for a reunion of sorts and the team members were all given prominent speaking spots. They lived it up in Buenos Aires, eating steak, drinking Argentinian wine, and going to a tango performance with the other presenters at the conference. But for them and most of the foreigners at the conference, the most memorable thing about the event was not a part of the official proceedings. Everyone coming into the Hotel Melia, where the conference was held, passed two teenagers, a boy and a girl, whose wispy, almost ethereal features gave them away as twins. Both of them were wearing the same white T-shirt with the word Digicoins on the front, and both asked people entering the conference, in a gentle voice, if they wanted to buy or sell Bitcoins. Those who took them up on the offer were guided to a Subway sandwich shop across the street. There at a table sat a man with wavy silver hair, dark eyes, a computer, a white shirt unbuttoned enough to reveal his chest hair, and a backpack full of cash.
The man, the father of the twins, had his Bitcoin wallet up on the laptop and he could change money in either direction, in much the same unofficial way as all the other black-market money changers on Buenos Aires street corners. Dante Castiglione, the owner of Digicoins, had not created Digicoins just for this conference. He had, by this time, been serving as one of Argentina’s most successful virtual-currency exchangers for a few months. His twins were his runners, going out into the city each day to visit the customers in need of pesos or virtual currency. When people asked about his business, he was stingy with details and gave a wry smile, as if to ask, “Why do you think I’m doing this?” But he was willing to say that this was only the latest stop in an itinerant career built by finding opportunities in Argentina’s broken financial system.
“I am a working man,” he would say when pushed. “We are trying to give our service. We are earning our food and our rent.”
Bitcoin’s evolution in the United States and China was showing how the technology could become dependent on the official financial system and government approval. Argentina, on the other hand, was showing how it could develop without any of that. It certainly moved more slowly, but there was something more tangible and grounded about what was being created.
THE MAN WHO had gotten this ball rolling in Argentina, Wences, couldn’t make it to the conference in Buenos Aires. At the time, he was finalizing the sale of his most recent startup, Lemon, for $42.6 million. When he wasn’t winding down his work with Lemon, he was working on the new Bitcoin company he was creating with Fede Murrone, his longtime collaborator in Argentina.
The core of the new business was the system that Wences and Fede had begun developing early in the year to store their own, significant holdings of Bitcoin, having come to distrust Mt. Gox and the other available services. Their main goal had been to get the private keys for all their addresses off any computer hooked up to the Internet. Wences and Fede had begun by putting their private keys on an offline laptop and storing that laptop in a safe-deposit box at a bank in California; this allowed them to delete all the private keys from their online computers.
Over the course of 2013, the value of their Bitcoins had grown, as had the number of people who heard about their system and asked to store Bitcoins on the laptop. This had provoked Wences and Fede to take more and more strenuous measures to secure the private keys. First, they encrypted all the information on the laptop so that if someone got hold of the laptop that person still wouldn’t be able to get the secret keys. They put the keys for decrypting the laptop in a bank near Fede in Buenos Aires. Then they moved the laptop from a safe-deposit box to a secure data center in Kansas City. By this time, the laptop was holding the coins of Wences, Fede, David Marcus, Pete Briger, and several other friends. The private keys on the laptop were worth tens of millions of dollars.
The interest shown by friends suggested to Wences that there was a broader need for a more reliable way to store Bitcoins. People didn’t want to hold the private keys on their home computers, but they also didn’t trust Mt. Gox and Coinbase to keep digital files worth millions. The vault, as Wences and Fede called it, was just a starting point. Wences imagined that this would be the first offering in what would become a full-service Bitcoin company that could provide a place for people everywhere to store and spend their coins. Unlike the previous startups that Wences had started and sold, this one was intended to be his lifework—the last company he would ever found. He called it Xapo, a name that he and Fede settled on after looking for a simple, distinctive word for which the dot-com domain name was available.
Wences initially had little interest in taking money from investors for this company. He didn’t want to give control to anyone else and he had enough money to pay for it all himself. But over the fall of 2013, his friends convinced him that starting a company without investors would deprive him of all the connections and marketing possibilities that funders bring.
The value of having investors became very clear to Wences the same day that he completed the sale of Lemon, when Coinbase announced that it had raised $25 million from Andreessen Horowitz to grow the company. It was the biggest public investment in a Bitcoin company, by a good margin, and Coinbase reaped the reward in new customers and attention.
A few days after this, Wences journeyed to San Francisco to meet with Benchmark, a venture-capital firm that had been vying with Andreessen Horowitz to invest in Coinbase. Wences had been friendly with the Benchmark partners for some time, and he had hoped he might find an opportunity to work with them. One of them was the brother-in-law of Fortress’s Pete Briger.
The meeting at Benchmark’s offices was unlike Wences’s earlier fund-raising efforts. This time, he laid out what he needed from Benchmark to make it worth his while. After Wences’s presentation, the Benchmark team huddled briefly and then offered to put $10 million into Wences’s company, valuing it at $50 million. As in all of Wences’s past startups, there was no term sheet, just a handshake.
When Wences walked out, he immediately called his old friend Micky Malka to tell him the exciting news. Micky responded not with excitement, but instead with pique, because Wences hadn’t offered Micky and his firm, Ribbit, a place in the deal. After demanding an opportunity to put $10 million into Wences’s company, Micky finally settled for $5 million. A short while after that, Pete Briger called to demand a place in the round too, and Wences agreed to let him put in $5 million. This left Wences with $20 million before he even had a functioning business.
DURING HIS TWO-WEEK stay in the United States, Bobby Lee visited his brother Charlie, who had quit his job at Google over the summer and joined Coinbase to work on Bitcoin full-time. Bobby showed up at the company’s makeshift offices in a converted three-bedroom apartment a day after the company announced the $25 million investment from Andreessen Horowitz.
Charlie Lee didn’t need to work another day of his life. Litecoin, his alternative cryptocurrency, which was a slightly faster, lightweight version of Bitcoin, had now become the second-most-popular cryptocurrency in what was becoming an increasingly crowded field of Bitcoin knockoffs. In part because of Charlie’s transparency in launching Litecoin, people trusted it and were betting that it would be, as Charlie had intended, the silver to Bitcoin’s gold.
In November the value of all the outstanding Litecoins had briefly surpassed $1 billion. The particular computer chips that were good for mining Litecoins were sold out at nearly every online electronics retailer. Charlie had been mining Litecoins since the beginning, so he owned a sizable number of the coins, along with his significant Bitcoin holdings. His work at Coinbase was primarily due to his desire to help bring virtual currencies into the mainstream.
Charlie saw that Bitcoin had done similarly good things for Bobby. Despite all the long hours and uncertainty Bobby had endured over the last few months, his position as a CEO, after years in middle management, had given him a confidence and self-assurance that seemed to outweigh the stresses of the job.
Bobby had spent much of his time in the United States looking for new investors and partners for BTC China. But he was still trying to figure out what the People’s Bank of China statement on December 5 would mean for his company moving forward. On Bobby’s exchange, the price of Bitcoin had fallen from the all-time highs, but it stabilized at around 5,500 yuan, or $875, on Western exchanges. Bobby learned from his staff that the December 5 statement had come about after the enormous price spike in November. Several reports had gone up to the State Council, the highest administrative authority in China, and one of the four vice premiers of the council had ordered the People’s Bank to do something about the situation. As is generally the case in China, the whole process was enshrouded in secrecy and seemingly driven by officials trying to protect their backs.
On Bobby’s last night in the United States, his government-relations guru, Ling Kang, called again. The payment processor Tencent had just called BTC China to explain that Tencent was going to stop doing business with Bobby’s exchange in the next few days. Bobby was furious. Tencent had previously agreed to provide at least a ten-day notice of any changes. That night, he called everyone he could think of to argue his case. But he and Ling heard back that Tencent had gotten orders directly from the local branch of the People’s Bank and there was no fighting it.
When Bobby flew back to China the next day, everyone at his company was scrambling to get a new payment processor set up before Tencent shut the company off on Sunday at noon. But it now appeared that the problem wouldn’t end with Tencent. Bobby learned that all the payment processors had been called to the People’s Bank on Monday to discuss the issue.
The Monday meeting did not generate any official change in policy or new documents. But the real-time reports from the meeting that Bobby’s team was receiving revealed that the payment processors were all being encouraged to reconsider any business with Bitcoin companies. As the rumors began to leak, the price dropped, falling to around $600 on Western exchanges. Two days later, when Bobby officially confirmed that his company would stop taking new deposits, a new sell-off began, taking the price down to $430 on Bitstamp and 2,100 yuan on BTC China, or less than a third of what it had been at the high just two weeks earlier. Whereas 100,000 Bitcoins had been trading hands daily on BTC China a few weeks earlier, now the trading volumes were less than a tenth of that.
Bobby was in back-to-back meetings with his staff contemplating ways to stay alive without the payment processors. One of the other Chinese exchanges, Huobi, began taking in customers’ money through the personal bank account of the company’s CEO. The December guidance from the Chinese central bank seemed to bar banks from working with Bitcoin, but Bobby was surprised to see that the banks eagerly took the business from his competitors. Bobby’s Chinese deputies explained that the banks were doing this because, unlike the payment processors, they had not been called into a meeting and warned not to work with Bitcoin. Whereas in the United States, banks were unwilling to do work unless they were explicitly given a green light by regulators—and sometimes not even then—in the Wild West of China, the banks would try just about anything until they were explicitly told it was not allowed.
Bobby, though, had worked most of his adult life for American companies and he was uncomfortable skirting the rules. The best alternative seemed to be some sort of voucher system, in which third-party vendors would sell credit for BTC China, similar to the way vendors sell cards with cell phone minutes. But as his staff rushed to get this set up, Bobby watched customers flock to the competitors who had set up bank accounts. In China, scrupulously following the rules seemed to be a recipe for losing business.
EACH NEW RUN-UP in the price had drawn new and more sophisticated scrutiny of the principles underlying Bitcoin, and the December rise and fall were no different. This time, the people training their sights on Bitcoin were some of the highest-profile economists in the United States—including Paul Krugman, the progressive Nobel Prize winner; and Tyler Cowen, the prolific libertarian-leaning blogger. Few of them had much good to say.
Krugman focused largely on Bitcoin’s claim to be a currency, given the difficulty it seemed to have fulfilling one of the basic roles of money: serving as a reliable store of value. Why would people store their wealth in Bitcoin if they knew the value was going to fluctuate so violently? Krugman asked.
Cowen, meanwhile, argued that Bitcoin was going to have difficulty sustaining its value as new and better-designed cryptocurrencies came along and drew users away from it. Some people were, indeed, already choosing to hold Litecoin, Charlie Lee’s creation, and a hip, younger cryptocurrency, Dogecoin.
But a deeper strain lurking beneath these critiques was an awareness that one of the fundamental premises that had driven Bitcoin’s popularity seemed, increasingly, to have been disproved. Many early Bitcoiners, particularly in the libertarian camp, had believed that the Federal Reserve’s efforts to stimulate the economy in the wake of the financial crisis, by pumping lots of new money into banks, would devalue the dollar and lead to high inflation, similar to what had happened in Argentina.
This idea made a scarce asset like Bitcoin or gold look like a safer bet than holding dollars. But in late 2013 none of the fears about inflation had been borne out. In fact, the problem facing the American economy was not inflation, but deflation, because banks were holding much of the new money, rather than putting it out into the economy. The Fed’s stimulus program had been successful enough that the European and Japanese central banks were now copying it. This was a living economics experiment and it didn’t seem to be going the way libertarians expected. At the same time, the scarcity of Bitcoins still had the effect that early critics had warned about: it was encouraging people to hoard Bitcoins rather than actually use them.
Perhaps the most stinging criticism came from a well-known British science fiction writer, Charlie Stross, who wrote out a long list of Bitcoin’s potentially damaging effects, of which some were intended by the Cypherpunks (for example, tax evasion and weakening government social-welfare programs) and some were not. Stross noted that in the latter category, the hoarding encouraged by Bitcoins’ scarcity was leading to a vast inequality in the holdings of Bitcoins, “to an extent that makes a sub-Saharan African kleptocracy look like a socialist utopia.” Indeed, a few Bitcoin holders, like Roger Ver and Wences Casares, owned a material proportion of all the outstanding coins. This was unlikely to sit well with the Occupy Wall Street crowd, who objected to the undue power of the wealthiest 1 percent of the population.
The Bitcoiners had their ready responses to all these critiques and voiced them loudly. Bitcoin’s volatility would go away as it matured, the believers said, and Bitcoin had a first mover advantage against other cryptocurrencies that was showing no signs of abating. Meanwhile, inflation might not be a problem in the United States yet, but it was a problem in other countries.
Whatever the merits of the criticisms, they did not seem to be dulling the growing curiosity about Bitcoin within major financial institutions. The most notable name to show signs of interest was Wells Fargo, perhaps the nation’s most successful and most respected bank in the wake of the financial crisis. After the Senate hearings in November, Wells Fargo executives had reached out to Pete Briger to reopen the conversation about working together on a Bitcoin exchange. One sign of Wells Fargo’s openness was that executives of the bank agreed to travel to Fortress’s headquarters in New York for the meeting. Briger rounded up a team of people to make the case for Fortress, one that included Wences and others who flew in from California.
Fortress put aside a grand conference room on the forty-seventh floor of its Manhattan headquarters, and executives from several divisions of Wells Fargo showed up. Once the dozen or so people were gathered around the conference room, Pete stood up and made his basic pitch to the Wells Fargo team. He explained why the Fortress team was so intrigued by the technology and pointed at the smart people around the table, such as Wences, who had thrown themselves into it. He hinted that Wells Fargo should be keeping up with Bitcoin, given the potential for the new network to challenge some of the basic services, like payment networks, that the bank was providing. Pete closed by talking about the lack of an American-based regulated exchange for Bitcoin—something that Fortress and Wells Fargo could provide together.
The questions from the Wells Fargo executives did not reveal much about how serious the bank was about the project, but they had clearly done their homework and came with detailed questions about what exactly an exchange would look like and how it might satisfy regulators. The meeting concluded with an understanding that the bank would take it all under consideration.
The potential advantages of Bitcoin over the existing system were underscored in late December, when it was revealed that hackers had breached the payment systems of the retail giant Target and made off with the credit card information of some 70 million Americans, from every bank and credit card issuer in the country. This brought attention to an issue that Bitcoiners had long been talking about: the relative lack of privacy afforded by traditional payment systems. When Target customers swiped their credit cards at a register, they handed over their account number and expiration date. For online purchases Target also had to gather the addresses and ZIP codes of customers, to verify transactions. If the customers had been using Bitcoin, they could have sent along their payments without giving Target any personal information at all.
During this period, it was notable that some of the most encouragingly positive statements about virtual currencies came out of branches of the Federal Reserve, the archetype of the central bank that Bitcoin had set out to supplant. Fed officials didn’t love the idea of a currency outside the control of governments, but they were very eager to see methods of moving money that cut out middlemen, who introduced risk into each transaction and into the financial system. The Fed had, in fact, been making increasingly vocal calls for technology that would allow more direct methods of moving money. During late 2013 and early 2014, a number of branches of the Federal Reserve put out papers discussing the potential for the blockchain technology to eliminate risk in the financial system, if this technology could be harnessed properly.
“It represents a remarkable conceptual and technical achievement, which may well be used by existing financial institutions (which could issue their own Bitcoins) or even by governments themselves,” a Bitcoin primer released in late 2013 by the Federal Reserve Bank of Chicago said.
Bitcoin’s use as a new, more secure, and more private way to make payments online was given a big boost in early January 2014 when the online retailer Overstock announced that it would begin accepting Bitcoin for all purchases. The eccentric chief executive of Overstock, Patrick Byrne, had a PhD in philosophy from Stanford and was an outspoken libertarian. He clearly had political motivations for taking Bitcoin, hoping to get the country out from “under the thumb of Wall Street oligarchs,” as he put it. He also pointed to all the eager Bitcoiners looking to spend their money with anyone who would take the currency. But in interviews he emphasized the more practical reasons for any company to make the move: no more paying the credit card companies 2.5 percent of each transaction (the company helping Overstock take Bitcoin, Coinbase, charged Overstock 1 percent); no more dealing with chargebacks from customers who received shipments and then disputed the charges; and no more worrying about holding lots of sensitive financial information for customers. On the first day, Overstock processed more than $100,000 in orders paid for with Bitcoins.