Go small: Bitcoin and microtransactions

Bitcoin has been hailed as the saviour of microtransactions, small payments of cents or even less that up until now have not been an option due to simple economics. Traditional online payment methods charge fees for transactions that they process, be it mobile payments, credit card transactions, or direct transfers. You’re not going to pay 2 cents cost for a 2 cent transaction, are you? Enter Bitcoin, a frictionless, decentralized system that allows anyone to send any amount of money anywhere in the world for little or no cost. Hello, efficient and cost-effective microtransactions.

Only it doesn’t work like that.

Bitcoin is not useful for microtransactions.

Here’s why: On the Bitcoin blockchain, most payments will eventually need to include a transaction fee to incentivize the miners. Why do miners need to be incentivized? Because running the powerful computers that perform the validation functions is expensive, due to the hardware needed and the electricity consumed. Miners get rewarded with new bitcoins every time they successfully validate a block, but the amount of bitcoins they get halves every four years and will eventually reach 0. Transaction fees, a sort of voluntary “tip” added on to each transaction, will become more important to the miners – if there’s no transaction fee attached, they might choose to leave your transaction out of the block, in favour of a more lucrative operations. And as the block size limit is approached (unless the community can agree on an increase), space will become scarce and allocated to those transactors willing to pay extra. Transaction fees, however small, make micropayments less viable.

image via IMAX
image via IMAX

Yet nature, sorry, programming abhors a vacuum. Brilliant minds are working at coming up with a way to make micropayments easy and cheap or even free.

One of the most-talked-about micropayment solutions is the Lightning Network. This proposal is an efficient way to process transactions, even micro-transactions, faster and cheaper than one can on the blockchain. It’s a clearing network that sits on top of the blockchain, and eventually settles on it. But until then, it can pass around payment information in a secure and trust-less fashion (trust-less means that you don’t need to know or even trust your payment counterparty). And because there are no miners that need incentivizing, transaction fees are low or even non-existent.

To understand this better (because it’s darn complicated), visualize a Bitcoin earth with lots of payment channel spikes leading up to little moons. Each Lightning user can have one or several spikes. If he or she has several, each leads to a different moon. It’s a bit like having several bank accounts, or several bitcoin wallets. Your choice. And the moons have thin tunnels leading to some of the other moons. In my case, say I have only one spike (I’m a simple soul, really). I upload some bitcoin to my spike. Say I want to send a payment to you via these payment channels. The transaction goes up to my moon, which then figures out the quickest route through the thin tunnels to your moon. It then trickles down your spike to you.

This may sound inefficient, but it’s not, and it’s how the Internet works today. This packet of information that you’re reading found its way to your screen via a convoluted yet efficient route of hubs, it didn’t get to you directly. But it got to you quickly.

So, since the transaction is just between me and you, and doesn’t have to be broadcast to all the nodes, it’s almost instantaneous. And, since no miners are involved and there are virtually no costs (except perhaps a payment channel creation and/or maintenance fee), it’s almost free. When we’re done transacting, we can bring the transactions back down to the Bitcoin earth for settlement. It is not as secure as Bitcoin, but with microtransactions, that shouldn’t be an issue worth worrying about. And it is much more convenient.

The Lightning Network is in development, with no release date announced yet. But the idea is generating buzz amongst developers and Bitcoin enthusiasts alike, who see it as a way to make Bitcoin more efficient without losing the decentralisation. Stand-alone implementations (that don’t need the blockchain) are being built for testing, and crypto think-tank/developer  Blockstream has started Lightning application development.

Strawpay’s Stroem protocol (a Swedish company, be grateful that they didn’t insist on Ström) is very similar, with a few technical differences that I confess I don’t quite understand yet (working on it). They seem to be a bit further along the development rail, but they are making a lot less noise and receiving a lot less attention. Amiko Pay is another potential contender for a role in Bitcoin micropayments, but it is in early stages still.

So who will be the first to launch? My money is on Lightning. Keeping hefty brainpower focussed takes money, as even programmers need to eat. I mentioned earlier that Blockstream has begun work on the Lightning Network, hiring a specialized developer. Late last year Blockstream secured a $21 million funding round from 40 investors, including top venture capital firms. A few months ago Strawpay received a 500,000K (about $60,000) grant from the Swedish government, which is better than nothing, but probably won’t last very long.

The race is on, and the stakes are high. If we have access to an efficient micropayment platform, imagine what that can do for the media industry. It will be possible to pay per article read. The music industry could find a viable, fair business model. We could pay cents for each song listened to, and artists could receive income directly from listeners. Telephone bandwidth in which you pay by the minute, streaming in which you pay by the episode… With minimal overheads, the costs to the consumer would be low and proportional to consumption. With minimal overheads, the creators or originators receive more for their creation or service. And the economic boost to the intersection of creativity and quality will have ripple effects in culture, business and finance. Exciting.

Where’s the knife? The possible repercussions of a hard fork

A hard fork in Bitcoin is nothing new, and is generally not a problem. But the launch of BitcoinXT and the controversy surrounding the block size increase has given the phrase “hard fork” a sinister tone, with some claiming it portends the end of Bitcoin as we know it. Should we be worried?

photo by Alejandro Escamilla for Unsplash
photo by Alejandro Escamilla for Unsplash

First, some background. A hard fork is a change to the current Bitcoin Core protocol, the “program” that defines how Bitcoin is run by the mining nodes. The change is such that nodes running the previous protocol will reject new blocks created on the new protocol as invalid. So, some nodes will not add a block onto the chain, while other nodes will. Chaotic, confusing, and risky, as it’s possible that bitcoins spent in a new block could then be spent again on an old block (since the nodes running the previous code would not detect the spending on the new code, which they deem invalid).

Hard forks happen when a bug has been found: the programmers fix it, and inform the nodes that they need to switch to the new version. The old version is vulnerable to the bug, so a change to the new version is imperative. “New” blocks will not be valid on the “old” chain. Hard forks can also happen when a policy change needs to be made. When a hard fork happens, everyone switches as soon as possible to avoid the chaos described above.

So, no problem. However, a hard fork can come with controversy attached, as with the block size increase, which is an important component of the protocol. The current block size is 1MB. While bitcoin transactions are currently taking up less than half that, the use is growing. Some developers strongly believe that a block size increase is urgently needed, so urgently that they are urging a hard fork which will increase the limit by a factor of 8. Others think that a block size increase is a bad idea, that we should let the block sizes fill up and allow economics to regulate supply and demand. Bitcoin transaction fees would rise, as only the “profitable” ones will be allocated the scarce space. Others have no problem with a block size increase, but argue that a factor of 8 is either too much or too little.

Most developers seem to recognize that an increase is necessary, but that consensus is vital. There seems to be a consensus that we need a consensus (sorry, couldn’t resist). Why is consensus so important? Because without it, we could end up having two or more Bitcoin protocols. Coins could be spent and mined on one of two or more chains. This could lead to not only confusion and a collapse of the bitcoin price, but also to double-spending and fraud. If I spend my bitcoins on one chain, and it’s verified, I could also spend the same bitcoins on another chain, which will not have the information from the first chain.

The resulting lack of trust, combined with the fall in price, could well kill Bitcoin’s future.

For the first time since Bitcoin’s launch, a split Bitcoin community looks possible. It’s not because of a looming hard fork. Whatever size increase is agreed upon, a hard fork is necessary. The hard fork itself is not the problem. The main worry is the acceptable definition of “consensus”.

In August, Mike Hearn and core developer Gavin Andresen launched BitcoinXT, which will implement an increase to 8MB on the 6th of January 2016, if 75% of the nodes agree. The problem here is the threshold of 75%. Until now, the threshold necessary for implementation of the new Bitcoin protocol has been 95%, since everyone can agree that that is more or less unanimous. Yet if even if 75% agree, 25% choosing to stick with the current Bitcoin Core is still enough to maintain its own chain and thus cause a split. Two “current” bitcoin chains would not be good.

But don’t miners have to add blocks to the longest chain? Wouldn’t “old-school” miners have to add to the longer, newer chain? And wouldn’t that sort things out automatically? No, “old-school” miners have the obligation to add blocks onto the longest valid chain. And for them, the new chains are not valid. So they would continue adding blocks to the old chain. And 25% of miners doing so is enough to make that chain a viable alternative to the newer one.

This is a huge issue, which goes much deeper than the actual technicality of the amount of transactions that can fit in any one block. This issue speaks to the governance of Bitcoin. Bitcoin theoretically doesn’t have any governance, it is a decentralized network run by the network’s many operators. A team of core developers maintains and updates the code, relying on consensus to push forward. Decisions have been made with the well-being of Bitcoin in mind. Up until now, pretty much everyone has been able to agree on what that requires.

The move by BitcoinXT’s promoters is motivated by the conviction that if their plan is not adopted, then Bitcoin will fail. Hence the need for an urgent hard fork, with a lower consensus threshold.

It’s risky.

But it might happen. So far BitcoinXT has only received explicit support of 10% of the mining community. However, the underlying premise of BitcoinXT seems to be popular, with most of the “big players” in the sector behind it (Xapo, Circle, BitPay, Blockchain.info, Bitnet and others). That means that mining support could well increase significantly over the next few months. If that happens, more miners will sign on, “just in case”, which will gather momentum towards the 75% threshold. And if that is passed, two weeks later, the new block size limit of 8MB is in place, and Bitcoin has a hard fork.

It is very likely that consensus will be reached, simply because everyone has so much to lose if trust in Bitcoin fails. Yet the debate does highlight the difficulties in running a growing yet decentralized network. Personally, I believe that Bitcoin will remain Bitcoin, that some of the dissenting core developers will splinter off into altcoins or sidechain development, and that tempers will cool down. Until the next fundamental disagreement arises. But hopefully by then, Bitcoin’s use will have spread to the extent that its structure and market penetration are different from today. That in itself will give rise to a new decision-making organization, probably still decentralized, but with a clearer consensus-generating communication and with more to lose if it fails.

Bitcoins and banks and patents

Banks’ growing interest in Bitcoin is not news. Yesterday I came across a new twist: banks filing bitcoin-related patents. This development makes sense, given the increased activity in Bitcoin research. It looks like the banks, far from being terrified of the potential disruption, are jumping on board and seriously thinking about how this new method of value transmission can improve their operations and their service. By starting to file patents, they seem to be moving – however slowly – from research to actual implementation.

image via Death to the Stock Photo

Just last week the US patent office published a filing by Bank of America for a patent called “System and Method for Wire Transfers Using Cryptocurrency”. The idea is a simple exchange: client 1 exchanges dollars (for example) into bitcoins (for example), which are then transferred to client 2, who changes them back into its local currency. This way client 1 avoids hefty currency transfer fees, and client 2 receives the funds sooner (10 minutes or less, depending on the cryptocurrency, versus several days). In addition, client 1’s information is kept more secure, and stays with the originator (Bank of America), who obviously has complied with the Know-Your-Client/Anti-Money-Laundering laws.

The twist here is that Bank of America’s algorithm will decide whether a cryptocurrency is appropriate (there are cases in which it will be simpler to use traditional channels), and if so, which one.

Other financial services companies have tried the patents game: Western Union was granted a patent in 2014 for an alternative currency exchange. While it didn’t explicitly mention cryptocurrencies, it did refer to tokens and virtual “coins” in use at the time of filing in 2009. In 2014 Mastercard filed a patent for a “global shopping cart” that supports a variety of payment methods, including bitcoin. And Amazon, which seems to be on its way to becoming a financial services company, has been awarded a bitcoin-related patent for cloud computing payments.

Bank of America is the first “bank” to file a patent that would allow it to offer more flexible and lower-cost services to its clients. It certainly won’t be the last, and in the typical game of catch-up, we’ll probably see more activity in bitcoin-related patents filed by established institutions over the coming months. Barclays, UBS, Citi, Santander, ING and many other big banks have all acknowledged bitcoin “labs” dedicated to exploring and improving on the blockchain technology. Citi has so far said that the results of its experiments with Citicoin (a bitcoin-like in-house virtual currency) will be open source, which means that they have no intention of patenting, so that other brains can build on its work. But patents are a logical extension of private research, and an understandable way of getting some sort of return on the lab investment, as well as of stopping others from patenting “obvious” and/or proprietary technology.

A flurry of patent filings, which we’re likely to see over the coming months, is a good sign that case uses are being polished. Let’s hope that the patent office is sensible in which ones to grant. And let’s hope that patent filings are rapidly followed by implementation.

Bitcoin for charities

A few days ago we talked about Barclays’ confirmation that they were working with some of their charity clients to look at how Bitcoin* could help them collect and disburse funds. But we didn’t really go into how Bitcoin can help. If you’re familiar with Bitcoin, the advantages are obvious. But if you (like most people) are not, then talking about these advantages will give you a good idea of how Bitcoin can make payments and money transfers easier, faster and cheaper. Which, when it comes to the use of charity funds, we can all agree is a good thing.

by Neslihan Gunaydin for Unsplash
by Neslihan Gunaydin for Unsplash

Bitcoin is a digital currency that cannot be counterfeited or duplicated. It is not controlled by a bank or an organisation, so no one has control over how many there should be, nor what value it should have. No one can decide tomorrow that it doesn’t exist anymore, or that we’re suddenly going to issue lots more and dilute the market. While the original idea was thought up and initially programmed by a pseudonymous person or group called Satoshi Nakamoto, bitcoins are not created by anyone. They create themselves, according to a pre-programmed steady-release algorithm. A certain number of bitcoins are created as a reward every time a node (a powerful computer or group of computers) verifies a transaction, specifically that I have the bitcoin that I want to send to you, and that I haven’t already sent it to someone else. The process of verification is complicated, very mathematical and requires significant computing power, but is what gives Bitcoin its innovative qualities of being unhackable. Bitcoins have been “hacked” before, but only through incorrect application of the program, or through the theft of account keys.

The beauty of Bitcoin is that it can be sent anywhere in the world with almost no delay (10 minutes) and almost no cost (minimal transaction fees). It would be a huge advantage for most global charities to be able to receive funds from anywhere, and be sure that the funds are actually reaching you without the subtraction of hefty transfer fees, commissions, etc. If someone wants to donate $100, say, it would be nice to know that you’re getting $99 instead of $79. Those figures are approximate, of course: bitcoin transaction fees are not fixed, and at the moment are very low or even non-existent. The nodes that maintain the system get their reward for verification through additional bitcoin, but the amount awarded is programmed to decline over time to 0. Transaction fees will become more important, but they will remain much lower than with traditional methods (lower overheads, fewer people involved, and if they don’t, bitcoin users will switch to another system that is).

The low transaction fees broaden the potential pool of donors to those who can only spare a few dollars. Up until now, transfer fees would have made it uneconomic to donate small amounts. With Bitcoin, the collective weight of micro-donations could well equal or even surpass that of more substantial amounts.

Another huge advantage for charities, especially those working in parts of the world with unstable or corrupt governments, is that the funds go directly to you. They do not pass through any middleman. No-one can take an arbitrary cut. The charities have much more control over the donations. They will probably need to use an exchange to convert the bitcoin into the local currency, and these will take their commission, but the dent in the funds received is more transparent and more reasonable.

Personally, I think that one of the biggest impacts will come from ease of use. Sending bitcoin can be as easy as three taps on your smartphone. Or you can donate directly in the comments section of any webpage or via email using ChangeTip. Bitcoin is not limited by physical or political boundaries. It is true that it can be difficult to convert Bitcoin into local currency in certain places. But exchanges will become more efficient, and work-arounds will help overcome regulatory obstacles. The end result will be a more efficient funding for good causes. And if something is easier to do, more people tend to do it.

*You’ll notice how sometimes Bitcoin is written with a capital B and sometimes lower case. The convention is that when you’re talking about the system of Bitcoin, the protocol and the concept, you capitalize it, because it’s a name. But if you’re referring to the currency, as in “I’m sending you two bitcoin”, then it is lower case because it’s a thing. In another post we’ll go into the craziness of this naming system. Because, as you will see, even I get confused sometimes often.

The new stockmarket: Issuing shares on the blockchain

With stockmarket crashes, Black Mondays and popped bubbles in the headlines recently, this news passed by pretty much unnoticed: last week Digital Asset Holdings successfully issued stock in a private company on a totally different sort of exchange.

Why is that even news, you ask? Because it’s the start of something potentially huge, that could increase investment overall, help the circulation of money, improve funding efficiency and give liquidity to previously illiquid markets.


Some background: Digital Asset Holdings (DAH) is a blockchain startup that aims to use the technology behind Bitcoin to improve trading settlement. Focussing mainly on digital assets, DAH has developed an efficient and secure exchange system for digitized shares, cryptocurrencies and more, and plans to offer the services of this platform to financial institutions. Technically it’s not Bitcoin, as instead of one decentralized, public ledger with a token of value (currency) attached, DAH offers many, centralized private ledgers with no currency attached. But the transmission method is based on the same principles. By encoding securities’ information onto something similar to a blockchain, the company can improve transparency of ownership, and speed of transaction, both of which will make regulators, investors and traders happy. And if regulators, investors and traders are happy, then financial institutions will be happy.

Last week DAH created shares in Pivit, an online betting platform that uses the power of crowds to predict outcomes of elections, games, or any other public event, and sold them to private investors. This is the first time that the blockchain principle has been used to issue and distribute shares in a company. Not a lot of details are available, as in how exactly it works, or even exact figures, but we will find out more over the coming weeks. What I find most exciting is the potential to make investments in private companies more liquid. With the “decentralized ledger technology”, ownership should be much more easily transmittable, without so many contracts, verification procedures and time-consuming steps.

A limitation is that this is still not open to “ordinary people”, as the stock market is. The investors in this latest crypto-round are all qualified investors. That is fair, as the risk in investing in private companies is even higher than investing in the stock market – less information, less liquidity. But it is a step towards improving the efficiency of the financing of private companies, and to potentially broadening the field of startup funding. Will this lead to a more creative business ecosystem? Let’s hope so.

It’s not the size that matters, it’s what you do with it

When Clay Shirky said that “collaborative production is simple: no one person can take credit for what gets created, and the project could not come into being without the participation of many,” he could have been talking about Bitcoin. The digital currency was created anonymously, and is currently run by a handful of core programmers and a broad network of “miners” whose computers do the actual work of validating and publishing transactions, and an even broader network of “nodes” who help to maintain the public ledger of who sent what to whom. This is crowdsourcing almost at its purest. No one person decides what happens to the program, and no one person can unilaterally make a change to how it works.

While that no doubt has already raised some sceptical eyebrows, the system has worked pretty well since its initial roll-out in 2009. There have been differences of opinion, and accidents that needed fixing, but so far decisions have been made with the common good in mind. Because one of the beauties of this system is that the common good has, so far, equated to the individual good. If Bitcoin were to fail, all players would lose out.

Image by Jens Lelie for Unsplash
Image by Jens Lelie for Unsplash

The scene has changed, though. Now Bitcoin is coming up against a fundamental problem that has generated heated debate, with its share of prognoses of doom. The various sides are digging in, because each seems to be convinced that Bitcoin will fail if his adaptation isn’t universally adopted. This weekend core Bitcoin developers are gathering – apparently for the first time – in Montreal, Canada in the first (and sold-out) “bitcoin scalability workshop” to start the attempt to reach a consensus.

The upcoming problem is this: the volume of transactions is growing. It’s a problem because transactions are grouped into blocks for processing, and the original and current protocol stipulates a block size limit of 1MB. At first that wasn’t a problem, and even now, it’s not really an issue, as the average block size hovers around 425K. But if Bitcoin keeps growing, which it will, the limit is expected to be hit sometime next year. Smaller transactions will start to get pushed aside until a block comes along with space. The current confirmation time lag of about 10 minutes (the time between each block confirmation) could end up being hours or even days, which would seriously reduce its utility. We could end up in a bidding war, with miners giving preference to transactions with higher fees attached. Fees would climb to a level that would price out smaller transactions, which would further limit Bitcoin’s usefulness.

The debate is centred on the issue of a block size limit increase. Should there be one? And if so, to what? And when? It’s not a simple matter, as bigger block sizes can slow down the system and require even more bandwidth and energy to process. The main complication, though, comes from the democratic process. Opinion is divided. So who decides? Which option is best for the system as a whole?

The jury is still out on that, and will be at least until the end of the year. That’s when, effectively, the votes will be counted on the various proposals put forward by the Bitcoin factions (yes, I know, “votes” is an over simplification… I’ll talk more about this process another time). Let’s go over them:

  • Stay as we are. This group doesn’t see any reason to touch the block size. Miners like the idea of higher transaction fees, as it means more profits for them. Most, however, do realize that if Bitcoin transactions slow down, its growth will be limited, which will eventually hurt their income. Another possibility is that Bitcoin continues to grow, but with more and more transactions being done on sidechains (more on these later), so the actual blockchain capacity won’t need to increase. Sidechains tend to not enjoy the same level of decentralization as Bitcoin. But larger blocks could also lead to an erosion of the fundamental decentralizing principle.
  • BIP100. (BIP stands for Bitcoin Improvement Proposal). This proposal was authored by core developer Jeff Garzik, and stipulates a gradual increase of the block size, with thorough testing at each stage. This option is popular, largely due to the gradual increases proposed, and the voting power given to the miners. Every 90 days or so, miners can state what block size limit they would like to see, and the winning target becomes the new block size. This means that the block size can go down as well as up. The mining pools like this idea, but other major stakeholders (wallets, exchanges, etc.) worry about the concentration of influence.
  • BIP101 – by core developer Gavin Andresen, this proposal also suggests that the block size be gradually increased over time, at a linear rate, starting from 8MB on 11th of January 2016, and increasing linearly up to 8,192MB on the 6th of January 2036. This proposal has received support from big players such as Xapo, BitPay, Blockchain.info and Circle, among others.
  • BIP102 – another proposal by core developer Jeff Garzik (confused yet?), who proposes here an increase of the limit to 2MB. Jeff suggests this as an “emergency fallback” if consensus is not achieved on the other proposals.
  • BIP103 (actually, for some reason this BIP doesn’t technically have a number, but people seem to be referring to it as BIP103) – Bitcoin core developer Peter Wiulle thinks that we should increase the block size by 17.7% a year, starting in January 2017. Why 17.7%? Apparently that’s the estimated amount needed to stay in line with technological growth.
  • BIP105 – this is similar to BIP100 in that it lets the miners vote on block size increases. The difference is that BIP105 stipulates a cost to the miners if they vote for an increase. Miners would pay for an increase if it is profitable for them, but it would become costly to do so just to gain a competitive or political advantage. Although it sounds counterintuitive, adding a cost to a proposed increase would increase efficiency, as miners would not want to waste their resources on a vote unless they were reasonably sure that other miners would vote the same. BIP100 stipulates an upper limit of 32MB. BIP105 lowers that to 8MB.
  • BIP106 calls for a dynamically adjusted block size limit, according to the previous block size, with the possibility of including the previous transaction fees in the calculation. If the average block size is almost full, double the size. If it’s not even half full, halve the size. If it’s sort of in the middle, the block size stays the same.
  • Reassess. Adam Back’s idea is similar to BIP102 (Jeff Garzik’s suggestion that the block size increases to 2MB in the short term if no other solution has been agreed on) in that the increases only contemplate the short term, since no-one really knows what the Bitcoin world will look like in the future. Back proposes a 2MB increase as soon as possible, eventually going up to 8MB after four years. Once we get there, then we can reassess, and see if further increases are necessary.

There are actually a ton of other interesting ideas out there to solve the scalability issue, but these seem (to me) to be the main ones. How important is the question of size? That itself is open to debate. Satoshi himself said back in 2010:

It would be nice to keep the [block chain] files small as long as we can.

The eventual solution will be to not care how big it gets.

But it is worth bearing in mind that Satoshi started the ball rolling, and then left the developer community to continue with the experimentation, tweaking and adjustments. As with just about any invention, no creator can foresee all future bottlenecks, bugs and case scenarios.

More than the future of Bitcoin is at stake here. Bitcoin is more than an efficient payment system. It’s more than an entirely new way to transfer value and verified information. It’s a social experiment. Can we, as a group, manage a concept as potentially powerful as Bitcoin, without a clear chain of command? Are we capable of that level of teamwork?

Looking further ahead, a more interesting question than “Can we?”, is “What if we can?”.

Bitcoin and banks: a perplexing relationship

One of the most difficult aspects of setting up a Bitcoin-related company is finding a bank that will work with you. Simple things like collecting revenues and investment, and paying suppliers and employees, become insurmountable barriers. Because setting up a tech startup isn’t hard enough, right? And it’s not like the Bitcoin technology is easy or anything…

So it was with delight that I read earlier this week that Barclays would start accepting bitcoins into bank accounts. This was potentially huge, because actually accepting bitcoins is a huge leap forward compared to other banks, who won’t even accept dollars that have just been converted from bitcoins. I could almost hear the ripples of excitement going through the rapidly growing Bitcoin startup sector.

photo by Davide Ragusa for Unsplash
photo by Davide Ragusa for Unsplash

But the excitement was premature. CryptoCoinsNews and others announced soon after that Barclays has denied this. If this denial is true (and it most likely is), it is a huge blow to many who were expecting startup operations to get easier. And it is confusing to those of us following banks’ interest in Bitcoin, because Barclays is one of the leaders in the banking sector in Bitcoin investigation and experimentation.

How can an institution invest in a technology, yet at the same time turn away business because it feels that the technology is too risky?

The technology that Barclays is investing in is the blockchain behind Bitcoin. More and more banks, governments and exchanges are looking into how the blockchain can revolutionize payments, asset transfers, trade settlements, etc. Bitcoin works because transactions are grouped into transparent blocks that are then processed by a decentralized community of powerful computers. These blocks, once verified, get added on to an ever-increasing chain of previous blocks. The chain makes it impossible to alter previous blocks without altering every block that comes after, which would be prohibitively difficult. And the verification process makes it prohibitively difficult to duplicate coins or to spend coins more than once. I will talk about this more in future posts, but perhaps you can already see why banks are interested in the blockchain potential for faster asset transfer and settlement.

Investment aside, the business that Barclays (and other banks) are turning away is that of a volatile currency. Bitcoin went from $13 to almost $1,000 over the course of 2013, and is now trading at around $230. That’s volatile. Businesses that earn bitcoins are therefore categorized as “high risk”. Combine that with the public perception that Bitcoin is mainly used for criminal activity, and with banks fearful of public criticism and regulatory investigation, and the institutional reluctance to hold accounts for Bitcoin companies starts to become a bit more understandable. Banks are not known for their risk-taking intrepidity.

Yet, nor do they want to be innovated out of existence. Banks in general seem to be aware that blockchain technology has potential, and they have no doubt been following the headlines of valiant startups intent on shaking up the staid financial industry. So, cautious investment in the equivalent of “Research & Development” keeps them involved and gives them a reputation for being forward-thinking, without leaving their core business vulnerable to public or regulatory criticism.

So why the precipitate announcement? The press’ eagerness to announce good news for the sector probably led to the hasty interpretation of “we are looking into” as “we will” (my daughter does this all the time). Barclays has clarified that it is investigating a Proof of Concept (which means “let’s test it”) together with some of its charity clients, to see how Bitcoin could help them with fund raising and disbursement. It’s easy to interpret from that they will soon start allowing select clients to accept bitcoins for altruistic causes if, indeed, it does turn out to be an efficient transfer mechanism. But, Barclays has not committed either way.

Barclays has the advantage of being a UK-based bank. The UK government has repeatedly expressed an interest in Bitcoin, going as far to set up a £10m research initiative. So, if it’s regulatory approval that Barclays is waiting for, it probably won’t have to wait for much longer.

In the denial, Barclays stressed that “no Bitcoin is travelling through Barclay’s systems”. That emphasis is revealing, and underlines the understandable reluctance on the part of any publicly-traded bank to let the market think that it was holding such a volatile asset, either on behalf of clients or for its own book.

The reluctance is still perplexing. Most banks now have entire teams dedicated to Bitcoin research. In most cases they are looking into applications rather than the digital currency itself, but even so, they must be aware that Bitcoin is no more about criminal activity than cash is. Obviously, working with a Bitcoin-related business does not mean the bank account holds bitcoins – the bitcoin wallets can do that. These companies need currency accounts to accept payments with which to pay suppliers and employees, not to mention taxes. With KYC/AML (Know-Your-Client/Anti-Money-Laundering) regulations in force in most developed countries, the banks should feel relatively protected against illicit activity.

It will be interesting to see in what way Barclays lets its charity clients accept the digital currency. Will it act as a bitcoin wallet? Or merely a bitcoin exchange, transferring the bitcoins into pounds?

In June, Barclays announced that it has teamed up with Safello, a graduate from its fintech accelerator, to test blockchain applications for banking. Ironically, Safello, a Stockholm-based bitcoin exchange, had its account shut down by its UK bank (name withheld) earlier this year.

Perhaps Safello will play a role in Barclays’ careful Bitcoin acceptance, or perhaps the bank will end up incorporating other Bitcoin players into its stable. Either way, it looks like Barclays is in the lead when it comes to offering Bitcoin-related services to its clients.

Elsewhere, young Bitcoin startups are still struggling to get the basic level of service any business needs from its bank. Perhaps more startups will start to look at this as an opportunity. The lack of banking services for the Bitcoin community could lead to the development of a new subset of startups: the Bitcoin banks. Decentralized, hack-proof and unregulated. Appealing, or scary?