Banks and Bitcoin getting closer through forensics

Apart from investing heavily in blockchain research, banks have been wary of dealing with bitcoin-related companies. The anonymity and potential illegality of some of the transactions, as well as the generally unregulated nature of bitcoin as a “currency”, have led banks to close down accounts that they suspect of dealing in bitcoin, and to deny accounts to new bitcoin startups. Although the banks themselves would not be holding bitcoins for their clients, the (generally unfounded) fear of being caught without verifiable transaction records in the event of an audit has been stronger than the desire to capture new business.


This may be about to change.

Technically, Bitcoin is not anonymous, it is pseudonymous, and transactions are often traceable. It can be anonymous with extra effort, re-routings and mixing solutions, but for most Bitcoin businesses, that’s not an issue. Often it’s not even a feature that they offer their clients. It’s the possibility of untraceable transactions that spooks the official institutions, although they are reluctant to publicly admit this. The Bitcoin sector, and regulators, are starting to openly protest. Just last week Australia’s Competition and Consumer Commission launched an official investigation into banks’ policies regarding digital currency clients. Their findings will most likely be totally confusing.

Enter the Bitcoin forensics. Chainalysis offers the service of Bitcoin transaction tracking. Their website declares that “We built Chainalysis to spot connections between digital identities”, which means that they use transaction data to link addresses and to thus decipher the originators of certain bitcoin transactions.


Chainalysis is, as far as I know, the first to publicly offer this service, attracting considerable controversy. Its tracking methods have been accused of distorting network latency, and its de-anonymization purpose is rubbing freedom decentralists the wrong way. But, it is a service that will end up being necessary if official banks are to start opening their doors and their credibility to Bitcoin startups.

Just over a week ago Chainalysis signed a collaboration agreement with British bank Barclays, to add a layer of compliance onto digital currency transactions. This could pave the way to Barclays becoming the first large commercial bank to officially accept Bitcoin clients. This would not only be very good news for the startup sector, but it would also enforce Barclays’ reputation as being quite “with it” when it comes to Bitcoin. In June it signed a collaboration deal with bitcoin exchange Safello to try out various bitcoin-related services. And earlier this month it signed a contract with blockchain trade finance facilitator Wave.

This does not mean that Barclays will necessarily be holding bitcoins for its clients. But back in September they did say that they were looking into the possibility of helping their charity clients to collect and disburse bitcoin donations. Until bitcoin is officially declared a “bankable” currency, it is unlikely that we’ll be able to open a bitcoin-denominated account at our local branch. But regulators do seem to be heading towards declaring bitcoin official tender. Just a few days ago the European Court of Justice ruled that, for tax purposes at least, Bitcoin should be considered as money.

Hopefully, with Barclays scooping up the potentially lucrative market of Bitcoin businesses eager for respectability, other banks will take a similarly progressive stance and realize that Bitcoin is not about illegal activity, any more than cash is. And from what I gather, banks have never had any problem accepting and storing cash.

Is Bitcoin anonymous?

Much hype has been frothed about the anonymity of Bitcoin, and how that makes it ideal for illegal activities. (Let’s not even go into the illegal activities that the ever-so-anonymous cash is used for.) So it’s worth setting the record straight: Bitcoin is not anonymous. But it can be.

First, rather than anonymous, Bitcoin is pseudonymous. All your bitcoin transactions are linked to your bitcoin address (or addresses). In the Bitcoin transaction sphere, you are known by that address, no-one else can use it. It is your “pseudonym”. Totally anonymous transactions would have no attached pseudonym.

True, figuring out that that address belongs to you, specifically, is difficult. Difficult, but not impossible. How would one go about doing it? By combing through all other transactions to and from that address and looking for clues such as delivery destinations, transfers to private sidechains, links to other addresses that have been identified, donation requests in forums… Or, investigators could look for transactions that combine two Bitcoin addresses into one input. For instance, if you had 3 bitcoins in one address, 2 in another and wanted to buy something that cost 5, you’d combine your two bitcoin addresses into one transaction. If the identity behind one of the input addresses is known, then the other one is, too.

an example of bitcoin activity tracking, from An Analysis of Anonymity in the Bitcoin System
an example of bitcoin activity tracking, from An Analysis of Anonymity in the Bitcoin System

Another technique used for figuring out bitcoin ownership is patterns in activity. Parallels can be drawn between transaction activity and Twitter activity, for example. Periodic repeat purchases, even from different addresses, can be a giveaway.

And most of us get our first bitcoins on an exchange. In general, exchanges are regulated and have to comply with the local Know Your Client laws, which generally involve verifying your identity with authorised documents such as passports or ID cards. That address is linked to your real self (in theory), as are other addresses that that address transfers to. Even simple wallets (not related to exchanges) that don’t ask for your identity need to keep records of all transactions associated with your bitcoin address, in order to know how many bitcoins are rightfully yours. Records are hackable, and can be subpoenaed by the authorities.

The anonymity of Bitcoin has been one of the main barriers to banks’ willingness to work with Bitcoin-related businesses. Chainalysis (which recently signed a deal with British bank Barclays) intentionally combs through transaction data to de-anonymize the network and to provide banks with a compliance service. While this will no doubt bother many Bitcoin users who value the philosophical benefits of the freedom that anonymity brings, Chainalysis’ goal is to get banks more comfortable with working with Bitcoin users, which will help the digital currency’s spread and influence.

However, with some extra effort, Bitcoin can be anonymous. It is possible to buy bitcoins anonymously using cash and local exchangers. Bitcoin users can employ a different address for each transaction to make ownership harder to trace. The heavily encrypted network Tor makes it much harder to track transactions (among other features, IPs are not recorded), but even just using Tor can alert authorities that you are hiding something.

These aren’t foolproof anonymity methods, but they do make it harder to follow a bitcoin through the network. Mixing services, which shuffle your bitcoins with those of other users, do provide a very high level of anonymity, but are much riskier than traditional wallets in that they are unregulated and often unaccountable. If Bitcoin anonymity is important to you, your best bet would be to use a mixing service and withdraw your funds immediately, and to use a different address for each transaction. Of course, the best way to avoid getting caught for illegal activity is to simply not do it.

(For more on how Bitcoin works, see Bitcoin Basics.)

How can I get bitcoins?

Once you have your wallet set up, you can buy bitcoins online (in some cases directly through the wallet provider) or offline, you can earn them, or you can create them by becoming a miner.

Online bitcoin exchanges will sell you bitcoins for any of a wide range of fiat currencies (dollars, euros, yuan, yen, etc.). Kraken, Bitfinex and Bitstamp are just some of the main ones, and several offer wallet services in which to store the bitcoins you buy.

In many cities, you can buy bitcoins physically. LocalBitcoins, for instance, will post bitcoin offers, and it’s up to you to arrange to physically meet the seller to exchange cash for a bitcoin transfer. Some cities have regular gathering spots where you can just show up and offer cash in exchange for digital currency. You hand your cash to the seller, and he or she transfers bitcoin to your electronic wallet with a few taps on his or her computer or phone. More and more cities have bitcoin ATMs, where you feed your cash into the machine and then hold your bitcoin address (in QR code form) in front of the scanner so that it knows where to transfer the equivalent amount of bitcoins to.

You can also earn bitcoins, just as you can earn any other type of currency, by working for them. Several companies prefer to pay their employees in bitcoins, especially if that’s the currency that the business operates in. And the subreddit Jobs4Bitcoin posts one-off tasks that will be paid in bitcoins.

gold mining

The most complicated way of earning bitcoins is by becoming a miner. You’ll need a very powerful processor (the current standard is ASICS) onto which you download the Bitcoin program. You then compete against other miners to solve a mathematical puzzle that at the same time validates a block of transactions and adds it onto the blockchain. If you get the right answer first (which depends mainly on guesses and very fast computing), you earn 25 bitcoins (this amount halves every 4 years, in approximately 2017 it will go down to 12.5).

These methods of acquisition may remind you of another currency from hundreds of years ago: gold. Back then you could get gold by mining it, by earning it or by buying it. Like gold, bitcoins are backed by no-one. Like gold, bitcoins are not in unlimited supply. I think that we can all agree that bitcoins are easier to carry.

(For more on how Bitcoin works, see Bitcoin Basics.)

What is a bitcoin wallet?

Before owning any bitcoins, you need somewhere secure to store them. That place is called a “wallet”. Since bitcoin is really just a snippet of code, your wallet will probably live on your computer and/or mobile device, but physical storage gadgets are also used, and there even is such a thing as a paper wallet. Here we’ll take a look at the different types of wallets, with a brief overview of how they work.

But first, it’s important to clarify something that will help to understand how they work. You store your bitcoins at your Bitcoin address, not your wallet. What your wallet holds is the private key that gives you access to your Bitcoin address (which is also your public key). If the wallet software is well designed, it will look as if your bitcoins are actually there, which makes using bitcoins more convenient.

Electronic wallets can be downloaded software, or hosted on the web (“in the cloud”, as we say these days). The former is simply a formatted file that lives on your computer or device, and that facilitates transaction formatting. Hosted wallets tend to have a more user-friendly interface and more on-the-go functions, but you will be trusting a third party with your private keys. There are a few hybrid models, and some really strange ones, and each provider is slightly (in some cases very) different from the rest. This summary is meant as a general overview of the different types, not a list or a recommendation of specific services.

One very cool function worth mentioning is that most wallets will convert your public bitcoin address into a QR code, which makes it so much easier to send bitcoins directly from your phone. You just hold your phone’s camera up to the square, scan it, and the address is entered into the “send” location.

Here’s mine:

(feel free to send me some bitcoins if you wish!)
(feel free to send me some bitcoins if you wish!)

Software wallet

Installing a wallet directly on your computer gives you the security that you control your keys. Most have relatively easy configuration, and are free. The disadvantage is that they do require more maintenance in the form of backups. If your computer gets stolen, hacked or corrupted and your private keys are not also stored somewhere else, you lose your bitcoins.

The original software wallet is the Bitcoin Core protocol, the program that runs the Bitcoin network. You can download this here and become a node (that doesn’t mean that you need to mine bitcoins) with wallet capability, but you’d also have to download the ledger of all transactions since the dawn of bitcoin time (2009). As you can guess, this takes up a lot of memory (over 20GB).

Most wallets in use today are “light” wallets, or SPV (Simplified Payment Verification) wallets, which do not download the entire ledger but sync to the real thing. Armory is a good example of a software bitcoin wallet, as are Electrum and MultiBit.

Web-based wallet

Web-based wallets offer increased convenience – you can generally access your bitcoins from any device if you have the right passwords. All are easy to set up, come with desktop and mobile apps which make it easy to spend and receive bitcoins, and most are free. The disadvantage is the lower security. With your private keys stored in the cloud, you have to trust the host’s security measures, and that it won’t disappear with your money, or close down and deny you access.

Several offer a wide range of services such as bitcoin purchase or sale, multi-wallet generation, coin mixing (to hide the origin), offline storage, merchant services, bank account connection, search function for address of people you know or people near you, maps of places near you that accept bitcoins…  Some are accessible via a web page, others as a browser extension, and almost all have a smartphone app. Among the best-known ones are Blockchain, Coinbase, Xapo and Hive.


image via KeepKey
image via KeepKey

Hardware wallets

Hardware wallets are small devices that occasionally connect to the web to enact bitcoin transactions. They are extremely secure, as they are generally offline and therefore not hackable. They can be stolen or lost, however, and the bitcoins that belong to the stored private keys along with it.

Trezor, KeepKey, LedgerWallet and Case are recent examples of efficient hardware wallets.

Paper wallets

Perhaps the simplest of all the wallets, these are pieces of paper on which the private and public keys of a bitcoin address are printed. Ideal for the long-term storage of bitcoins (away from fire and water, obviously), or for the giving of bitcoin as a gift, these wallets are more secure in that they’re not connected to a network. They are, however, easier to lose. With services such as and, you can easily create a new address and print the wallet on your printer. Fold, seal and you’re set. Send some bitcoins to that address (the QR code that you see in the picture), and then store it safely or give it away.

image via BitcoinPaperWallet
image via BitcoinPaperWallet


This relatively obscure variety invokes some heavy cryptography to make it not necessary to store private keys anywhere other than in your head. If your memory’s as bad as mine, this is understandable cause for concern, but apparently all you have to do is remember a long phrase (such as the first sentence from your favourite book, or the first few lines from your favourite Beatles song).

— x —

Even within these categories there is a wide variety of services and functions, some very technical, some incredibly useful, and some both. Going into more detail will involve delving into cryptography and connectivity, which is best saved for individual profiles and security updates. Bitcoin wallets is a fascinating sector, impacted by technology, regulation and some unusual business models. And it’s a rapidly changing sector, too. The capabilities of the wallets are deepening in line with our understanding of how it all works, consolidating in line with the regulator’s interest, and broadening in line with our increasing use of digital currency.

(For more on how Bitcoin works, see Bitcoin Basics.)

How Bitcoin works

(This is the first in a series of articles about the basics of Bitcoin, which I will also include in a separate section on the web called Bitcoin Basics.)


Understanding how bitcoin works is not necessary to be able to see its potential and genius. Most of us use the Internet without understanding transfer protocols and IPs, right? We will, as a society, end up being quite comfortable with the underlying technology without thinking about hash functions and state outputs. We probably won’t even notice that we’re using bitcoin, the blockchain or whatever it will be called by then. Much like how now, when we click, we don’t think about data packets.

But if you’re like me, understanding how it works is fun. And for many, it’s a question of trust: understanding is believing. So, without going into too much cryptographic detail, here goes:

(As a convention, when I introduce a technical-ish term for the first time, I’ll put it in quotation marks, but after that, it gets treated as a normal word. And Bitcoin = the system and the concept, while bitcoin = the currency.)

Simple version:

If I want to send one of my bitcoins to you, I “publish” my intention and the entire bitcoin network validates that I have the bitcoin that I want to send, and that I haven’t already sent it to someone else. Once that information is validated, my transaction gets included in a “block” which gets attached to the previous block. Hence the term “blockchain”. Transactions can’t be undone or tampered with, because the blockchain can’t be tampered with. A bit like Lego and superglue.

Getting a bit more complicated:

I keep my bitcoins in my “bitcoin address”, which is a long string of 34 letters and numbers. This address is also known as my “public key”.  I don’t mind that the whole world can see this sequence. Each address/public key has a corresponding “private key” of 64 letters and numbers. This is private, it’s crucial that I keep it secret, and that I don’t lose it. The two keys are related, but there’s no way that you can figure out my private key from my public key.

That’s important, because any transaction I issue from my bitcoin address needs to be “signed” with my private key. To do that, I put both my private key and the transaction details (that I want to send you 1 bitcoin, for example) into the bitcoin software on my computer or phone. With this information, the program spits out a digital “signature”. I send this out to the network for validation.

This transaction can be validated – that is, it can be confirmed that I own the bitcoin that I am transferring to you, and that I haven’t already sent it to someone else – by plugging the signature and my public key (which everyone knows) into the bitcoin program. This is one of the genius parts of Bitcoin: if the signature was made with the private key that corresponds to that public key, the program will validate the transaction, without knowing what the private key is. Very clever.

The network then confirms that I haven’t previously spent the bitcoin by running through my address history, which it can do because it knows my address (= my public key), and because all transactions are public on the bitcoin ledger.

Even more complicated:

Once my transaction has been validated, it gets included into a “block”, along with a bunch of other transactions.

A brief detour to discuss what a “hash” is, because it’s important for the next paragraph: a hash is produced by a “hash function”, which is a complex math equation that reduces any amount of text or data to 64-character string. It’s not random – every time you put in that particular data set through the hash function, you’ll get the same 64-character string. But if you change so much as a comma, you’ll get a completely different 64-character string. This whole article could be reduced to a hash, and unless I change, remove or add anything to the text, the same hash can be produced again and again. This is a very effective way to tell if something has been changed, and is how Bitcoin can confirm that a transaction has not been tampered with.

Back to our blocks: each block includes, as part of its data, a hash of the previous block. That’s what makes it part of a chain, hence the term “blockchain”. So if one small part of the previous block was tampered with, the current block’s hash would have to change (remember that one tiny change in the input of the hash function changes the output). So if you want to change something in the previous block, you also have to change something (= the hash) in the current block, because the one that is currently included is no longer correct. That’s very hard to do, especially since by the time you’ve reached half way, there’s probably another block on top of the current one. Since the current hash needs to be changed, the hash of the current block included in the next one would also need to be changed. And so on.

This is what makes Bitcoin virtually tamper-proof. I say virtually because it’s not impossible, just very very very very very difficult and therefore unlikely.

How are bitcoin created?

This part is actually simpler than it seems (thank goodness).

Bitcoins are created as a reward for creating blocks of validated transactions and including them in the blockchain.

Backtracking a bit, let’s talk about “nodes”. A node is a powerful computer that runs the bitcoin software. Anyone can run a node, you just buy the right hardware (pretty expensive if you want to be a “mining node”) and download the Bitcoin software (free). Nodes spread bitcoin transactions around the network. One node will send information to a few nodes that it knows, who will relay the information to nodes that they know, etc. That way it ends up getting around the whole network pretty quickly.

Not all nodes are mining nodes. Some just help to keep Bitcoin running by participating in the relay of information. Mining nodes actually create blocks and add them to the block chain. How do they do this? By solving a complex mathematical puzzle that is part of the Bitcoin program, and including the answer in the block. The puzzle that needs solving is to find a number that, when combined with the data in the block and passed through a hash function, produces a result that is within a certain range.

How do they find this number? By guessing at random. The hash function makes it impossible to predict what the output will be. Changing a text or data set by just a little bit could change the resulting hash value by a lot, or by a little, there’s no way of knowing ahead of time. So, miners will start guessing what the mystery number could be, and applying the established hash function to the combination of that number and the data in the block. The first mining node to get a resulting hash within the desired range announces its victory to the rest of the network. All the other mining nodes immediately stop work on that block and start trying to figure out the mystery number for the next one. As a reward for its amazing work lucky guess, the victorious mining node gets to send itself some new bitcoins.

At the time of writing, the reward is 25 bitcoins, which at $270/BTC is worth about $7,000. Not bad for 10 minutes’ work.

Although it’s not nearly as cushy a deal as it sounds. There are a lot of mining nodes competing for that reward, and it is a question of luck. Also, the costs of being a mining node are considerable, not only because of the powerful hardware needed (if you have a slower processor than your competitors, it’s unlikely that you’ll find the correct number before they do), but also because of the large amounts of electricity that running these processors consumes. And, the number of bitcoins awarded as a reward for solving the puzzle halves approximately every four years. It’s 25 now, but should go down to 12.5 sometime in 2017, then 6.25 in 2021, etc. It’s likely that the value of bitcoin relative to the dollar will go up over the next few years to partially compensate this reduction, but it’s not certain.

Why 10 minutes? That is the amount of time that the Bitcoin developers think is necessary to keep the entry of new bitcoins to a trickle rather than a flood. It’s arbitrary, and is controlled via the difficulty of solving the block puzzle. They could make it easier or more difficult by changing the puzzle rules (reducing or expanding the range of acceptable answers, for example), but they like 10 minutes.

Why try to keep the introduction of new bitcoins down? Because the limit on the eventual supply of bitcoins is one of the factors that gives it value (you can’t have a currency that’s in unlimited supply, right?). To enforce this control, the Bitcoin program stipulates that there can never be more than 21 million bitcoins in existence. Given the halving of the reward, plus the timed entry of new bitcoins, we should reach that level in 2140.

If you’ve made it this far, then congratulations! There is still so much more to explain about the system, but at least now you have an idea of the broad outline of the genius of the programming and the concept. For the first time we have a system that allows for convenient digital transfers in a decentralized, trust-free and tamper-proof way. The repercussions, the applications and the potential of this will be huge.

(For more on how Bitcoin works, see Bitcoin Basics.)

Liquid sidechains and Bitcoin development

The Blockstream guys – the ones working on a commercial application of the Lightning Network I told you about the other day – have announced the upcoming launch of Liquid, the first commercial application of the sidechain concept. This is exciting, as sidechains have been talked about for a while now, but have yet to be put to practical use. And the use of Liquid is indeed practical: it will help bitcoin exchanges improve their service and reduce their risk, with faster settlement and lower costs. Before we go into why this is important, let’s take a look at the background.

by Andrew Welsh for Unsplash
by Andrew Welsh for Unsplash

First, what are sidechains?

Sidechains are effectively private blockchains, linked to the public Bitcoin system. They use the transmission and custodian power of Bitcoin – information stored in a tamper-proof block – while enjoying greater speed and lower cost. The idea is that an amount of bitcoin could enter a sidechain, the participants can trade that bitcoin amongst themselves as many times as necessary before sending the new distribution back to the Bitcoin blockchain for settlement. The transactions on the sidechain are governed by the sidechain’s rules, which can be anything the administrators want them to be. The only stipulation is that the same amount of bitcoin that goes in needs to come out, although obviously the ownership of those bitcoins will be different.

Second, what are bitcoin exchanges?

A bitcoin exchange will sell you bitcoin in exchange for a fiat currency, such as dollars or euros or whatever you use on a day-to-day basis. They will also buy your bitcoins in exchange for a fiat currency. One of the main frustrations of the exchanges has been the latency of bitcoin transactions, that is, the time they take to settle. It’s much faster than traditional transactions, but it is still not instantaneous, and an exchange’s business needs to be instantaneous.

A brief review of the technology: once a bitcoin transaction is validated by the network, it is included in a block of other transactions, processed by the miners, and added to the blockchain. A block is processed and added to the chain every 10 minutes or so. This is actually an artificial amount of time, chosen to limit the amount of new bitcoin entering the system. Every time a block is processed and added to the chain, the miner who does so gets rewarded with new bitcoins. Processing each block involves computing a cryptographic hash, which is set at a level of difficulty that takes about 10 minutes to calculate. That was deemed enough time to keep the system efficient while restricting the entry of new bitcoins to a trickle instead of a flood.

Each block contains a coded reference to the previous block. If the previous block is tampered with, that coded reference is no longer valid, which makes the whole block invalid. So, to tamper with a block, you would also have to change the coded reference in the block that comes next. That is very difficult to do. And if there are not just one but six blocks that come after, it’s virtually impossible, as you would have to re-configure and validate all the posterior blocks, which would take an unimaginable amount of computing power. So, the standard is that, to be absolutely sure of a transaction’s validity, you should wait until it has 6 blocks on top of it. Given that each block takes about 10 minutes to process, that is a settlement time of about 1 hour.

Because exchange customers don’t want to wait an hour for confirmation of their trade, the exchanges need to keep on hand a pretty big balance of bitcoin and fiat currencies to cover the trade until it is technically secure. Part of the cost of the necessary capital requirement, as well as the risk the exchanges incur in trusting that the trade will settle correctly, can be seen in the exchanges’ commissions and/or spreads. If the capital requirement is reduced, trades can become cheaper.


image via Blockstream

How will Liquid help?

Each participant of Liquid will maintain a node, that is, it will be responsible for verifying the cryptography on the trades on its exchange. Because no new bitcoins will be entering the system, the artificial 10 minute lag time is unnecessary. Transactions will still be grouped into blocks, which will still be added onto previous blocks, but it will happen almost instantaneously. This way, bitcoins and other currencies can flow between accounts of the participating exchanges much faster than at present, which will reduce the capital requirements and the operating costs. Several of the big exchanges – Bitfinex, BTCC, Kraken, Unocoin, and Xapo – have already signed up, and it’s likely that more will follow.

Why is this important?

This development looks like it will remove some of the Bitcoin inefficiencies (speed, energy cost) while maintaining the advantages (decentralization, security), and should enhance the attractiveness and liquidity of the digital currency. That will have ripple effects throughout the sector and beyond, as the pool of participants and users grows.

Also important is the innovation that this is likely to encourage. Several of the founders of Blockstream authored, along with other collaborators, a white paper back in October 2014, discussing the sidechain concept and its potential uses. The paper is open-source, and the authors encourage other developers to experiment with the idea. The development of sidechains allows Bitcoin experimentation, such as the inclusion of new features, the use case for new assets, even new cryptography. Previously, this kind of experimenting had to be done with altcoins, which are Bitcoin alternatives, separate currencies using the same or a similar technology. A system that only allows experimentation through competition is weaker than one that encourages it “in house”.

Sidechain implementation will require a soft fork (a change in the Bitcoin protocol which will not affect trades using the old protocol), which takes time. This is probably why the launch of Liquid was announced yesterday, but will not be implemented until the first quarter of 2016. Apparently a white paper is forthcoming which will explain in detail how Liquid works. This is likely to breed a flurry of other use cases, which will further increase Bitcoin’s usefulness and applicability. These are interesting times, with change happening fast. And with Liquid, it could be time to pour another cup.

Gemini exchange and Bitcoin mainstream

The struggle and the patience paid off. This morning the Gemini bitcoin exchange opens for business, after a year-long process of getting regulatory approval from the New York State Department of Financial Services (NYSDFS). This authorisation is pretty big, much broader than the infamous BitLicense that the state requires of bitcoin operators. And Gemini is only the second exchange to get this approval. All of which is interesting, but not as interesting as the big picture behind it: this is the biggest step so far that Bitcoin has had towards going mainstream.

gemini front page

Let’s rewind a bit. First, the regulatory approval. A NYSDFS license, which grants permission to operate as a chartered limited liability trust company, is more rigorous and tougher to get (and I imagine a lot more expensive) than the BitLicense that New York requires of bitcoin operators. So why did the founders, Cameron and Tyler Winklevoss, choose this more complicated route? Because their main target market is institutional investors, to whom they would not be able to offer a complete service with just a BitLicense. The trust charter license that they now have allows them to 1) hold deposits, 2) operate a bitcoin exchange, and 3) offer other corporate trust services such as escrow (holding funds pending contract resolution). A BitLicense wouldn’t allow Gemini to do that. More importantly, the charter obliges the firm to act as a fiduciary, which means that it has to always put its customers’ interests before its own. That that even needs putting into law is sad, but this is the new frontier of financial services, and we’ve all seen the worrying headlines. For the Winklevoss twins, winning the trust of the large institutional investors is key. They felt that a BitLicense just wasn’t enough.

Gemini has competition. In May itBit was granted the same permission, and also offers OTC (over-the-counter) trading. And Coinbase classifies itself as a US-based bitcoin exchange, although it does not yet have the necessary regulatory approval.

But how will Gemini help Bitcoin to go mainstream? First, security. Safety has been the main priority, which is smart given the fears over Bitcoin’s lack of security and the “unregulated” nature of most exchanges. The founders have apparently been thorough in their dealings with the regulators, insisting on approval before trading. They are currently authorised to trade in 26 states and Washington DC, and are working on getting approval in the remaining areas. Customer deposits are held in FDIC-insured US banks, which means that the deposits are protected by federal insurance up to $250,000. And bitcoins are held in “cold storage”, which means offline devices such as pen drives, kept in vaults. (I’m not implying that itBit doesn’t make security a priority, the FDIC also insures itBit-held funds, and they also use cold storage for bitcoins… but read on…)

Another priority seems to be the visualization of information, also smart given that Bitcoin is quite hard to get your head around, and buying on online exchanges is confusing for first timers. Simplicity inspires confidence. The Gemini interface lets users visualize a graph showing the effect that their trade is likely to have on the market, even if it’s a small one. Get people familiar and comfortable with the idea of buying bitcoins for their investment portfolio, and you’ve gone a long way towards bringing Bitcoin into the mainstream.

image via Coinbase
image via Coindesk

Which will tie in very nicely with the upcoming launch of the Winklevii’s Bitcoin ETF (Exchange Traded Fund), the first publicly traded bitcoin-based investment trust. The twins are counting on more and more funds and private investors deciding to hold modest bitcoin positions, but without actually buying bitcoins (because either they don’t want to, or they can’t for regulatory reasons). These investors will be able to buy a NASDAQ-listed investment trust that will reflect the currency’s movements, but without direct exposure. The trust is awaiting regulatory approval.

At the moment the only alternative currency traded on Gemini is Bitcoin, although they haven’t ruled out changing that (notice that they didn’t put “bit” in the exchange’s name). In a Reddit AMA last night, there was some interest expressed in the trading of Dogecoin and Ether (the Ethereum currency). Tyler’s response was along the lines of “first Bitcoin, lots to do there, and then we’ll see”, so it’s unlikely that the portfolio of possible trades will spread much beyond BTC/$ in the short term. They are looking at opening up to other currencies, especially the Euro, but that will involve a lot of regulatory work, and the potential volume may make it not worthwhile.

So, what’s that about mainstream? Well, the Winklevoss twins are famous, not just because of their Facebook history. They’re media-friendly very wealthy ex-Olympic athletes. To give you an idea of their lifestyle, they came across Bitcoin for the first time while on holiday on glamorous Spanish island Ibiza. They’re New York elite, championing an alternative currency, and assuring their influential friends that institutional bitcoin investments will be safe and will do well. itBit is a reputable firm with a stellar management team and undoubtedly a good product, but without Gemini’s star power. This guarantees a certain amount of media attention. As a rudimentary metric, the number of entries that come up when you type “Gemini + bitcoin” into the Google search bar is over 480,000. Type in “itBit + bitcoin” and you get just over 87,000. So, the photogenic and well-connected Winklevoss twins are more likely to get Bitcoin into the mainstream press than equally able competitors.

And, there’s the emphasis on institutional funds. While their first customers are more likely to be early-adopter individuals, they plan on building up enough liquidity to attact the larger funds and Wall Street players. Until now, most Wall Street and bank activity in the sector has been through blockchain applications. Few have actually waded into bitcoin investment or trading. When that happens, the currency and the concept will get a credibility boost.

Which brings up the underlying existentialist dilemma. Bitcoin going mainstream would be good for the currency, increasing both liquidity and value, making some early purchasers wealthy, and attracting even more traders and investors. But, Bitcoin was not built on mainstream foundations. It started out as a decentralized, anti-institution concept, in part as a reaction to the financial crisis and the institutions that made it worse. So if those very same institutions start investing and trading in bitcoins, what happens to its reason for being? Does that even matter, when its use and value could significantly increase? Is Bitcoin embracing the institutions and the government, or is it the other way around?