Bitcoin and governments… Wait, what??

Wasn’t bitcoin about evading the control of governments? Weren’t we at the dawn of a truly global currency that knew no politics? What happened to freedom from boundaries? Won’t governments moving in take out all the fun?

No. Bitcoin was and still is about evading the control of governments. But that doesn’t mean that governments can’t also benefit from bitcoin’s advantages. And the official entities aren’t interested in bitcoin as much as in its underlying technology, the blockchain. Governments, both national and local, as well as central banks, are sniffing around, speaking at conferences, writing papers and trying to figure out how this new financial development can extend their reach and reduce their costs. It makes sense.

by Thomas Brault for Unsplash - bitcoin and governments
by Thomas Brault for Unsplash

But how, exactly, can governments use the blockchain? Leaving aside the potential as a currency and the impact on monetary policy, the list of possible uses is long, and includes archive management, welfare distribution, budget allocation, voting mechanisms… A respectable roster of sovereign organizations are officially “investigating the technology”, which sounds very much like a me-too policy. But more and more concrete use-case studies are emerging, with powerful public backing.

The UK government has been particularly active in the sector. Late last year it pledged funding of £10 million to investigate blockchain technology, and has been coming up with interesting applications. From record keeping to tracking financial movements such as student loans and international aid, the Cabinet Office has been running trials on and investigating practical solutions to bureaucracy-heavy processes.

Just a few days ago, the UK government revealed that it is experimenting with distributing welfare payments on the blockchain, through a digital “benefit coin” which could replace welfare payments. This has raised significant privacy concerns, which in turn is generating healthy focus on the technology and debate on the advantages and drawbacks.

Tomorrow the House of Lords is holding a hearing to debate potential governance applications, which you can watch live at this link if you’re interested.

The US government is not quite as proactive in applying blockchain efficiencies, but is stepping up its funding for research projects. In June, it awarded $600,000 in grants to six projects investigating the application of blockchain technology to the issue of identity, privacy and security. And last week it issued a call for papers on blockchain research relating to the healthcare industry.

The US defense and research agency DARPA wants to look at ways to use the blockchain for secure messaging. The Department of Homeland Security is funding research into blockchain authentication of IoT devices. And the initiatives are not just federal: in May the State of Delaware launched an initiative that includes the blockchain trial to store and secure government archives.

Estonia is often held up as an example of blockchain governance. Over a decade ago it launched an e-residency program (not blockchain-based) which allows anyone to establish “fiscal” residence in the nation, to set up companies and administer their finances. Late last year it announced a collaboration with BitNation to offer a blockchain notary service to these e-residents, which would not just cover company documents but also marriage licenses, birth certificates, etc.  Earlier this year it started the process of storing all of its health records on the blockchain.

Ukraine announced a few days ago that it would start to use eAuction, a blockchain-based auction platform, to sell government assets, eliminating the possibility of official interference. A few weeks ago Sweden revealed that it is testing the blockchain for land registration, and the Republic of Georgia has been trialling blockchain-based land titling since April. The city of Zug, in Switzerland, allows its residents to pay for public services with bitcoin. The Finnish city of Kouvola has just received €2.4m of public funding for a blockchain-based smart container shipping system.

In spite of the huge potential scope, it does look like the most advanced initial projects are the relatively “easy” ones of managing documents. Which is, of course, totally understandable, as well as efficient and necessary. The problem in most cases is not that the systems are not digital. The problem is more one of inter-communication between different systems, and the portability of data. A file on one system in this day and age still needs to be replicated on another, even if the end use is similar, and even if the end owner of that information is the same. The blockchain gives governments the opportunity to streamline processes, optimize storage, and extract and share more useful information while keeping it private and secure. The integrity of public registries is fundamental, not only as a matter of trust in authority, but because the information they contain – property and automobile ownership, passports, birth certificates, marriage certificates, business licenses, penal records, and a long etc. – is often the base of a democracy and an economy.

A few intrepid initiatives are looking at the sticky problem of voting, an issue which fundamentally affects most sovereign nations in this day and age. The current process is cumbersome, inefficient and often subject to tampering. But since this revolves around the even sticker problem of online identity, few initiatives have progressed much beyond the initial stage.

The will is there, though, and it is only a matter of time. Most governments have moved from rejecting the frivolous notion of a universal and immutable digital currency, to realizing that bitcoin is just a certain type of information, and that the blockchain can be used for other types of information as well. We have seen some practical applications, and will see many more emerge over the coming months. And we will all of us, soon, be enjoying greater blockchain-enhanced bureaucratic efficiency, without even noticing the technology that makes it work.

Kenya vs. Bitcoin

Over breakfast on December 15th, readers of the main broadsheet newspapers in Nairobi were greeted with a full-page ad taken out by the Central Bank of Kenya, warning them about dealing in bitcoin. The public notice was also posted online.

This is in equal measures surprising, disappointing and encouraging.

The main surprise is in the timing. The day before, the Kenyan justice system decided to postpone a ruling on the lawsuit brought by bitcoin remittance company BitPesa against the mobile payments giant M-Pesa for intimidation and unfair business practices. M-Pesa had blocked access to its platform, citing as the reason BitPesa’s unregulated status. Bitpesa claims that the Central Bank told them that bitcoin fell outside their remit, and therefore they could not offer a license. The decision, which allows M-Pesa to continue to block access to the main mobile money platform in East Africa, not only denies the convenience and economy of bitcoin remittances to a significant portion of the rural population. It also highlights the absurdity of trying to get a license, being told that licenses are not available, and then being punished for not having one.

While in theory the Central Bank does not influence the justice system, and the government does not control the Central Bank, the timing of the announcement in the newspapers can be interpreted as an indication of which way the government would like the courts to rule. For a fairly modern government battling increasing concerns over deepening corruption, this level of public “intervention” is perplexing.

Another perplexing aspect of this public approach is the list of warnings about bitcoin, and the subliminal messages they contain. The first one reads:

“Transactions in virtual currencies such as bitcoin are largely untraceable and anonymous making them susceptible to abuse by criminals in money laundering and financing of terrorism.”

Putting bitcoin’s untraceability and anonymity first and foremost as a help to criminals will surely attract the attention of even more criminals (or at least those that read the newspaper), and could possibly increase rather than decrease bitcoin use. BitPesa does follow KYC/AML guidelines to prevent money laundering and terrorist financing, but other less high-profile exchanges may not be so rigorous.

The second warning claims that bitcoin exchanges “tend to be unregulated”.

“Virtual currencies are traded in exchange platforms that tend to be unregulated all over the world. Consumers may therefore lose their money without having any legal redress in the event these exchanges collapse or close business.”

While not untrue, it is misleading. Some regulated exchanges do exist (Coinbase, Gemini, itBit), many more are in the pipeline, and many others, while not officially regulated, behave as if they are. Often it’s not that they don’t want to be regulated. It’s that they can’t, as there is no regulation in place. Such as in Kenya, for instance. BitPesa complies with KYC/AML regulations, yet is being treated as if it didn’t.

And the third warning, pointing out bitcoin’s vulnerability and volatility because there is “no underlying or backing of assets”, will surely draw attention to the fact that there is no underlying or backing of assets on the Kenyan shilling, either, other than faith in the economy (doing quite well) and the government (not so much).

Political mistrust is a strong motivator in bitcoin use, and the Central Bank’s request that the public “desist from transacting in Bitcoin” could have the opposite effect. With a fragile democratic stability (the current president took power with only 50.07% of the popular vote in the 2013 elections, and is currently under investigation by the International Court of Justice for crimes against humanity), and with increasing political violence and concerns about corruption, many readers of the major newspapers could well take an official call to refrain from using bitcoin as an open invitation to try it out.

Kenya vs bitcoin

The disappointment comes from the closed-minded approach to financial innovation, from a government that has a reputation for encouraging it. In its early days M-Pesa was not required to comply with complicated and expensive regulations, which allowed it to grow rapidly and inexpensively, creating efficiency and opportunity, as well as a near-monopoly on mobile money transfers. Although it has increasing competition, its extensive network and brand mindshare still give it considerable power in the sector, which enables it to maintain the relatively high transfer fees. Lower fees from a more nimble competitor would benefit the recipients and the economy, while technology and scale bring costs down. Lower profits for M-Pesa, perhaps, but greater wealth for Kenya. Bitcoin-based services can complement the established mobile money networks by expanding their reach and broadening their client base to include remittance senders from all over the world. Trying to limit participation to competitors with less potential is short-termist and damages the incumbent’s reputation.

However, it is encouraging that the Central Bank deemed bitcoin important enough to issue a public statement. In so doing, it has called attention to the digital currency: no doubt most of those that saw the ad hadn’t heard of bitcoin. Now they have. And while it is important that those interested in buying bitcoin be aware that it is not government-backed, all who investigate further will start to realise the opportunity that it presents.

This announcement could be a first step towards regulating bitcoin, which would be positive for the sector (although why the Central Bank didn’t just issue a statement about contemplating regulation instead of advising against bitcoin use is a mystery). It would also be in line with an incipient regional trend. In August of this year the Nigerian Central Bank called for bitcoin regulation, and an increasing interest in Bitcoin conferences on the continent indicate that other nations are contemplating doing the same.

Trying to wipe out bitcoin use makes no sense, especially when the economic advantages are so strong. Harnessing the opportunity, establishing regulation to protect users and limit illicit use, and incorporating a global virtual currency into an economy already heavily dependent on mobile-based local virtual currencies would increase economic activity, encourage saving and bring even more of the population into the virtually banked sector. And it would entrench Kenya’s reputation as a regional technology hub with an innovation-friendly government. Kenya has a lot to lose if it tries to stamp out bitcoin, and a lot to gain if it cautiously supports its integration into the already strong virtual economy.

 

 

Innovators blocking innovation: bitcoin in Kenya

The bitcoin graveyard is littered with ideas that were going to revolutionize the field of remittances, spread income more evenly and lift developing economies. Structural barriers, higher-than-expected costs and limited markets are the usual culprits. But even when those obstacles have been overcome, success is no sure thing. On Monday, the best-funded business in the sector was dealt a blow by a fellow fintech, in a move that shows that even innovators can become establishment, and that unclear regulation is perhaps the biggest hurdle of all.

Remittances – money sent home by relatives working abroad – are the economic lifeblood of not only hundreds of thousands of families but also of entire countries. By not requiring a bank account, remittances are crucial for wealth distribution and financial inclusion – the sent money can be received at participating agents, which could be stores, supermarkets, pawn shops or mobile money handlers. One of the largest and fastest-growing markets is sub-Saharan Africa, which received $33 billion in 2014. In some countries, remittances account for 20% of GDP. Yet these inflows comes with a high price: the fees and commissions. The global average cost of sending money is about 8%. In sub-Saharan Africa it rises to 12%, reaching as much as 20% in some countries. In 2011, Bill Gates urged G20 leaders to commit to bringing the costs down to a more reasonable 5%, which would generate global savings of $15bn. Yes, billion. More money in the hands of low-income, unbanked families in developing countries would be a significant step towards reducing poverty.

Bitpesa

BitPesa was founded in November 2013 to improve the UK-Kenya remittance corridor using bitcoin transfers. It soon moved into other originating markets, and now handles remittances from just about anywhere to Kenya, Tanzania, Nigeria and Uganda. Users deposit bitcoins which are converted into the destination local currency and sent via the blockchain, for a 3% fee. BitPesa doesn’t handle the cash-out side of the equation, but instead deposits the funds in a mobile money wallet, which the receiver can then cash out in his or her usual way.

Yet businesses almost never develop as originally planned. The startup soon found that their service was being used by an increasing number of businesses to pay suppliers and employees, rather than for personal transfers. Their website shows a partial pivot away from remittances, towards a business payment platform. It has also diversified into trading, and offers one of the largest bitcoin exchanges on the continent.

In February of this year, BitPesa secured a $1.1m funding round led by Pantera Capital, one of the prime VC investors in the bitcoin space. Yet, as is usually the case, securing the round does not mean that their troubles are over. In November, M-Pesa stopped payment gateway company Lipisha from processing M-Pesa transactions, freezing Lipisha funds held in M-Pesa accounts. They offered to reinstate the service if Lipisha stopped working with BitPesa, claiming that BitPesa does not have the necessary license and does not comply with anti-money laundering (AML) regulations. According to BitPesa, they do comply with all AML and know-your-client (KYC) regulations, and that the Central Bank of Kenya has told them that a license is inapplicable to its business. Both Lipisha and BitPesa have taken M-Pesa to court. A preliminary ruling on Monday declared that more time is needed to make a definitive ruling. Meanwhile, BitPesa’s access to M-Pesa’s clients remains cut off.

The Kenyan remittance market is surprisingly tough. It is competitive: the World Bank lists 12 official participants in the sector, with fees ranging from 3.4% to 11.3%. Innovation is beginning to play a bigger role. WorldRemit and Equity Direct keep rates low with their online channels. The Cooperative Bank of Kenya announced last month a partnership with mobile payments startup SimbaPay to facilitate low-cost and instantaneous remittances between account holders in the UK and Kenya. UK-Kenya payment services company Continental Money has teamed up with TransferTo, a mobile remittance hub, to allow users to send remittances in the form of mobile airtime.

by Scott Webb for Unsplash
by Scott Webb for Unsplash

Losing the Kenyan remittance market would be a blow, but not necessarily game over. M-Pesa is not the only platform that BitPesa can use: its gateway Lipisha also works with Airtel Money, Visa and Mastercard. BitPesa has managed to diversify its markets over the past few months, recently moving into Tanzanía, Uganda and Nigeria, the continent’s largest remittance market ($21bn in 2014, vs Kenya’s $1.5bn), and 5th largest in the world. It has also managed to develop a liquid bitcoin exchange in Kenya, Nigeria and Uganda, and will no doubt keep on innovating in payment mechanisms and services.

M-Pesa’s blocking manoeuvre can be seen as the recognition of the potential threat that innovative platforms pose, at a time when M-Pesa’s high fees and restrictive business practices are being increasingly called into question. Which is ironic, since M-Pesa is itself a classic example of successful financial innovation. What’s more, a large part of its success is due to relatively relaxed regulation, the same concept that it is now arguing against. It is surprising to see it attempt to block a new player such as BitPesa instead of working with them – unless their plan is to move into bitcoin remittances as well. Perhaps their intention is to provoke explicit bitcoin regulation, which in the long run will help the sector. Yet there are less destructive ways to do it. In the end, BitPesa will hopefully come out stronger, more diversified, and having benefitted from the public support of the underdog. As the saying goes: “When they start shooting at you, you know you’re doing something right.”

 

Bitcoin and remittances – a long-lasting relationship?

“Bitcoin will not be a significant player in the remittance industry.”

At the Money 20/20 conference last month, the Executive VP of Business Development at MoneyGram dismissed bitcoin as a possible remittance solution, alleging that “you can send money to a phone, but these people need cash”. It is somewhat perplexing that someone so involved in moving money has not realized that mobile money can be converted to cash relatively easily, using any existing extensive network of mobile money agents. And that it is precisely the spread of convenient mobile money services that is relaxing the dependence on cash, as more merchants and suppliers are happy to accept the digital equivalent. It is even more perplexing that MoneyGram does not seem to have realized that the move towards mobile is one of the main factors behind the fall in MoneyGram’s market value to almost half its value of three years ago, and the net loss of $72 million in the first quarter of this year. Someone should give them a Kodak camera.

Market statistics aside, though, the Executive VP may have a point, at least in the short-term. Bitcoin has been hailed as the revolution of cross-border payments, whose cost savings will lift entire regions out of poverty. Unfortunately, it doesn’t work like that. For now.

by Mohammad Yearuzzaman for Unsplash
by Mohammad Yearuzzaman for Unsplash

Remittances – money sent home by foreign workers – is a complicated issue. Too many middlemen eat away at the sometimes already meagre amounts sent. Currency controls delay delivery. But most difficult is the “last mile”, the physical problems of actually receiving the money. In the most common remittance destinations (India, China and the Phillipines), a significant portion of adults do not have a bank account, so they depend on exchange offices. In rural areas, exchange offices are not plentiful, competition is scarce, the fees are high and the security is low.

Enter bitcoin. Finally, money can be sent to anywhere in the world, to anyone with a computer or a mobile phone, almost instantaneously and with almost no fees. All the sender needs to do is to convert some of his or her wages into bitcoins, and with a couple of swipes and taps send it to another bitcoin address, which could be anywhere. Within a few minutes, the receiver has the bitcoins in his or her wallet. And here we come up against the problem.

Well, actually, two problems. The first is that to set up a wallet, you usually have to confirm your identity to comply with the local anti-money laundering laws, and to do this you need to upload a photograph of yourself next to your ID. Easy if you have access to a computer or a smartphone. Not everyone does.

The other, bigger, problem is that most money exchangers in typical remittance destinations do not accept bitcoin. It isn’t hard to switch your bitcoins into a more “acceptable” currency on an exchange, but relatively few exchanges operate beyond the trinity of dollars, euros and yuan. Even if the local money exchanger does accept a non-local fiat currency, there may be barriers to accepting it from an entity they are not familiar with.

Liquidity could be an issue. For an exchange to work efficiently, both sides of the trade need to be fairly liquid. There needs to be enough holders of Ghanaian cedis who want bitcoins, for example, and enough bitcoin holders who want Ghanaian cedis for the trade to go through at the recent market price. Trading bitcoins in and out of the major currencies is not a problem. Beyond that, bitcoin is just not that liquid.

But let’s say that everything has gone smoothly and the receiver has the bitcoin-converted-into-fiat mobile money in his or her digital wallet. What then? Finding an agent to convert that into cash is usually possible although with varying degrees of convenience. In Kenya, for example, M-Pesa agents are ubiquitous, as even rural areas depend on the mobile money system. Other countries don’t have that kind of opportunity or infrastructure. And the scarcity of agents allows them to charge whatever fees they wish. Often the most convenient option is to use the expensive MoneyGram or Western Union facility. Western Union and Money Gram have a combined 50% or more of the remittance market of almost 80% of sub-Saharan countries, and in some, their market share goes up to 90%.

And bitcoin-based remittances have significant competition from other innovators. Payment startups have brought remittance costs down for those willing to seek them out, to a level that in many cases competes with the bitcoin solution. In Kenya, for example, bitcoin remittance startup BitPesa charges a 3% transaction fee. Equity Direct, a payment platform that does not run on the blockchain, operated by Kenya’s Equity Bank and money changer VFX, charges 3.4%.

In some cases, the structural barriers to converting your bitcoins into a local currency are prohibitive. Bitcoin is banned in several remittance-heavy countries, such as Bangladesh, Russia, Ecuador, Bolivia and Thailand.

In others, regulation is clamping down amidst increasing concern about terrorist financing and money laundering. Money transfer businesses have to tighten their account requirements, report any suspicious movement and install a more rigorous screening process, the costs of which will obviously be borne by the users. The off-ramping gets more complicated as well: to avoid red-tape and possible fines, some banks are refusing to handle remittances of any type.

The biggest barrier of all, though, is habit. Even with all the remittance innovation and the more efficient and economic choices that senders have at their disposal, only 2% of remittances are sent via mobile. In part this is due to poor interoperability of mobile providers, and the cumbersome identity proof regulations. Innovators have their work cut out for them to overcome these barriers, and to convince long-term users that the cost saving is worth the effort of overcoming the innate resistance to change.

by Jayakumar Ananthan for Unsplash
by Jayakumar Ananthan for Unsplash

The potential for bitcoin to make a big impact in the developing world is still there. In theory bitcoin is ideal for the “unbanked” in that it gives users control over their financial transactions with minimal cost. An estimated 80% of rural people receiving remittances do not have access to traditional banking services. In sub-Saharan Africa, more than 70% of adults do not have access to a bank account. In the developing world, the average is 46%. In five sub-Saharan African countries – Cote d’Ivoire, Somalia, Tanzania, Uganda, and Zimbabwe – more adults have only a mobile money account than have an account at a financial institution.

In countries with political unrest and volatile currencies, bitcoin makes even more sense. While the value of local currencies depends on relative growth prospects, the financial health of the government and faith in ruling stability, the value of bitcoin is above all those things. The value of bitcoin fluctuates, true, but its worth is determined almost exclusively by market forces. No-one can unilaterally devalue bitcoin, no-one can ban it outright, no-one can dictate what it’s used for. Bitcoin is a self-determined alternative store of value, whose worth is protected by cryptography.

As with all innovation, the idea is “essential but not sufficient”. The secret to success is in the implementation. Bitcoin’s use is growing and spreading, and its benefits are still being explored. The potential it holds to put economic power in the hands of the hitherto disenfranchised is real, and exciting. But making that happen is something else altogether. The shift required in regulation, infrastructure and habit is profound, but it is starting. And as bitcoin use spreads, the change will gather speed and the economic benefits will become apparent. That should be enough motivation for the current startups to keep on trying, and for others to fill the service and technology gaps that impede the progress. Bitcoin may not be ideal for remittances now. But in one form or another, it will be.

Bitcoin and terrorism

This is a risky thing to write about, as so many people tragically died in the Paris attacks, and no amount or sequence of words on the subject can hope to convey how so very sad and unfair that is.

But, while technology obviously facilitated the coordination of the atrocity, and electronic payment rails probably helped move the money that financed it, it is important to point out that technology is not the culprit. Yet that doesn’t stop the gleeful finger pointing and the vindicated headlines proclaiming that Bitcoin’s days are numbered because it obviously finances terrorists.

Quartz last Thursday brandished the provocative headline, “The Paris attacks look to be altering the EU’s stance on bitcoin”:

quartz bitcoin

The Telegraph newspaper declared that “Europe plans crackdown on Bitcoin after Paris attacks”, Business Insider claimed that “Europe is going to clamp down on Bitcoin to try to stop terrorism funding”, and the International Business Times UK ran with a SEO-friendly “Paris attacks: EU to crack down on bitcoin transfers in attempt to strangle Isis funding”. The Washington Times seems to have had the most fun with “EU look [sic] to ban Bitcoin after Paris attacks”. Apparently Reuters had reported that EU Interior and Justice ministers were going to propose a crackdown on cryptocurrencies and the anonymous use of pre-paid cards, to prevent those channels from being used for terrorist funding. Now, I confess that I haven’t seen the draft document, but surely it’s a leap to go from “propose a crackdown” (whatever that means) to “banned”?

The sparse excerpt given of the memo in the Reuters report recommends that the European Commission “strengthen controls of non-banking payment methods such as electronic/anonymous payments and virtual currencies and transfers of gold, precious metals, by pre-paid cards.” Again, I’m not sure why “strengthen controls” is interpreted to mean “clamp down”, other than to produce a catchier headline. A strengthening of controls would, in my opinion, have happened anyway, as virtual currencies become an increasing part of the financial fabric. A better anti-money laundering policy is, I think we can all agree, a good idea, unless the regulation stifles the application of innovation for social good.

Extreme reactions from politicians and the media are totally understandable in extreme circumstances. But realistically, even if a Bitcoin “clamp down” is recommended, is this really going to stop terrorist funding? No, probably not, and the setback to economic progress is likely to be material. Another victory for the terrorists?

And for the record, just last month the UK government published a national risk assessment, which concluded that the most likely vulnerability when it comes to money laundering and terrorist financing is… traditional banks. The least likely? Digital currencies.

UK govt national risk assessment

As an aside (although it’s not really an aside), I get thoroughly annoyed when the press touts Bitcoin’s anonymity as a threat. First of all, Bitcoin is not anonymous. It is pseudonymous, and it is usually possible, with careful forensics, to detect where a payment originated. After all, the history of every single bitcoin in existence is on the public ledger for all to see. It is possible to enhance Bitcoin’s anonymity, but it requires some manipulation, and even then, is not totally undetectable.

And if you want to claim that anonymity is bad, we should look at doing away with cash, don’t you think? Of course I’m not being serious (although maybe not totally, we can debate this another time), my point is that anonymity in finance is something that we have dealt with ever since money was invented. A dollar, or a piece of gold, or a shell, does not care who holds it. The current backlash over the power of encryption falls on the same weak argument – that terrorists and criminals use encrypted communications to plan and plot, so obviously it should be banned – without taking into account the good that encryption can do. Governments and dissidents can communicate securely. State and business secrets can be preserved. Privacy can be respected.

Suppose that we squash implicated technological innovations because of the potential for abuse. I’ll wager that more criminal or even terrorist activity has been plotted via email, web bulletin boards, even blog posts or web pages. So, should we ban the Internet? The UK government’s risk assessment puts banks as the top potential terrorist finance funnel – should we ban banks? The French police found an unlocked phone with an un-encrypted message that triggered the attacks. Should we ban mobile phones? Messaging services?

Would it even make any difference?

It’s worth bearing in mind that the same technologies that facilitated the criminal communication also helped to identify the mastermind and catch the accomplices. The same technologies that offered logistical and economic help for the terrorists, also delivered copious amounts of connection and support for the families and friends of the victims, and for a society in shock. I believe that regulation is good. Over-regulation is not. And in something as decentralized as Bitcoin, regulation is difficult to enforce. It needs to be regulation that the community as a whole recognizes as being beneficial for widespread acceptance. Bitcoin is a self-regulating concept. What we need is regulation that we believe is fair and appropriate. Regulation that encourages and protects.

“Strengthening controls” of Bitcoin and other cryptocurrencies, if it goes beyond enhancing anti-money laundering barriers, is no more than unproductive finger pointing which could set back the development and acceptance of a financial innovation which can help people around the world transfer assets securely and inexpensively, enjoy greater financial independence, and even emerge from poverty. And the media should be careful about playing a pivotal role in the barriers to innovation, just to grab attention.

 

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.

talk-to-the-hand

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

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.

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?

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.

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?