During the past 18 months, attitudes about Bitcoin have undergone a metamorphosis. Despite being battered by scandals, besieged by regulators, repeatedly written off as a fad and decried as a ponzi scheme for most of its short existence, Bitcoin has survived to capture the attention of the global financial industry. In fact, digital currency has gone from being a four-letter word on Wall Street to one of the hottest and most dynamic areas of the burgeoning financial technology (fintech) world.
However, six years and well more than a billion dollars in venture capital after it was created by a person (or entity) operating under the nom de guerre Satoshi Nakamoto, Bitcoin is approaching something of an inflection point. It has now entered what many adherents describe as the “show me” stage.
We speak to the key players who will have a major role in determining how Bitcoin will fare in 2016. In “Bitcoin advocates,” (page 23) Grayscale founder Barry Silbert and director Michael Sonnenshein discuss launching the first publicly traded securities based on bitcoin. We also interview Tyler Winklevoss (page 24), who along with his brother is launching Bitcoin exchange Gemini. Even Felix Salmon, perhaps the most outspoken Bitcoin critic, chimes in (see “Bitcoin skeptic,” page 27).
In digital currency circles, 2015 is already known as the year in which Bitcoin, and more specifically the blockchain—the massively distributed, secure ledger that clears, records and settles bitcoin transactions—garnered a modicum of mainstream respect. For a number of reasons, though, 2016 is shaping up to be the year in which a confluence of factors come together at a key inflection point.
For instance, many of the bitcoin and blockchain-related products and services developed by the horde of coders backed by that $1 billion will either come to market or fail. With New York’s Bitlicense in effect, it’s also when we are likely to see significantly more comprehensive and consistent regulation. Relatedly, and of more importance to traders, it is when more derivative instruments and multiple publicly traded vehicles are likely to become available.
Seeing how it all shakes out
The largest of these factors is that 2016 may see Bitcoin’s first real industry consolidation. Despite improved attitudes and greater institutional interest in the blockchain, it is obvious to veteran VC and private equity operators that not all of the hundreds of bitcoin-related startups created during the past several years will survive.
Truly profitable, cash-flow positive bitcoin-related companies are as rare as unicorns at the moment. While many have developed interesting and promising technology, they’ve burned extraordinary amounts of capital to do so. Moreover, many of these companies raised funds in late 2013 and 2014 when VC firms were tripping over one another to fund bitcoin startups. They are facing a vastly more educated and demanding investor community as they return for new rounds, which will make it much harder to raise capital.
One possible result? A good, old-fashioned shakeout. You know the drill—a few eye-popping buyouts, a slew of smaller acquisitions/mergers and the inevitable bankruptcies—akin to what occurred with the first generation of dotcom startups at the end of the 1990s.
Some of the early, although anecdotal, warning signs are already there. In September, for instance, London-based blockchain investment company Coinsilium postponed its £3 million IPO, originally slated for August, for undisclosed reasons. Consumer and merchant adoption, which was all the rage 18 months ago, has stalled; global bitcoin transactions—i.e., people using the digital currency to buy or sell somethinghave plateaued at around 125,000, while the number of merchants accepting bitcoin at year-end 2015 is now 120,000, down sharply from the 150,000 estimated six months ago. Growth is still there, but it is slowing.
Meanwhile, the velocity and manner in which venture capital is flowing into the digital currency ecosystem has changed. VCs poured $365 million into bitcoin startups last year, more than three times 2013’s tally of $103 million. And this year, they’ve put an additional $436 million to work through September 8 (a whopping 19% more than during all of 2014). On the surface, bitcoin looks as hot as can be in the early-stage world.
However, a closer look reveals a trend toward fewer seed deals and a greater concentration of follow-on rounds for established players. In the fourth quarter of 2014, 31 deals totaling $133 million were announced, averaging $4.6 million apiece. In the first quarter of 2015, the absolute total was even higher, at $229 million, but it was across only 24 deals—one of which was 21 Inc.’s massive $116 million round—and average transaction size rose to $9.5 million (see “New paradigm investing,” below).
In the second quarter, only $145 million was raised across 15 deals, and with six weeks to go, the third quarter has seen nine deals worth around $64 million—nearly half of which came from blockchain specialist Chain’s $30 million series B round. Indeed, August 2015 was the slowest month for digital currency venture funding in more than a year.
A narrowing of early-stage financing activity is normal for any new industry because competitive pressures eventually separate the wheat from the chaff. But in this case, there may be more going on.
Potentially much more relevant is the belated discovery by large, mainstream companies that Bitcoin’s blockchain may be able to rewrite how a lot of things actually get traded, recorded, verified and transferred, increasing efficiency and lowering the cost of back office processes. Although not all of them admitted it at the time, a number of firms abandoned their previous skepticism about bitcoin starting around mid-2014, and began to tinker with blockchain applications.
For Wall Street, the interest is whether blockchain technology can improve a range of mundane yet critical activities, such as settlement, clearing, legal contracts, custody, verification, even proxy voting—all of which currently rely on an army of third parties to process. This is no small thing; some 20% of the U.S. economy (or more than $3.4 trillion in annual GDP)is estimated to be generated by companies that act as a trusted third party, according to Wedbush Securities payments analyst Gil Luria.
Even a partial roster of the large financial services companies now working on bitcoin applications is impressive: Goldman Sachs, Credit Suisse, VISA, Citigroup, BNY Mellon, UBS, Barclays, NYSE, Nasdaq, AXA and even the Bank of England. Moreover, a veritable who’s who of financial luminaries have gotten involved with bitcoin startups: Former JP Morgan derivatives specialist Blythe Masters, former U.S. Treasury Secretary Larry Summers, former SEC Commissioner Arthur Levitt, former U.S. FDIC chair Sheila Bair and VISA founder Dee Hock, to name just a few. Together, the interest has lent the Bitcoin ecosystem a key thing it lacked two years ago—mainstream credibility.
“It’s really a paradigm shift,” notes Dax Hansen, who has been involved with digital currencies since 2013 and heads Perkins Coie’s 35-member digital currency practice, the largest of its kind. “The cost for exploring potential blockchain applications is immaterial for these firms, but the penalty for ignoring it is potentially enormous if it turns out to be wholly disruptive.” Perkins Coie partner Andrew Cross adds that Bitcoin represents efficiency looking for inefficiencies, and financial institutions know very well where those inefficiencies lie.
As a result, the age-old question of buy-vs.-build is about to become much more prevalent, largely for the first time in this industry. Large, deep-pocketed companies will weigh the advantages of snapping up smaller ecosystem participants against the cost of hiring and developing in-house capabilities themselves, partly driving the consolidation mentioned earlier.