Digital Gold (25 page)

W
HILE
B
ITCOIN WAS
winning mainstream approval in the United States, it was moving in the opposite direction in China. On December 5, just after Bobby Lee had boarded a plane in Shanghai for his first business trip to the United States since Bitcoin had exploded in China, he got a call from a reporter at Bloomberg News, who explained that sources were telling him that China's central bank, the People's Bank of China, was about to release virtual-currency regulations.

This was news to Bobby. The deputy governor of the People's Bank had said back in November, in unscripted comments, that Bitcoin was unlikely to get legitimacy, but that people were nonetheless free to participate in the market. That had led many people to assume that the central bank would take a hands-off approach. This had helped the frantic speculation on Bitcoin to continue, with the price above 7,000 yuan on the day Bobby was flying to San Francisco.

But as a longtime observer of markets, Bobby knew this frenzy was unlikely to end with anything other than a dramatic crash and, when it did crash, it was not going to help Bitcoin's long-term popularity or status with the Chinese government. Bobby had been warning people that the price was unlikely to keep rising, but he wasn't averse to some help from the central bank.

“We're happy to see the government start regulating the Bitcoin exchanges,” Bobby told the reporter before quickly signing off.

Bobby spent the flight in an optimistic mood, imagining that
the uncertain state in which he'd been operating would soon be cleared up. But when the plane landed and he turned on his phone, he had over a dozen messages waiting for him. In one of them, his head of government relations, Ling Kang, said, “Whatever you do, call me first.”

On the long walk to customs, Bobby got Ling on the phone and told him he had heard about the regulations before taking off.

“No, no,” Ling said in the Mandarin they used in conversation, with an audible note of fear in his voice. “Bobby, this is the real deal.”

The document that had been released while Bobby was in the air was indeed from the People's Bank, but it was also signed by four other major ministries, and it created deep uncertainty for the future of Bitcoin in China, Ling said.

The good news was that the agencies had declared that Bitcoin was not in itself illegal and could be considered a kind of digital asset that people should be allowed to buy and sell. The document also said that virtual-currency exchanges needed to register with the Ministry of Information; this suggested that the exchanges weren't going to be shut down.

The bad news, Ling explained, was that the government had ruled that Bitcoin was not a currency, but was, instead, a digital commodity.

The Chinese government had stepped right into the middle of the ongoing debate about how to define Bitcoin and had actually found itself in agreement with Wences Casares and many other advocates for Bitcoin, who believed that in 2013 the files on the blockchain were more similar to commodities, like gold, than to currencies, like dollars and euros, because Bitcoins were not yet widely or easily used as a medium of exchange or as units for accounting. Beyond those qualities, the Chinese government had also said that Bitcoin lacked the most important characteristic of a currency: government backing.

The Chinese government's categorization of Bitcoin as a digital commodity didn't, on its face, seem terrible to Bobby. Within China, almost no one was using Bitcoin to buy and sell things—it was still just a speculative investment. The problem, though, was that because it was not considered money, the government had declared that banks and payment processors could not deal with Bitcoin, either directly or indirectly.

Bobby grilled Ling on what this meant. Would Tencent, the payment processor, have to stop transferring yuan to BTC China for customers if Tencent itself wasn't touching Bitcoins? If so, that could be deadly.

As was often the case with Chinese government statements, the specifics were left unclear, giving party officials flexibility to deal with the situation as it progressed. Ling wasn't hopeful about where this would lead. The statement made it clear that government officials were not happy with the degree of speculation they had seen.

But Bobby was an American-educated optimist and Tencent hadn't shut BTC China down yet. What's more, there was obvious room in the statement for them to continue doing business.

The market seemed to agree with Bobby. In the hour immediately after the Chinese government statement had come out, the price of Bitcoin had entered a free fall, dropping 25 percent to 5,200 yuan. But soon thereafter the price began recovering, and it was already back to around 6,400 by the time Bobby was through customs.

That afternoon Bobby gave a talk at his alma mater, Stanford, and explained that he was “cautiously optimistic” about the new rules. But that day's statement was not the final word from the government.

December 7, 2013

T
he extent to which Bitcoin could survive and grow without government approval was on display in Buenos Aires, at the first conference hosted by Bitcoin Argentina. The group had been founded by Wences Casares's old friend Diego along with a partner he had met at a Bitcoin Meetup earlier in the year. For the conference the men had booked a big hotel in downtown Buenos Aires and managed to sell four hundred tickets, with about 40 percent going to foreigners like Roger Ver, Erik Voorhees, and Charlie Shrem.

The ticket-buying process itself had put a spotlight on one of the most promising Bitcoin startups to emerge from Argentina and one of the first companies anywhere using the network to legally provide a service that wasn't possible with the traditional financial system.

In Argentina, credit card transactions with foreigners, like the sale of conference tickets to Americans, normally took a long and expensive route before paying out in Argentina. The American customer's credit card company would deduct around $2.50 from
the $100 ticket price to send the money to Diego's Argentinian bank. From there, the Argentinian bank would generally charge another 3 percent for the foreign exchange, leaving $94.50. The big hit, though, happened when the Argentinian bank turned the dollars into pesos. If Diego converted the $94.50 with a money changer on the street he could have gotten the unofficial rate of around 9.7 pesos for each dollar, leaving him with 915 pesos. But the bank exchanged the money at the official exchange rate set by the government—6.3 pesos at the time of the conference—giving him, instead, 595 pesos. On top of that, Diego's bank wouldn't give him those pesos until twenty days after the customer purchased the ticket.

The Argentinian Bitcoin startup, BitPagos, provided a clever way around this expensive morass. BitPagos took the $100 credit card payment in the United States and charged a 5 percent fee. But instead of transferring the remaining $95 to an Argentinian bank, BitPagos used the dollars to buy Bitcoins in the United States. BitPagos then transferred the Bitcoins directly to Diego. He could either keep the Bitcoins or exchange them for pesos at the unofficial exchange rate, thus ending up with around 920 pesos, instead of 595. And rather than taking twenty days, BitPagos gave him his Bitcoins in two days.

BitPagos had been started earlier in the year by two young Argentinians, a man and a woman, who had been running a consulting company and struggling to take payments from foreign customers. In addition to collecting ticket payments for the foundation, the new company was getting traction with hotels that took money from foreign tourists and didn't want to pay the cost of getting those payments into pesos. By the time of the conference, BitPagos had already signed up around thirty hotels. Most of these hoteliers didn't care about the ideas behind a decentralized currency; they were just happy to find a way around the expensive
tollbooths that littered the Argentinian financial system. As an added bonus, they could end up with money in Bitcoins rather than the rapidly depreciating peso.

This was an eminently practical use of Bitcoin to deal with the inflationary mess in Argentina, but it was so practical that it actually swung around into the domain of the ideological ambitions that Satoshi Nakamoto and the Cypherpunks had imagined. The Argentinian hoteliers might not have been libertarians, but they would have easily understood Satoshi's early writing about Bitcoin, which explained that “the root problem with conventional currency is all the trust that's required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust.” Mismanagement of currencies was a part of daily life in Argentina.

The conference in Argentina attracted many of the more ideologically minded Bitcoin followers from around the world. The old team from BitInstant gathered for a reunion of sorts and the team members were all given prominent speaking spots. They lived it up in Buenos Aires, eating steak, drinking Argentinian wine, and going to a tango performance with the other presenters at the conference. But for them and most of the foreigners at the conference, the most memorable thing about the event was not a part of the official proceedings. Everyone coming into the Hotel Melia, where the conference was held, passed two teenagers, a boy and a girl, whose wispy, almost ethereal features gave them away as twins. Both of them were wearing the same white T-shirt with the word
Digicoins
on the front, and both asked people entering the conference, in a gentle voice, if they wanted to buy or sell Bitcoins. Those who took them up on the offer were guided to a Subway sandwich shop across the street. There at a table sat a man with wavy silver hair, dark eyes, a computer, a white shirt unbuttoned enough to reveal his chest hair, and a backpack full of cash.

The man, the father of the twins, had his Bitcoin wallet up on the laptop and he could change money in either direction, in much the same unofficial way as all the other black-market money changers on Buenos Aires street corners. Dante Castiglione, the owner of Digicoins, had not created Digicoins just for this conference. He had, by this time, been serving as one of Argentina's most successful virtual-currency exchangers for a few months. His twins were his runners, going out into the city each day to visit the customers in need of pesos or virtual currency. When people asked about his business, he was stingy with details and gave a wry smile, as if to ask, “Why do you think I'm doing this?” But he was willing to say that this was only the latest stop in an itinerant career built by finding opportunities in Argentina's broken financial system.

“I am a working man,” he would say when pushed. “We are trying to give our service. We are earning our food and our rent.”

Bitcoin's evolution in the United States and China was showing how the technology could become dependent on the official financial system and government approval. Argentina, on the other hand, was showing how it could develop without any of that. It certainly moved more slowly, but there was something more tangible and grounded about what was being created.

T
HE MAN WHO
had gotten this ball rolling in Argentina, Wences, couldn't make it to the conference in Buenos Aires. At the time, he was finalizing the sale of his most recent startup, Lemon, for $42.6 million. When he wasn't winding down his work with Lemon, he was working on the new Bitcoin company he was creating with Fede Murrone, his longtime collaborator in Argentina.

The core of the new business was the system that Wences and Fede had begun developing early in the year to store their own, significant holdings of Bitcoin, having come to distrust Mt. Gox and
the other available services. Their main goal had been to get the private keys for all their addresses off any computer hooked up to the Internet. Wences and Fede had begun by putting their private keys on an offline laptop and storing that laptop in a safe-deposit box at a bank in California; this allowed them to delete all the private keys from their online computers.

Over the course of 2013, the value of their Bitcoins had grown, as had the number of people who heard about their system and asked to store Bitcoins on the laptop. This had provoked Wences and Fede to take more and more strenuous measures to secure the private keys. First, they encrypted all the information on the laptop so that if someone got hold of the laptop that person still wouldn't be able to get the secret keys. They put the keys for decrypting the laptop in a bank near Fede in Buenos Aires. Then they moved the laptop from a safe-deposit box to a secure data center in Kansas City. By this time, the laptop was holding the coins of Wences, Fede, David Marcus, Pete Briger, and several other friends. The private keys on the laptop were worth tens of millions of dollars.

The interest shown by friends suggested to Wences that there was a broader need for a more reliable way to store Bitcoins. People didn't want to hold the private keys on their home computers, but they also didn't trust Mt. Gox and Coinbase to keep digital files worth millions. The vault, as Wences and Fede called it, was just a starting point. Wences imagined that this would be the first offering in what would become a full-service Bitcoin company that could provide a place for people everywhere to store and spend their coins. Unlike the previous startups that Wences had started and sold, this one was intended to be his lifework—the last company he would ever found. He called it Xapo, a name that he and Fede settled on after looking for a simple, distinctive word for which the dot-com domain name was available.

Wences initially had little interest in taking money from investors for this company. He didn't want to give control to anyone else and he had enough money to pay for it all himself. But over the fall of 2013, his friends convinced him that starting a company without investors would deprive him of all the connections and marketing possibilities that funders bring.

The value of having investors became very clear to Wences the same day that he completed the sale of Lemon, when Coinbase announced that it had raised $25 million from Andreessen Horowitz to grow the company. It was the biggest public investment in a Bitcoin company, by a good margin, and Coinbase reaped the reward in new customers and attention.

A few days after this, Wences journeyed to San Francisco to meet with Benchmark, a venture-capital firm that had been vying with Andreessen Horowitz to invest in Coinbase. Wences had been friendly with the Benchmark partners for some time, and he had hoped he might find an opportunity to work with them. One of them was the brother-in-law of Fortress's Pete Briger.

The meeting at Benchmark's offices was unlike Wences's earlier fund-raising efforts. This time, he laid out what he needed from Benchmark to make it worth his while. After Wences's presentation, the Benchmark team huddled briefly and then offered to put $10 million into Wences's company, valuing it at $50 million. As in all of Wences's past startups, there was no term sheet, just a handshake.

When Wences walked out, he immediately called his old friend Micky Malka to tell him the exciting news. Micky responded not with excitement, but instead with pique, because Wences hadn't offered Micky and his firm, Ribbit, a place in the deal. After demanding an opportunity to put $10 million into Wences's company, Micky finally settled for $5 million. A short while after that,
Pete Briger called to demand a place in the round too, and Wences agreed to let him put in $5 million. This left Wences with $20 million before he even had a functioning business.

D
URING HIS TWO
-
WEEK
stay in the United States, Bobby Lee visited his brother Charlie, who had quit his job at Google over the summer and joined Coinbase to work on Bitcoin full-time. Bobby showed up at the company's makeshift offices in a converted three-bedroom apartment a day after the company announced the $25 million investment from Andreessen Horowitz.

Charlie Lee didn't need to work another day of his life. Litecoin, his alternative cryptocurrency, which was a slightly faster, lightweight version of Bitcoin, had now become the second-most-popular cryptocurrency in what was becoming an increasingly crowded field of Bitcoin knockoffs. In part because of Charlie's transparency in launching Litecoin, people trusted it and were betting that it would be, as Charlie had intended, the silver to Bitcoin's gold.

In November the value of all the outstanding Litecoins had briefly surpassed $1 billion. The particular computer chips that were good for mining Litecoins were sold out at nearly every online electronics retailer. Charlie had been mining Litecoins since the beginning, so he owned a sizable number of the coins, along with his significant Bitcoin holdings. His work at Coinbase was primarily due to his desire to help bring virtual currencies into the mainstream.

Charlie saw that Bitcoin had done similarly good things for Bobby. Despite all the long hours and uncertainty Bobby had endured over the last few months, his position as a CEO, after years in middle management, had given him a confidence and self-assurance that seemed to outweigh the stresses of the job.

Bobby had spent much of his time in the United States looking for new investors and partners for BTC China. But he was still trying to figure out what the People's Bank of China statement on December 5 would mean for his company moving forward. On Bobby's exchange, the price of Bitcoin had fallen from the all-time highs, but it stabilized at around 5,500 yuan, or $875, on Western exchanges. Bobby learned from his staff that the December 5 statement had come about after the enormous price spike in November. Several reports had gone up to the State Council, the highest administrative authority in China, and one of the four vice premiers of the council had ordered the People's Bank to do something about the situation. As is generally the case in China, the whole process was enshrouded in secrecy and seemingly driven by officials trying to protect their backs.

On Bobby's last night in the United States, his government-relations guru, Ling Kang, called again. The payment processor Tencent had just called BTC China to explain that Tencent was going to stop doing business with Bobby's exchange in the next few days. Bobby was furious. Tencent had previously agreed to provide at least a ten-day notice of any changes. That night, he called everyone he could think of to argue his case. But he and Ling heard back that Tencent had gotten orders directly from the local branch of the People's Bank and there was no fighting it.

When Bobby flew back to China the next day, everyone at his company was scrambling to get a new payment processor set up before Tencent shut the company off on Sunday at noon. But it now appeared that the problem wouldn't end with Tencent. Bobby learned that all the payment processors had been called to the People's Bank on Monday to discuss the issue.

The Monday meeting did not generate any official change in policy or new documents. But the real-time reports from the meeting that Bobby's team was receiving revealed that the payment
processors were all being encouraged to reconsider any business with Bitcoin companies. As the rumors began to leak, the price dropped, falling to around $600 on Western exchanges. Two days later, when Bobby officially confirmed that his company would stop taking new deposits, a new sell-off began, taking the price down to $430 on Bitstamp and 2,100 yuan on BTC China, or less than a third of what it had been at the high just two weeks earlier. Whereas 100,000 Bitcoins had been trading hands daily on BTC China a few weeks earlier, now the trading volumes were less than a tenth of that.