Digital Gold (26 page)

Bobby was in back-to-back meetings with his staff contemplating ways to stay alive without the payment processors. One of the other Chinese exchanges, Huobi, began taking in customers' money through the personal bank account of the company's CEO. The December guidance from the Chinese central bank seemed to bar banks from working with Bitcoin, but Bobby was surprised to see that the banks eagerly took the business from his competitors. Bobby's Chinese deputies explained that the banks were doing this because, unlike the payment processors, they had not been called into a meeting and warned not to work with Bitcoin. Whereas in the United States, banks were unwilling to do work unless they were explicitly given a green light by regulators—and sometimes not even then—in the Wild West of China, the banks would try just about anything until they were explicitly told it was not allowed.

Bobby, though, had worked most of his adult life for American companies and he was uncomfortable skirting the rules. The best alternative seemed to be some sort of voucher system, in which third-party vendors would sell credit for BTC China, similar to the way vendors sell cards with cell phone minutes. But as his staff rushed to get this set up, Bobby watched customers flock to the competitors who had set up bank accounts. In China, scrupulously following the rules seemed to be a recipe for losing business.

E
ACH NEW RUN
-
UP
in the price had drawn new and more sophisticated scrutiny of the principles underlying Bitcoin, and the December rise and fall were no different. This time, the people training their sights on Bitcoin were some of the highest-profile economists in the United States—including Paul Krugman, the progressive Nobel Prize winner; and Tyler Cowen, the prolific libertarian-leaning blogger. Few of them had much good to say.

Krugman focused largely on Bitcoin's claim to be a currency, given the difficulty it seemed to have fulfilling one of the basic roles of money: serving as a reliable store of value. Why would people store their wealth in Bitcoin if they knew the value was going to fluctuate so violently? Krugman asked.

Cowen, meanwhile, argued that Bitcoin was going to have difficulty sustaining its value as new and better-designed cryptocurrencies came along and drew users away from it. Some people were, indeed, already choosing to hold Litecoin, Charlie Lee's creation, and a hip, younger cryptocurrency, Dogecoin.

But a deeper strain lurking beneath these critiques was an awareness that one of the fundamental premises that had driven Bitcoin's popularity seemed, increasingly, to have been disproved. Many early Bitcoiners, particularly in the libertarian camp, had believed that the Federal Reserve's efforts to stimulate the economy in the wake of the financial crisis, by pumping lots of new money into banks, would devalue the dollar and lead to high inflation, similar to what had happened in Argentina.

This idea made a scarce asset like Bitcoin or gold look like a safer bet than holding dollars. But in late 2013 none of the fears about inflation had been borne out. In fact, the problem facing the American economy was not inflation, but deflation, because banks were holding much of the new money, rather than putting it out
into the economy. The Fed's stimulus program had been successful enough that the European and Japanese central banks were now copying it. This was a living economics experiment and it didn't seem to be going the way libertarians expected. At the same time, the scarcity of Bitcoins still had the effect that early critics had warned about: it was encouraging people to hoard Bitcoins rather than actually use them.

Perhaps the most stinging criticism came from a well-known British science fiction writer, Charlie Stross, who wrote out a long list of Bitcoin's potentially damaging effects, of which some were intended by the Cypherpunks (for example, tax evasion and weakening government social-welfare programs) and some were not. Stross noted that in the latter category, the hoarding encouraged by Bitcoins' scarcity was leading to a vast inequality in the holdings of Bitcoins,
“to an extent that makes a sub-Saharan African kleptocracy look like a socialist utopia.” Indeed, a few Bitcoin holders, like Roger Ver and Wences Casares, owned a material proportion of all the outstanding coins. This was unlikely to sit well with the Occupy Wall Street crowd, who objected to the undue power of the wealthiest 1 percent of the population.

The Bitcoiners had their ready responses to all these critiques and voiced them loudly. Bitcoin's volatility would go away as it matured, the believers said, and Bitcoin had a first mover advantage against other cryptocurrencies that was showing no signs of abating. Meanwhile, inflation might not be a problem in the United States yet, but it was a problem in other countries.

Whatever the merits of the criticisms, they did not seem to be dulling the growing curiosity about Bitcoin within major financial institutions. The most notable name to show signs of interest was Wells Fargo, perhaps the nation's most successful and most respected bank in the wake of the financial crisis. After the Senate hearings in November, Wells Fargo executives had reached out to
Pete Briger to reopen the conversation about working together on a Bitcoin exchange. One sign of Wells Fargo's openness was that executives of the bank agreed to travel to Fortress's headquarters in New York for the meeting. Briger rounded up a team of people to make the case for Fortress, one that included Wences and others who flew in from California.

Fortress put aside a grand conference room on the forty-seventh floor of its Manhattan headquarters, and executives from several divisions of Wells Fargo showed up. Once the dozen or so people were gathered around the conference room, Pete stood up and made his basic pitch to the Wells Fargo team. He explained why the Fortress team was so intrigued by the technology and pointed at the smart people around the table, such as Wences, who had thrown themselves into it. He hinted that Wells Fargo should be keeping up with Bitcoin, given the potential for the new network to challenge some of the basic services, like payment networks, that the bank was providing. Pete closed by talking about the lack of an American-based regulated exchange for Bitcoin—something that Fortress and Wells Fargo could provide together.

The questions from the Wells Fargo executives did not reveal much about how serious the bank was about the project, but they had clearly done their homework and came with detailed questions about what exactly an exchange would look like and how it might satisfy regulators. The meeting concluded with an understanding that the bank would take it all under consideration.

The potential advantages of Bitcoin over the existing system were underscored in late December, when it was revealed that hackers had breached the payment systems of the retail giant Target and made off with the credit card information of some 70 million Americans, from every bank and credit card issuer in the country. This brought attention to an issue that Bitcoiners had long been talking about: the relative lack of privacy afforded by
traditional payment systems. When Target customers swiped their credit cards at a register, they handed over their account number and expiration date. For online purchases Target also had to gather the addresses and ZIP codes of customers, to verify transactions. If the customers had been using Bitcoin, they could have sent along their payments without giving Target any personal information at all.

During this period, it was notable that some of the most encouragingly positive statements about virtual currencies came out of branches of the Federal Reserve, the archetype of the central bank that Bitcoin had set out to supplant. Fed officials didn't love the idea of a currency outside the control of governments, but they were very eager to see methods of moving money that cut out middlemen, who introduced risk into each transaction and into the financial system. The Fed had, in fact, been making increasingly vocal calls for technology that would allow more direct methods of moving money. During late 2013 and early 2014, a number of branches of the Federal Reserve put out papers discussing the potential for the blockchain technology to eliminate risk in the financial system, if this technology could be harnessed properly.

“It represents a remarkable conceptual and technical achievement, which may well be used by existing financial institutions (which could issue their own Bitcoins) or even by governments themselves,” a Bitcoin primer released in late 2013 by the Federal Reserve Bank of Chicago said.

Bitcoin's use as a new, more secure, and more private way to make payments online was given a big boost in early January 2014 when the online retailer
Overstock announced that it would begin accepting Bitcoin for all purchases. The eccentric chief executive of Overstock, Patrick Byrne, had a PhD in philosophy from Stanford and was an outspoken libertarian. He clearly had political motivations for taking Bitcoin, hoping to get the country out from “under
the thumb of Wall Street oligarchs,” as he put it. He also pointed to all the eager Bitcoiners looking to spend their money with anyone who would take the currency. But in interviews he emphasized the more practical reasons for any company to make the move: no more paying the credit card companies 2.5 percent of each transaction (the company helping Overstock take Bitcoin, Coinbase, charged Overstock 1 percent); no more dealing with chargebacks from customers who received shipments and then disputed the charges; and no more worrying about holding lots of sensitive financial information for customers. On the first day,
Overstock processed more than $100,000 in orders paid for with Bitcoins.

January 20, 2014

W
ences Casares pulled his white Subaru Outback into an elegant, understated strip mall off Woodside Avenue, one of the main roads winding down out of the hills above Palo Alto. It was 7:30 a.m. and Wences was looking forward to his breakfast at Woodside Bakery and Café, a favorite spot for Silicon Valley deal making that provided a bit more seclusion than the restaurants down in Palo Alto.

The man waiting for him inside was often referred to as the best-connected person in the Valley, and not just because he had cofounded LinkedIn, the business-networking site. Reid Hoffman's girth and bearing hinted at his larger-than-life character. After studying at Oxford, on an elite Marshall Scholarship, Hoffman had been brought in by Pete Thiel to help build PayPal—
Thiel called him the “firefighter-in-chief.”
Hoffman later introduced Thiel to Mark Zuckerberg, an introduction that led to Thiel's making the first major investment in Facebook. By that point, Hoffman had already begun building LinkedIn with some colleagues from an earlier startup. When Wences first met Hoffman, not long after
arriving in Silicon Valley, Hoffman was looking for new investments and serving on the boards of startups. The breakfast at Woodside Café was one of their periodic check-ins. Wences was finalizing the investments in his new company, Xapo, and was eager to tell Hoffman about his plans.

Wences knew that Hoffman had first gotten hooked on Bitcoin by Charlie Songhurst, who had, in turn, gotten hooked on Bitcoin by Wences at the Allen & Co. event in 2013. Hoffman, an expert on social networks, had been captivated by Songhurst's arguments about the power of the incentives built into Bitcoin—primarily through the mining process—that encouraged new users to join the decentralized network while also encouraging powerful miners to do what was best for the system so as not to see their holdings lose value.

“That's actually super important,” Hoffman would say later. “That makes it less of a pure technological marvel and more of a potential social movement.”

But Hoffman had remained skeptical and was particularly put off by the suggestion that Bitcoin would replace credit cards—the possibility that all the bank research reports were talking about. Credit cards seemed to work pretty well in Hoffman's estimation. Despite the security risks and costs to merchants, he didn't see too many consumers complaining about their credit cards failing them. If that wouldn't get people using this new kind of network, Hoffman wondered, what would?

Hoffman had finally gotten a satisfying answer to this at a dinner with Wences and David Marcus and a few other Valley power players late in 2013. Wences agreed with Hoffman that Bitcoin was unlikely to catch on as a payment method anytime soon. But for now, Wences believed that Bitcoin would first gain popularity as a globally available asset, similar to gold. Like gold, which
was also not used in everyday transactions, Bitcoin's value was as a digital asset where people could store wealth.

This was enough to get Hoffman to go home from that dinner and ask his wealth adviser—the Valley's most prominent money manager, Divesh Makan—to buy some Bitcoins for his portfolio. When Wences sat down for breakfast with Hoffman at Woodside Café in January, Wences told him about the progress he was making with Xapo.

“Just to be clear, I'd be super interested in investing,” Hoffman told Wences.

Wences paused, a bit chagrined.

“I wish you'd told me that the last time we talked,” he said.

“You told me you weren't interested in venture investing,” Hoffman shot back.

Wences explained that things had changed since they last talked, and that he had decided to take on investors and had struck a deal with Benchmark Capital.

“I just don't think I can include you in that,” Wences said. “It wouldn't be the honorable thing to do.”

Hoffman was not so easily deterred. He told Wences he was going home to figure out a way they could make it work. Wences said he would do the same.

Hoffman's newfound enthusiasm was part of a broader passion sweeping Silicon Valley in early 2014. While Wall Street research reports were talking about the possibility of a new payment system, the best minds in the Valley were thinking in much more ambitious terms after looking deeply at the code underlying Bitcoin. These views were crystallized, and projected to a much broader audience, the day after Wences's breakfast with Hoffman, when Marc Andreessen, cofounder of the investment firm that had put $25 million into Coinbase, published a lengthy cri de coeur on
the
New York Times
website, explaining what had the Valley so worked up.

“The gulf between what the press and many regular people believe Bitcoin is, and what a growing critical mass of technologists believe Bitcoin is, remains enormous,” Andreessen explained.

Andreessen's list of the potential uses for the technology was lengthy. It was an improvement on existing payment networks, owing to its security and low fees, but it was also a new way for migrants to move money internationally, as well as a way to provide financial services to people whom banks had left behind. Like many Valley firms, Andreessen's was thinking about intelligent robots, and Bitcoin seemed like a perfect medium of exchange for two machines that needed to pay each other for services.

Beyond all that, though, the decentralized ledger underlying Bitcoin was a fundamentally new kind of network—like the Internet—with possibilities that still hadn't been dreamed up, Andreessen said. He went on:

Far from a mere libertarian fairy tale or a simple Silicon Valley exercise in hype, Bitcoin offers a sweeping vista of opportunity to reimagine how the financial system can and should work in the Internet era, and a catalyst to reshape that system in ways that are more powerful for individuals and businesses alike.

Less than a year earlier, Wences had sat in Arizona with Chris Dixon, a young partner at Andreessen Horowitz who had been trying to get the firm to dive into Bitcoin. Now Andreessen himself was becoming the most outspoken public advocate for the technology, taking on a role that had previously been occupied by people like Roger Ver and Hal Finney.

Andreessen had quietly begun his investing in Bitcoin a year earlier, when he put some of his own money into the Series A fund-raising round of the secretive Bitcoin mining company, 21e6, created by the Stanford wunderkind Balaji Srinivasan. Since then, in addition to the $25 million that Andreessen Horowitz had put into Coinbase, the firm had also made a secret $25 million investment in the confidential Series B round for Balaji's mining company. That Series B also included another $10 million from other Series A investors and $30 million more in venture debt. The best-funded company in the Bitcoin world, with $70 million, was one that only a small elite even knew about. Andreessen liked the investment in part because while he and many others in the Valley believed that venture capital firms should not buy Bitcoins outright, he thought it was kosher to invest in a mining company like 21e6 that paid out its dividends in the virtual currency it mined.

Balaji's mining company had already started rolling out its custom-fabricated mining chips in the fall of 2013 and had quickly come to account for 3 to 4 percent of the hashing power on the entire network. In early 2014 the company was planning to pay the first dividends to investors and was building its own dedicated data center that would hold more than nine thousand machines containing the company's custom chips.

Balaji's promise was so great that in late 2013 Andreessen had invited him to become the ninth partner at Andreessen Horowitz, in no small part to help scout out new investments related to virtual currencies and the blockchain. Balaji was as ambitious and utopian as anyone out there about what Bitcoin could do.
He believed that it could help open the door for what would essentially be new breakaway countries, created by people wanting to push technological experimentation to the limits.

For Wences, the more immediate indication of how quickly this was all moving came in an e-mail from Hoffman not long after their breakfast. Hoffman had talked with a friend at the venture capital firm Index Ventures, and together they were prepared to offer Wences another $20 million for Xapo. He could still take the $20 million he already had as a Series A, but this could be a quick follow-on—a Series A1. And while Wences's first investors had valued Xapo at $50 million, Hoffman and his partner were ready to value it at $100 million. In little more than a month, Wences had doubled the value of his company.

S
TANDING BEHIND THE
black bar, Charlie Shrem opened a fridge under the liquor and pulled out two beers, a Blue Moon for himself and an Amstel Light for Nic Cary, the chief executive of Roger Ver's company Blockchain.info, who was in New York on a business trip. The bar, EVR, was closed, but Charlie lived right upstairs and had all-hours access thanks to his investment a year earlier. His girlfriend Courtney, who now lived with him, stopped by to see if Charlie needed anything.

Charlie looked noticeably more weathered than he had the previous summer when he shut down the BitInstant site. He had shaved off his youthful curls and grown a scruffy beard that matched his bushy eyebrows. None of this, though, signaled defeat. Charlie was, in fact, benefiting as much as anyone from the rising interest in Bitcoin. He had taken on a role as an unofficial money changer for some of the big holders of Bitcoin, allowing them to sell large blocks of coins without going on an exchange, where big sales could move the price.

More important, Charlie had managed to connect with a new group of investors who were looking at putting up money so that Charlie could reopen BitInstant. The potential investment was a
complicated deal, providing a way to pay off the legal bills from the previous summer while also giving the site a more simple regulatory structure moving forward.

After taking a swig from his beer, Charlie boasted that one of the consultants who had been helping him—one who was a former regulator—had told him: “You and some of your friends have become such super experts in finance, law, and Patriot Act and all these things. There are people who have like thirty graduate degrees who don't know as much as you do.”

“And I'm like, ‘It's Bitcoin,'” Charlie said with a grin.

David Azar, his old investor, was ready to sign off on the deal to reincarnate BitInstant. The one hitch was the Winklevoss twins. Charlie had offered to give the new investors more than half of his own equity in the company—bringing him from a 27 percent stake down to a 12 percent stake. All the twins and David had to do was give the new investors 2 percent of their 25 percent stake. When the twins shot back a curt e-mail dismissing Charlie's offer, Charlie quickly replied that he would provide all the shares to the new investors so that David and the twins did not have to dilute their stake in the company at all. When Charlie met with Nic, he was still waiting to hear back from the twins.

In the meantime, though, Charlie was not twiddling his thumbs. Earlier the same day, he and his girlfriend Courtney had lunch with a few guys who wanted to sell shares in private jets for Bitcoin.

“It's fucking, excuse my language, it's an amazing idea,” Charlie said. A few weeks earlier, he had splurged and sold some of his Bitcoins to pay for a private jet to take him and Courtney to the Bahamas.

He also was still working with the Bitcoin Foundation, preparing for its second annual conference, this one in Amsterdam.

“We're looking for a celebrity speaker,” Charlie told Nic. “I want to get like Snoop Dogg to come.”

“How about Richard Branson?” Nic asked, referring to the mogul who had recently announced that he would be accepting Bitcoin for tickets on Virgin Galactic, his commercial space company.

“A lot of these guys aren't even out of reach,” Charlie said.

A few days after seeing Nic, Charlie and Courtney flew to Amsterdam. They stopped by the convention center where the foundation's conference would be held. But the main purpose of the trip was a technology conference in Utrecht that had paid Charlie $20,000 to speak about Bitcoin. Flying home from the gig, in business class, Charlie couldn't help feeling that, after all his earlier struggles, things were starting to work out again.

After landing in New York, he had just presented his passport to the customs officer when another agent appeared, seemingly out of nowhere, and said, “Mr. Shrem, come with us.” When Charlie asked why, the agent said, simply, “We'll explain everything,” and led him to a holding room. The agent there handed Charlie a warrant for his arrest and told him he was facing charges of money laundering, unlicensed money transmission, and failure to report suspicious transactions.

When Charlie asked for more information he was told the agents would be happy to tell him more if he'd just answer a few of their questions. He knew better than to talk without a lawyer present and so he was left not knowing what conduct had led to the charges. He was allowed into a larger holding room, where Courtney was waiting, crying hysterically. He calmly told her to call the lawyer who had been working on BitInstant and not to answer any questions the federal agents might ask her. While he was talking to her, he was put in cuffs and led away to a black SUV, which took off in a caravan of police cars and traveled to the Drug Enforcement Administration headquarters in downtown Manhattan. After getting booked, Charlie was taken to the Metropolitan Correctional Center, where he was changed into an orange jumpsuit
and locked up in a cell by himself. He had the rest of the night to cry and nervously think through all the things that might have gotten him here and all the ways it might play out.

In the morning, the marshals took him to a holding cell under the federal courthouse, where he met with one of the lawyers he had worked with at BitInstant, whom Courtney had called. He learned, finally, that the charges stemmed from his work in early 2012, selling Bitcoins to BTC King, the money changer who had helped Silk Road customers secure Bitcoins to buy drugs.
The prosecutors had e-mails in which Charlie acknowledged knowing what the coins were being used for and doing it anyway without filing any suspicious-activity reports with regulators.