For Bitcoin VCs, There’s No Sexier Word Than “Compliance”

There are few things that people agree on about bitcoin, the virtual currency that has increasingly come under the media spotlight this year. But here’s one: If the controversial payment method is going to receive mainstream adoption, it’s going to have to get easier to both buy and sell.

As a result, when you look around at U.S. startups trying to enter the space, a large chunk are bitcoin infrastructure businesses, either trying to build an exchange to rival Mt. Gox, a digital wallet, or tools to trade or transfer the currency. So it’s only fitting that at an investor pitch event last week in New York City for bitcoin startups, all nine of the pitches centered on at least one of these elements.

For the winning startup, a yet-to-launch bitcoin exchange called CoinX, the differentiator was not a superior product (we didn’t even see it in action); it was simply a thought-out plan on how to comply with state policies that regulate money transmitter businesses.

“There are few things scarier than the threat of the government turning off your [portfolio] business and that possibility 100 percent exists with bitcoin,” said Matthew Witheiler, principal at Flybridge Capital Partners, and one of the four investor panelists at the pitch event. “The bitcoin companies that win will be the ones that play by the rules.”

Andrew Chang, a partner at Liberty City Ventures, a VC firm that has created a dedicated bitcoin startup fund, said he is looking for startups that approach their business “not necessarily as tech startups would approach it, but as financial institutions would.”

“That means complying with all the regulations that exist in the different countries you operate, and getting the necessary licensing,” he said. “Rather than approaching it from the standpoint of, ‘Let me just launch, open up a bank account here, without addressing the appropriate regulatory issues.'”

In March, the Treasury Department’s Financial Crimes Enforcement Network issued some guidance on virtual-currency businesses, but there are still many gray areas when it comes to bitcoin and compliance.

Still, the better you articulate your plan for making sure the government is cool with your bitcoin business, the better your chances are for raising capital. CoinX founder Megan Burton did not demo the exchange during last week’s pitch, but she did present a plan for complying with anti-money-laundering policies that money-service businesses have to abide by. Namely, she said her startup had hired a law firm to apply for a money-transmitter license in all the states that mandate it — a task that requires equal parts patience and capital.

Burton also said she had signed deals with three banks who would do business with CoinX — such a rare occurrence for bitcoin-related money-service businesses in the U.S., according to several VCs, that the panel of investors almost didn’t believe the news. They were so surprised, in fact, that Witheiler asked again if Burton actually had finalized agreements.

“We actually went through 46 banks to find three that said yes,” Burton told him.

Burton wouldn’t divulge who those banks were, But that’s almost besides the point, Witheiler said.

“Getting any bank is a huge plus and validation,” he said.