It has been a wild October and November for bitcoin. Things are moving so quickly right now that two months in the bitcoin ecosystem is like two years in most other segments of the economy. The Silk Road shutdown, the Chinese government endorsing bitcoin, and the US regulatory bodies speaking favorably about bitcoin as a disruptive payment protocol that has legitimate uses have been the major catalysts that have cause the value of bitcoin in US dollars to go from $143.28 on Mt. Gox on October 1 to $1205.00 on Mt. Gox on November 28th. While the past 2 months have been crazy, I am more excited about the months ahead. The primary driver for the recent price surge has been the media hype generated from these three big news events. The primary driver for the next leg up will be more meaningful and long-lasting than media hype: merchant adoption, and useful applications built on top of the bitcoin protocol.

Merchant Adoption

Today, there are no more than a handful of well-known organizations accepting bitcoin (high profile web businesses like Reddit, Khan Academy, OKCupid, and Baidu are the first four companies that come to mind, and just yesterday China Telecom, the third largest teleco in China, announced that they will be accepting). But none of the aforementioned are traditional web merchants, and the large, well-known traditional merchants have been hesitant to adopt. I expect this to change in the coming months.

The vast majority of merchants I have talked to immediately acknowledge the compelling reasons to adopt bitcoin: transaction fees, instantaneous and irreversible payments (no chargebacks), and more effective international monetization, among others. Their hesitation lies in the fact that they are not convinced that consumers will pay using bitcoin and so they can’t justify spending developer time and resources to add bitcoin as a payment option. Their concerns are justified—it is estimated that roughly 90% of bitcoin owned right now is owned for speculative and investment purposes, and not to buy goods and services. I believe this will change in the coming months.

As the price of bitcoin increases and the purchasing power of bitcoin owners increases, the appetite to spend on goods and services will increase. The IRS has not officially commented on the tax implications of bitcoin, but it appears that one of the core advantages of spending compared to selling is that one does not have to pay capital gains taxes on bitcoin spent, while one does on bitcoin sold and converted to fiat currency. In the US, capital gains taxes are between 15% to 20%, depending on tax bracket and the holding period. As more people buy goods and services with their increased purchasing power, the existing retailers that accept will get more and more cost savings from bitcoin, and will become strong advocates of it.

Useful Applications Built on the Bitcoin Protocol

Many newcomers to bitcoin fail to understand and recognize the power of the technology behind the bitcoin protocol. Bitcoin is much more than a currency—it is a peer to peer payment protocol that has extremely unique fundamental technical underpinnings that can be widely used in a number of different use cases. Some of the characteristics of the technology are: peer-to-peer network, digital signatures, proof-of-work, and a distributed ledger. These characteristics enable developers to build applications that have clear uses across the world, and I believe there are going to be a number of hugely popular applications built on top of the protocol that will drive adoption of bitcoin. Coinbase has an easy to use API that companies are already starting to use build interesting applications on top of bitcoin. A few companies of note that are built on the Coinbase API are BitWall, a paywall that allows online publishers to accept micro-transactions, and Gliph, a mobile wallet and messaging application. It is the very early days of building applications on the protocol, but I believe that the next few months will see several take off and help drive adoption of bitcoin. There are also a few very interesting “color coin” layers being built on top of bitcoin that I am tracking closely. Mastercoin and nxt are a few examples of teams trying to use the bitcoin protocol to enable decentralized exchanges for other financial products, like stocks, commodities, and property contracts. I believe these protocols on top of bitcoin are more interesting than the alternative currencies such as litecoin, namecoin, and primecoin, which have followed bitcoin and surged in value over the past month.