And Failure to Understand That Could Cost Investors Billions



It never ceases to amaze me how hard it can be for the media to separate hype from real-world potential in technology.

On one hand, you have amazing breakthrough technologies like the CRISPR immune system, which go virtually unnoticed by the mainstream press, even as they create miracles every day.

On the other, there's the sycophantism of reprinting the hyperbole common among investors with a specific bias to push in their own favor, which goes unchallenged and unchecked. Hedge fund managers, venture capitalists, and other commentators with a monetary interest in their ideas—paid not by readers but by their ability to sell an idea for more than they bought it—speak out with few questions posed as to why they say what they say.

Like with Bitcoin.

Last week famed technology pundit and venture capitalist Marc Andreessen penned an op-ed in the New York Times in which he espoused the world-changing potential of Bitcoin—from freeing us from enslavement by banks to enabling social change globally to saving cute puppies from slaughter (OK, I made that one up). But he tells the story of a technology virtually unbounded in its potential for social and economic change.

That article, while articulate (as Andreessen always is), came just ahead of a meeting held by NY securities regulators to discuss how to deal with Bitcoin. This meeting was scheduled on the heels of news that the FBI had arrested a few noted Bitcoin entrepreneurs in connection with a conspiracy to sell bitcoins to the now-shuttered Silk Road illegal drugs/guns marketplace, thereby enabling that criminal enterprise.

The timing of these items is, of course, not coincidental.

Andreessen painted a very rosy picture for the potential of Bitcoin: one in which transactions on the Internet are not gated by banks and credit card processors—where the customary 2-3% fees these institutions charge disappear—and currencies can be freely exchanged absent from regulations. For him, as an active investor in Bitcoin-related startups (he's ponied up some $50 million), he touts this perceived benefit as the main competitive differentiator. So he's hardly an objective observer; it's in his personal interest to paint exactly such a landscape.

However, the reality is that most of the scenarios he posits in the letter will not work with Bitcoin or with any alternative currency, as they fly in the face of the very political and financial might that make a nation-state possible to begin with. Bitcoin threatens the hegemony of modern power. Its tolerance at any scale, let alone wholesale acceptance, would require the involvement and acquiescence of the very banks and governments most threatened by its existence. What are the chances?

The precedent, in fact, was clearly set when China cracked down on Bitcoin last December. Its central bank didn't outlaw or prohibit individuals from owning bitcoins, but new guidelines specify that it isn't to be considered a currency. The rules prohibit financial institutions in China from trading, underwriting, or offering insurance in bitcoins or any other digital currency. And China's top Internet retailer, Alibaba, prohibited the use of bitcoins on its shopping platforms as of January 19.

Moreover, on a strictly commercial basis, the technology will reintroduce huge problems to the payment infrastructure Andreessen means for it to compete with. These have already been solved. In essence, he advocates moving us back in time to the digital equivalent of the Pinkertons and train robberies.

To be clear, Bitcoin is an excellent technology, with many very good use cases. But for the average end user—be it an individual wanting to pay for goods or a merchant wanting to accept payments—the new reality of those risks will be more than they can swallow.

Breaking Down the Bitcoin Hype

Let me demonstrate with a bit of a point-by-point rebuttal of what Mr. Andreessen proposes is possible in his letter:

"The practical consequence of solving this problem is that Bitcoin gives us, for the first time, a way for one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer. The consequences of this breakthrough are hard to overstate.

What kinds of digital property might be transferred in this way? Think about digital signatures, digital contracts, digital keys (to physical locks, or to online lockers), digital ownership of physical assets such as cars and houses, digital stocks and bonds … and digital money."

Let me start with a firm agreement with Mr. Andreessen. This is precisely the importance of Bitcoin, its open-source demonstration of an algorithm for establishing trust in an untrusted network—an algorithm which has stood up to extreme scrutiny from mathematicians, computer scientists, and hackers of all stripes over the years since its release.

It's one of the reasons I'm an active proponent of the technology and its further development. However, the fallacy lies in how it's currently applied—as a tool to transfer cash—and its failings in the above.

"That last part is enormously important. Bitcoin is the first Internet-wide payment system where transactions either happen with no fees or very low fees (down to fractions of pennies). Existing payment systems charge fees of about 2 to 3 percent—and that's in the developed world. In lots of other places, there either are no modern payment systems or the rates are significantly higher. We'll come back to that."

It is technically true that there is little to no cost to transfer bitcoins between parties. However, it is not true that it's the first way to do so with no or low fees.

To begin with, there is the Automated Clearing House (ACH) electronic funds transfer system between banks. Any developer can create its own ACH-based payment system—vacation rental startup HomeAway, for instance, made waves in sharing how it did exactly that—and utilize the system for free. A handful of startup platform providers have emerged too, charging only nominal fixed fees (usually between $0.10 and $0.25 per transaction) to make the process very simple for developers.

Then there's the debit card infrastructure in the US, and many similar systems globally. Accepting debit cards requires a payment processor in the middle, but typically fees for accepting debit cards run in the pennies; rarely are they ever based on transaction size.

Nor does it cost anything to authorize a credit card transaction in most cases. The moving of those bits across the Internet is free.

The charges these facilitators provide is ultimately for the transfer of funds between parties. This is a subtle but hugely important difference. Moving money is far more complicated than moving bits. It requires the credit card processor to verify availability, process transfers, and most important provide service when things go wrong.

With Bitcoin, if you send your digital money to a disreputable vendor, there is no recourse to get a refund. There is no "chargeback" system. The funds, once gone, are permanently gone. It requires active participation from the receiver to reverse a transaction—and that's not always an option. This service is in high demand by consumers and is one of the reasons that they push vendors to accept credit cards: that customer-of-my-customer demand is what allows credit card companies to demand fees.

Also, with Bitcoin the sender and receiver each take on exchange-rate risk in the process, in exchange for the ability to effectuate the transaction without a middleman. It's a costly trade-off, though, as the floating exchange rate between Bitcoin and various currencies adds risk for both parties of mispricing goods unless they transfer in and out in real time.