Bitcoin Buzz Grows Among Venture Investors, Despite Risks

Bitcoins Rise
Rick Bowmer/AP
By Wanfeng Zhou
and Nick Olivari

NEW YORK -- Venture capitalists show no sign of shying away from investing in startups related to bitcoin even as authorities step up their scrutiny of the virtual currency and its possible connection to money laundering and other illegal activities.

Investment has jumped in recent months as bitcoin, the prominent digital currency not backed by a government or central bank, has begun to gain a footing among businesses and consumers, a key step for it to go mainstream.

Startups such as Coinbase and BitPay Inc., which help facilitate bitcoin adoption by merchants and consumers, have raised millions of dollars so far. Interest is also growing in bitcoin trading, investment funds and "mining" -- the process of creating the digital currency.

Bitcoin, until recently a niche alternative currency touted by computer geeks and anti-government advocates, has garnered attention from a growing list of notable investors such as Andreessen Horowitz, which has invested in Facebook (FB), Twitter and Groupon (GRPN), and Founders Fund, which includes three founders of PayPal. Some devotees promote bitcoin, which exists solely in cyber form, as the future of money, and in some investing circles it has created a buzz reminiscent of the early Internet age.

"What keeps me up at night is 'are we missing out on investments?' because if this is what I think it can be, we will regret not being even more active," said Micky Malka, founder of Palo Alto, Calif.-based Ribbit Capital, which has invested in three bitcoin firms, including San Francisco-based Coinbase.

Bitcoin startups raised nearly $12 million from venture capital investors in seven deals in the three months ended June, according to CB Insights, a New York-based venture capital data firm. That compares with just five deals totaling less than $2 million in the previous four quarters.

More money is expected to flow into the bitcoin market, where the amount of venture capital financing remains modest compared with some sectors like social networking. Some industry participants estimate available money for funding ranges from $65 million to $100 million, while the number of bitcoin startups in the United States is probably in the hundreds.

Last week, SecondMarket, a platform for facilitating investment in privately held companies, launched the Bitcoin Investment Trust, which allows sophisticated investors to gain exposure to the price movement of bitcoin without the risks of direct bitcoin ownership.

%VIRTUAL-article-sponsoredlinks%The move comes three months after Cameron and Tyler Winklevoss, the twin brothers famous for their legal battle with Mark Zuckerberg over the founding of Facebook, filed plans to launch the Winklevoss Bitcoin Trust, an exchange-traded product that would allow investors to trade the digital currency like stocks.

There are 11.7 million bitcoins in circulation, with a market capitalization of more than $1.7 billion. The price of bitcoin is currently around $142, down from more than $250 in April.

Investors say they expect bitcoin to grow in popularity in businesses related to storage, payment processing, remittance and micro transactions. The key is finding the right entrepreneurs to build the best consumer-friendly applications.

Coinbase, a virtual wallet and platform where merchants and consumers can do business using bitcoin, said on its website that it has about 282,000 users and handles 175,000 transactions a month. The firm has raised more than $6 million.

Fees charged by bitcoin firms are typically far less than those charged by banks, credit card companies or other online payment processors. Coinbase charges merchants a 1 percent fee to convert bitcoin into local currencies, but is currently waiving it for the first $1 million.

Atlanta-based BitPay charges a flat 0.99 percent fee. The firm, which has raised $2.7 million, said over 10,000 approved merchants in 164 countries use its platform to accept bitcoin payments.

Supporters say using bitcoin offers benefits including faster speed, lower fraud risk and increased privacy, though critics argue the anonymity it offers makes the currency a magnet for drug transactions, money-laundering and other illegal activities.

Highly Risky

Regulators have ramped up scrutiny of digital currencies. In August, New York's top banking regulator issued subpoenas to about two dozen companies associated with bitcoin. Earlier this year, U.S. prosecutors accused Liberty Reserve's Costa Rica-based operations of laundering about $6 billion.

Legal troubles can also deter investors. In July, a lawsuit was filed against New York-based BitInstant, accusing the firm of making "false representations about its services and the inflated fees that it failed to refund as promised." BitInstant operates a platform for bitcoin transfers and has received $1.5 million from the Winklevoss brothers.

BitInstant CEO Charlie Shrem said the firm "is committed to doing the right thing and it will be vigorously defending itself against these allegations, which it believes are not true."

Bitcoin advocates say a lot of the concerns have to do with fear of the unknown, and more regulatory clarity will bolster the currency's use. Until then, bitcoin investing will remain highly speculative.

An added risk is that, unlike investing in startups in established areas such as social media, generating long-running returns from a bitcoin company relies on the currency proving to be more than a passing fad.

Even some active players don't give high odds to that: BitPay co-founder and CEO Anthony Gallippi estimates an 80 percent chance the value of bitcoin could go to zero.

Still, given the prospect, however slim, for a big windfall, investors with the right risk tolerance are finding it appealing.

"We believe that bitcoin may have significant upside given the size and scope of the industries that potentially are impacted by bitcoin," said SecondMarket founder and CEO Barry Silbert in New York. "However, bitcoin also faces regulatory uncertainty and widespread adoption issues that make investing in bitcoin a highly risky endeavor."

5 Bubbles That Ended Badly
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Bitcoin Buzz Grows Among Venture Investors, Despite Risks
Though flower bulbs might seem an unlikely asset to trigger rampant speculation, the Tulip Craze is often cited as the first recognized economic bubble. In the 16th century, tulips were first brought from Turkey to Western Europe, where the colorful flowers became extraordinarily popular. But it was in the 17th century that the vivid blooms hit super-fad status, especially in Holland, where they become a much-sought-after luxury item. By the 1630s, some rare varieties of tulip bulbs traded at prices equal to that of an house, with the entire limited supply of bulbs changing hands multiple times every day. Based on the limited price data still available, the Dutch tulip bubble apparently reached its peak in early 1637, after which prices plunged by 95 percent to 99 percent in the span of just a few weeks.
Before the economic meltdown of 2008, the biggest bear market that most living investors had seen was the plunge from 2000 to 2002 -- the Dotcom Bust that resulted from a  bubble in Internet-related technology stocks. During the late 1990s, the adoption of the Internet for commercial purposes led to an explosion in investing, as the early successes of AOL and convinced many investors that just about any business with a connection to the Internet would produce huge profits. But many of these businesses lacked any reasonable strategy or plan to profit, and the result was, eventually (and inevitably) debacles like Although some high-flying tech firms survived the Internet bust, the vast majority met their end during the bear market.
Looking at the large population of the Sunshine State today, it doesn't seem all that surprising that Florida real estate would have a history of high demand from land speculators. During the 1920s, the strong economy and soaring stock market left many Americans with the means to invest. The general perception of Miami as a paradise led to unprecedented marketing efforts from developers who sought to create brand new cities well into the Everglades. As brokers and dealers pushed plots to investors, trading activity reached a fevered pitch. But when negative reports from financial publications brought the true value of the land to light, buying interest dimmed, and an ill-timed hurricane put an end to the boom in 1926, leaving Florida in the grips of economic decline that lasted until after the Great Depression.
When investors think about precious metals, rhodium isn't the first to come to mind. But during the first half of 2008, prices of the rare metal shot from less than $1,000 an ounce to more than $10,000 before plunging back to the $1,000 level when the financial crisis hit. Because its most common use is in catalytic converters for cars, investors saw rhodium as a play on the auto market, and its rarity helped inspire speculators to keep bidding prices higher. Yet -- just as had happened earlier in the decade with palladium -- the rhodium boom came to an end quickly once it became clear that demand wouldn't support the inflated prices.
After its defeat in World War II, Japan recovered and became one of the fastest growing, strongest economies in the world. By the 1980s, it was commonly predicted that Japan's economy would soon exceed the size of the U.S. economy, and that the country's culture and language would come to dominate the global commerce. Land speculation helped fuel the Japanese economy, but the availability of cheap financing led companies to take on increasing levels of leverage in their real estate portfolios. From 1984 to 1989, the Nikkei stocks\ index soared from below 10,000 to nearly 39,000, only to plunge in the ensuing years when the bubbles burst. The Nikkei touched the 14,000 level in 1992, and the land of the rising sun settled into period of economic stagnation that still persists today.
The moral of these stories: While it's impossible to know when Bitcoin's bubble-like rise will reverse itself, given the weight of history, it's almost certain that it will.
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