Why I’m interested in Bitcoin

Some people assume that all Bitcoin advocates are motivated by a libertarian political agenda. That is certainly not my agenda. I’m a lifelong Democrat who supported Obama in the last two elections. I think the Federal Reserve plays an important function, and I don’t agree with people who think inflation should be our nation’s primary economic concern.

It is true that many early Bitcoin proponents were libertarians. But it is also true that almost every significant computing movement had early proponents who were ideologically motivated. The developers of the first personal computers were closely aligned with the 60s counterculture movement. Open source software was originally created by people who believed that all software should be available for free. Early advocates of blogging and collaborative systems like Wikipedia were trying to democratize the production and dissemination of information. This isn’t coincidental: broad-based technology movements have depended on non-economic participants early on since it often took years for commercial participants to get involved.

If not for political reasons, why am I interested in Bitcoin? Like a lot of people, I was disturbed by the aftermath of the 2008 financial crisis. I thought the government did what it had to do at the peak of the crisis but missed an important opportunity afterwards to reform the financial system. It seemed to me that there were two ways to improve the system: from above through regulation (which I support), or from below through competition.

I wrote a blog post about this issue about four years ago. My argument was that if the technology industry wants to change the financial services industry, it can’t just build new services on top of existing financial services companies. That would be like trying to disrupt Google or Apple by building services on top of their platforms. To actually have an impact (and create large businesses) you need to create services that completely bypass incumbent financial companies. I gave a series of examples including payments:

Charging 20% interest rates (banks) and skimming pennies off every transaction (Visa and Mastercard) is a very profitable business. Starting a new payment company that doesn’t depend on the existing banks and credit card companies could be disruptive.

Since then I made a number of financial services technology investments, all of which were consistent with this thesis.

I started getting interested in Bitcoin about two years ago. Like a lot of people I initially dismissed Bitcoin as a speculative bubble (“Internet tulip bulbs”) or a place to stash money for people worried about inflation (“Internet gold”). At some point, I had an “aha!” moment and realized that Bitcoin was best understood as a new software protocol through which you could rebuild the payments industry in ways that are better and cheaper.

The payment industry is a $500 billion industry (or larger, depending on how you measure it). That means banks and payment companies charge $500B per year in fees to provide a service that mostly involves moving bits around the Internet. There are other services they provide like credit, security, and dispute resolution, but in any reasonable analysis these services should cost dramatically less than they currently do. The payment industry should be at least an order of magnitude smaller than it is today.

Another thing that informed my view was seeing what a huge headache payments were for startups I was involved with. Let’s say you sell electronics online. Profit margins in those businesses are usually under 5%, which means the 2.5% payment fees consume half the margin. That’s money that could be reinvested in the business, passed back to consumers, or taxed by the government. Of all of those choices, handing 2.5% to banks to move bits around the Internet is the worst possible choice. The other main challenge startups have with payments is accepting international payments. If you are wondering why your favorite technology service isn’t available in your country, the answer is often payments.

But the most exciting aspect of Bitcoin (and this is admittedly more speculative) are all the interesting new business and technology models that “programmable money” could enable. For example, I am very bullish on micropayments (this is a longer topic which I plan to write about separately). The world recently ran its first large-scale micropayments experiment – so called in-app payments on iOS and Android – and despite some serious design flaws (centralized control, 30% fees), it was a smashing success. I think Bitcoin could enable a micropayment system for the open web, and thereby provide a business model beyond banner ads for many important services such as journalism.

I’m not claiming that Bitcoin (or any new technology) can save the economy or the world. The technology industry is in the business of creating products and services that either enable new activities or make existing activities less expensive. Venture capitalists are in the business of funding entrepreneurs who run experiments to try to create these new products and services. I believe the only way the technology industry can offer meaningfully improved financial services is by building new services that don’t depend on incumbent companies. Bitcoin is a serious proposal for dramatically improving the payments industry. There are plenty of open questions but I think it’s an experiment worth running.

Coinbase

One of the interesting things about Bitcoin is the contrast between how it is portrayed in the press and how it is understood by technologists. The press tends to portray Bitcoin as either a speculative bubble or a scheme for supporting criminal activity. In Silicon Valley, by contrast, Bitcoin is generally viewed as a profound technological breakthrough.

The Internet is based on a set of core protocols that specify how information such as text, photos, and code should be transmitted. The designers of the Web built placeholders for a system that moved money, but never successfully completed it. Bitcoin is the first plausible proposal for an economic protocol for the Internet.

This matters for two reasons:

1) It fixes serious problems with existing payment systems that depend on centralized services to verify the validity of transactions. These services are both expensive (roughly a 2.5% tax on all transactions) and prone to failure (Internet payment fraud is rampant).

2) More importantly, Bitcoin is a platform upon which new technologies can be developed. Developers have created some early applications, and speculated about future applications. Some potential applications include: a) micropayments as a replacement for banner ads or subscription fees, b) machine-to-machine payments to reduce spam and denial-of-service attacks, c) a way to offer low-cost financial services to people who, because of financial or political constraints, don’t have them today.

But to proliferate widely, Bitcoin needs a killer app the same way HTTP had web browsers and SMTP had email clients. That’s why today I’m excited to announce that Andreessen Horowitz is leading a $25M financing of Coinbase, a service that provides an accessible interface to the Bitcoin protocol. Consumers can use Coinbase to convert to and from other currencies and to pay for goods and services. Merchants can use Coinbase to accept payments and convert currencies. Developers can build new services using Coinbase’s API.

Coinbase has grown extremely fast and is now the most widely used Bitcoin service in the US. The founders of Coinbase, Brian Armstrong and Fred Ehrsam, have worked closely with banks and regulators to ensure that the service is safe and compliant. We think Coinbase can significantly accelerate Bitcoin’s proliferation, and as that happens the Internet will enter a new phase of invention and opportunity.

The Internet is for snacking

Web products have followed a steady evolutionary path from the compound to the atomic. Today’s popular social sites are spin outs of behaviors that emerged from blogs and forums, the primordial soup of the early social web. Before there was Twitter, people were doing something similar to tweeting on so-called link blogs or micro blogs. Tumblr was a direct descendent of a particular strain of blogs known as tumble blogs.

The successful products took big meals and converted them to snacks. The Internet likes snacks – simple, focused products that capture an atomic behavior and become compound only by linking in and out to other services. This has become even more so with the shift to mobile. People check their phones frequently, in short bursts, looking for nuggets of information.

A notable exception to this pattern are online products that users pay for. The dominant payment systems (mainly, credit card systems) were designed to be offline systems and only much later awkwardly grafted onto the Internet. They are inefficient and prone to fraud. As a result, paying online means making a commitment of time and trust. That’s why one of the most valuable assets an online business can have is “credit cards on file”. It is also one of the reasons there is a rich-get-richer dynamic for paid products. Big companies like Amazon and Apple are the beneficiaries.

The perverse result of this system is that products that are naturally suited to be “paid snacks” have to contort themselves to make money. News and music are good examples. Only a few news sites are popular enough to entice users to commit to paying, and even those have had only limited success with paywalls. Other news sites depend on intrusive ads to support themselves. Music is mainly purchased through aggregators like iTunes and Spotify who charge a hefty tariff. You need a comprehensive catalog to convince users to commit to a payment relationship.

In-app payments on iOS and Android are the one place where paid snacks exist at scale. They have been wildly successful, quickly becoming the dominant business model for games, replacing up-front payments and banner ads. (There are individual games that generate over one billion dollars per year from in-app payments.) Outside of games, entrepreneurs have started building interesting new products that wouldn’t have been viable without in-app payments.

This is one of the main reasons people are excited about new payment systems like Bitcoin. A broadly adopted form of “programmable money” has the potential to bring paid snacking to the rest of the Internet, and in doing so enable the save level of innovation in paid products that we’ve seen in the free and ad-supported products.

Technology predictions

For those of us in the prediction business, it’s sometimes useful to go back and read past predictions to try to discern patterns in what they got right and wrong.

Back in the early 90s, a lot of people thought the Internet was overhyped. Here’s one example from Newsweek:

Do our computer pundits lack all common sense? The truth in no online database will replace your daily newspaper, no CD-ROM can take the place of a competent teacher and no computer network will change the way government works…. What the Internet hucksters won’t tell you is tht the Internet is one big ocean of unedited data, without any pretense of completeness. Lacking editors, reviewers or critics, the Internet has become a wasteland of unfiltered data.

Today, it’s easy to find people expressing similar skepticism about emerging technologies like the Internet of things, robotics, 3D printing, Bitcoin, etc.

What the skeptics overlook is that platforms that are open to third-party developers have the following characteristic: it’s hard to think of important use cases before they are built, and hard to find examples where important use cases weren’t developed after they were built.

Just look at the founding years of top websites. Google: 1998. Wikipedia: 2001. YouTube: 2005. Twitter: 2006. No wonder it was so hard to imagine these services early on. It took years to imagine them even after the Internet had gone mainstream.

What the smartest people do on the weekend is what everyone else will do during the week in ten years

Many breakthrough technologies were hatched by hobbyists in garages and dorm rooms. Prominent examples include the PC, the web, blogs, and most open source software.

The fact that flip-flop wearing hobbyists spawn large industries is commonly viewed as an amusing eccentricity of the technology industry. But there is a reason why hobbies are so important.

Business people vote with their dollars, and are mostly trying to create near-term financial returns. Engineers vote with their time, and are mostly trying to invent interesting new things. Hobbies are what the smartest people spend their time on when they aren’t constrained by near-term financial goals.

Today, the tech hobbies with momentum include: math-based currencies like Bitcoin, new software development tools like NoSQL databases, the internet of things, 3D printing, touch-free human/computer interfaces, and “artisanal” hardware like the kind you find on Kickstarter.

It’s a good bet these present-day hobbies will seed future industries. What the smartest people do on the weekends is what everyone else will do during the week in ten years.