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Familiar Price Gains, Updated Infrastructure: A Look at the Bitcoin Economy (Part 1)

The recent climb in bitcoin’s exchange rate has driven heavy attention from media and investors. As the second time this has occurred at such scale in 2013 alone, the broader conversation has made a subtle but important shift from simply trying to understand what bitcoin is and where it came from, to what is happening in the space and what the future might hold. Recent growth has been driven not just by speculators, but also entrepreneurs, venture capitalists and bitcoin users that have contributed to remarkable change in the digital currency economy since the last time these types of exchange rate gains were made.

As bitcoin’s mainstream popularity grows, the tone with which it is addressed has largely begun to shift. For example, in 2011, some of the earliest comments about the industry from federal legislators arose when US Senator Charles Schumer referred to bitcoin as “an online form of money laundering used to disguise the source of money.” A more recent letter from US Senators urging a discussion around bitcoin noted,

“the federal government must make sure that potential threats and risks are dealt with swiftly; however, we must also ensure that rash or uninformed actions don’t stifle a potentially valuable technology.”

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Underlying this advancement of the digital currency conversation is an evolving infrastructure that has grown tremendously since the last time this level of media attention, yet remains significantly less apparent.

Exchange Dynamics

While the increase in bitcoin exchange rates are commonly referenced, the growth so far this year in the bitcoin exchange industry is equally as interesting. Perhaps most notable is the increased distribution of the market and associated lack of a single point of failure.

In April, Mt. Gox was handling approximately 70-80% of global exchange volume and ultimately fell victim to DDoS attacks on April 3, April 12, April 18, April 21 and crashed on April 9 (denied as a DDoS by the company), debatably catalyzing the initial correction on the same day. In the seven months since, global exchange volume has become far more distributed, with even the largest exchanges owning no more than approximately 25% of the market recently.

exchange distribution

Even the currency pairs that comprise bitcoin markets have become more distributed, particularly a result of the increase in CNY volume. This change helps quantify the expanding and increasingly distributed nature of bitcoin markets. Previously dominated by US and European investors, interest in bitcoin has not only spread but significantly begun to embed itself across some of the world’s widest cultural barriers.

currency distribution

Meanwhile, at least three exchanges have received million-dollar or greater venture capital investments since April, in addition to the two in the latest class of the Boost accelerator program, meaning the development of the industry has likely only begun.

That’s good news, because the exchange ecosystem still has a long way to go. Institutional players looking to trade significant amounts of capital ($100K – $1M, or more) are likely to move the market with trades of those sizes, meaning slowed liquidity for major players or premiums paid to off-exchange brokers – the network for which has grown significantly as a result. Moreover, US account holders are still having difficulty withdrawing funds from Mt Gox after months of waiting and have to deal with international wire transfers to fund accounts at the leading exchanges.

Stability and distribution in the world of bitcoin exchanges has come a long way since April, but fundamental problems around market depth and the necessity of dealing with an unaccommodating legacy banking system are still overhanging.

Payment Processors

Bitcoin’s exchange rate tends to receive the most attention from the media, but the heaviest venture capital has flowed to the companies facilitating bitcoin’s use as a transactional currency – payment processors. Since April, at least five companies in the space have raised investment capital so far, with some of them already demonstrating significant growth.

BitPay garnered a $2M investment in May (now $2.5M total) and has since grown to $6.4M equivalent of monthly transaction volume, up from $670K in February. The company also increased to 10,000 merchants as of September, 1,000% growth compared with the same time in 2012. If bitcoin’s price is climbing because of the vast potential uses of digital currency, these sorts of figures show that at least to some extent, the potential is becoming reality.

BitPay is not alone in their endeavor the bring the benefits of bitcoin and it’s protocol to the world of merchant acquiring. Coinbase, a graduate of the Y Combinator accelerator, raised $6.1M in a venture capital round led by Union Square Ventures in May (now $6.9M total) and has since grown to 12,000 merchants, according to the company’s website. Just last week Circle, founded by the creator of ColdFusion, announced the largest venture investment round in bitcoin’s history, raising $9M from General Catalyst Partners and Accel Partners. The company hasn’t offered any significant details about their plans, but has indicated merchant acceptance tools would be a core component of product offerings.

While Atlanta-based BitPay boasts merchant presence in 164 countries, other bitcoin merchant processors have targeted non-US regions. GoCoin, which announced a $550K angel round, including an investment from the former COO of Facebook. BitPagos, another graduate of the latest class of the Boost Accelerator has already begun signing merchants in Argentina and plans to expand into the rest of South America soon.

The user experience around transacting in bitcoin has grown dramatically since April and is only set to increase, given the capital flowing into the industry. Even if the latest price gains aren’t sustained, the infrastructure pushing forward bitcoin’s advancement as a transactional currency is only getting larger.

While that’s good for the industry as a whole since more capital is now committed to merchant adoption, one has to wonder if there is room for this many companies. Geographical distribution may insulate some of the newer entrants, but with three US-based companies receiving multi-million dollar investments and vying for the same business, the competition and associated landgrab is likely to accelerate. It may turn out that there is room for multiple companies in the space, much like credit card brands. Companies like PayPal have benefited from being first to achieve consumer and merchant adoption in the processing space, but unlike PayPal, bitcoin inherently allows for payments between any wallet and processor, meaning more than one successful company in the space could well be viable.


Any industry based around the transfer of capital is sure to encounter heavy regulatory scrutiny, as bitcoin has come to learn. The FinCEN guidance around digital currencies has been available since March, but it’s deeper understanding and resulting implementation have brought clarity to an otherwise murky environment.

Knowing now that many bitcoin companies are considered Money Transmitters has made anti-money laundering regulations the foundation of any discussion of new bitcoin companies, with experts being hired throughout the industry. Circle, for example, brought on the former Chief Regulatory Counsel for The Financial Services Roundtable as their Chief Compliance Officer. Regulation and compliance has become an equally important part of industry events, with conferences generally featuring a panel of lawyers, regulators and entrepreneurs offering guidance.

Regulators have made a number of inquiries about the money transmission aspect of bitcoin companies and organizations since April, including an unfounded cease and desist letter from the California Department of Financial Institutions, and the New York Department of Financial Services issued subpoenas to twenty-two bitcoin companies and investors. Yet, for all of the highly-publicized regulatory activity, punitive action against bitcoin companies for alleged violation of money transmission laws has been limited to the seizures of Mt. Gox’s US bank accounts, which were opened originally in 2011. That may have something to do with the vast majority of bitcoin trading volume taking place on exchanges domiciled outside the US, even in the USD-BTC market.

Outside of the US over the past months, other countries have mostly been either directly accommodative or have explicitly stated that bitcoin companies do not yet fall under regulatory guidelines. Canada and the UK, for example, have both issued formal letters to bitcoin exchanges informing them that registration as money transmission business is not currently required, though that may change in the future. According to some reports, China has taken similar (non) action. Meanwhile, countries like Germany have officially recognized it as money and begun to clarify tax implications.

Regardless of the direction of regional regulatory action, clarity is significantly improved relative to April, offering investors a better sense of a core risk this new financial instrument faces. That said, there is sure to be further developments in the regulatory arena, particularly from the US. The Senate Homeland Security and Governmental Affairs Committee, for example, is scheduled to have a hearing this month on virtual currency, the outcome of which only time will dictate.

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