had probably gone to the bank that very day to do business, or logged on to an Internet banking platform.
Yet the very next morning, they woke to a completely new reality: the nation’s banks were broke, and the government was in no position to rescue them.
All the promises they had been told about government guarantees and having a ‘well-regulated’, sound banking system turned out to be lies. The government proclaimed a bank holiday, and banks remained closed for the next several days. Accounts were frozen and ATM withdrawals were limited to only 100 euros a day.
Eventually the plan materialized [as a hard-line demand from the island nation’s German creditors]: substantial portions of deposits over 100,000 euros would be confiscated in exchange for equity in the banks. (Just imagine – Bank of America, RBC, or Lloyds takes your money and gives you stock certificates that subsequently plummet in value!)
And for everyone else, severe capital controls were instituted – some of the worst in decades.
Here again we see a peculiar property of Bitcoin: its value is bid up in a time of desperate uncertainty, and it is able to circumvent the traditional banking system and government-imposed restrictions on capital flows.
Savers in Cyprus could convert their cash to Bitcoin in an effort to escape local capital controls, but most of their funds had already been locked up in the bank holiday, aside from 100 euros a day, which in aggregate had a meaningful effect on Bitcoin’s price.
The burning question at that moment was how much Cypriot savers could expect to recover. Their fate was a warning to savers in other fragile Eurozone member states. With the rising fear that the same kind of policies could be imposed on their countries next, savers in Greece, Spain, Portugal, etc. started abandoning their euro-denominated bank accounts for the “safety” of Bitcoin.
In the event of contagion and banking collapse, Bitcoin balances could be moved out of the country rather than getting clogged in the system… and so the price naturally surged to a peak of $230 by early April 9, 2013.
But with more trading volume than the exchange could handle, problems arose, and hackers attacked, forcing another trading halt and making off with over $8.5 million in customer bitcoins. Then the idea of widespread levies on Cypriot bank accounts was dropped, and fears subsided across the Euro area. The price of a bitcoin fell more than 60%, although it remained far above its pre-crisis peak of $47.
With the virtual currency in the news and on the periphery of my radar screen, this was the third time I was forced to think about Bitcoin. I assumed the price surge would be the beginning of a government crackdown and the likely legal death of the experiment… so I continued to ignore it as an investment opportunity. Wrong again.
Bitcoin fell back into relative obscurity for several months, as indicated by Google searches:
Source: Google Trends
But rather than cracking down on Bitcoin itself, the US government went after nefarious dealers like Silk Road and effectively found itself invested in the virtual currency (which it later auctioned off to the general public).
Despite the price collapse, Bitcoin had caught the world’s attention, and venture capitalists started pouring real money ($88 million in 2013 compared to $36 million in 2012) into a wide range of related businesses, from wallet providers and exchanges to payment processing and other financial services. That meant not only an injection of capital but also a massive influx of expertise into an industry still dominated by inefficient and/or poorly run firms.
At that moment, it started to seem that Bitcoin might just change the world.
Bitcoin downloads spread like wildfire across the emerging world by the summer of 2013…
… and the search term bitcoin was suddenly more popular than ever:
Then China’s state-owned TV station, CCTV, aired a documentary on the crypto-currency around the same time that serious cracks started to show in China’s “miracle” economy. Suddenly China’s credit markets were acting more erratically than during the global financial crisis, and Bitcoin saw its greatest surge in demand to date – again as a way of circumventing the traditional banking system and the limited mix of financial assets available to Chinese investors.
As China’s interbank market began to freeze in the summer of 2013, John and I were watching closely. Here’s an excerpt from the August 31, 2013 Thoughts from the Frontline, “How Do I Hate Thee”:
The next chart shows the recent price spike in the Chinese SHIBOR (their short-term interbank rate, more or less equivalent to LIBOR). It is difficult to trust any of the economic data (positive or negative) coming out of China, so we really do not know whether China’s growth story is simply moderating or whether we are seeing a hard landing in progress; but the sudden shock in interbank lending rates is an important sign that all is not well in the Middle Kingdom. The big question: is the recent SHIBOR spike a harbinger of a banking crisis, or does it presage an RMB devaluation? Interbank rates do not spike from 3% to 13% (in about 2.5 weeks) in a healthy economy, and a big event along these lines in China would have enormous implications for global growth.
As I’ve written over the course of the past year, John and I have been nervously watching China’s slowdown and have voiced real concern over the possibility of capital flight if and when a debt crisis bubbles over; but we clearly underestimated the role that Bitcoin was already playing in China.
By late November 2013 demand for the virtual currency had grown so fast in the People’s Republic that BTC China quickly became the largest Bitcoin exchange in the world, and over 100,000 bitcoins were trading every day in China alone:
The price of Bitcoin surged by more than 10x, from $87 to over $1000, as Chinese savers piled in…
… until emerging-market central banks in places like China, India, Taiwan, and Thailand started to grasp the threat that Bitcoin’s rise posed in a world where US monetary policy was tightening and capital flows could reverse dramatically.
While the People’s Bank of China did not explicitly ban owning or mining Bitcoin, it issued a statement in December 2013 saying that the virtual currency was “not a currency in the real meaning of the word” and that “it cannot and should not be used as a currency circulating in the market.”
In addition to firm language intended to cool the speculative fever among Chinese investors, the State Council mandated a series of prohibitions on Bitcoin trading and forced banks and other payment institutions to refrain from dealing in the cryptocurrency… warning that virtual currencies like Bitcoin posed “a risk to the public interest and legal status of the renminbi.”
In other words, the People’s Bank of China all but spelled out that Bitcoin was an avenue by which local savers could circumvent long-standing Chinese capital controls. If Chinese investors continued to pile into Bitcoin, they could set up a situation where capital could leave very quickly in the event of a panic… or, in the meantime, the money could leave temporarily and then “round-trip” its way back into the Chinese economy, seeking the benefits afforded only to foreign investors.
From its peak in early December 2013, the price of Bitcoin fell more than 40% before finding its bottom. And the average daily trading volume in China fell from over 100,000 in November 2013 to only 2,000 today.
As if the crackdowns in China and other emerging markets in December 2013 and January 2014 were not enough, rumors began to swirl in February that the world’s largest Bitcoin exchange, Mt. Gox, had been hacked and more than $460 million in customer Bitcoin had been stolen.
In a Wired magazine article published in March 2014, “The Inside Story of Mt. Gox, Bitcoin’s $460 Million Disaster,” Robert McMillan explained it was not just one-time event but a “years-long hack,” dating back to the June 2011 incident. “According to a leaked Mt. Gox document… hackers had been skimming the company for years.”
Mt. Gox quickly went offline and collapsed into bankruptcy. It was a devastating blow to confidence in the entire Bitcoin system. With the shock that client accounts could be so insecure for so long, the value of Bitcoin plummeted another 60%+ in the following months.
With the successive blows, Bitcoin fell from nearly $1,200 in early December 2013 to less than $360 by April 2014 – a whopping 70% loss.
And then I really started paying attention.
At a dinner following John’s annual Strategic Investment Conference in San Diego, Raoul Pal (author ofGlobal Macro Investor and co-founder of Real Vision TV) helped me to see Bitcoin in a totally different light. He explained that Bitcoin could be as transformative for finance as the internet has been for commerce and communication, and it could happen FAST… especially if central banks and governments mismanage the next global downturn to the detriment of a highly leveraged, highly interconnected financial system. Or, in a less extreme scenario, the Bitcoin protocol could quietly but steadily replace the decades-old payment system that underpins the current system.
Up to that moment I had never really taken the time to understand the technology behind Bitcoin or how it could change the world… but the sudden fall in valuation was interesting. I had seen a lot of chatter about Bitcoin’s wild price swings in the media and on Twitter (feel free to follow us at @WorthWray and@JohnFMauldin), and I had heard wild claims from Libertarians and anarchists that this Bitcoin would soon replace the US dollar and all other forms of fiat money. I knew Bitcoin was an interesting way that money could flow freely around government-imposed capital controls in the emerging world. But until that moment I completely failed to grasp what Bitcoin could really mean for the global financial system.
I’ll omit the finer details of my conversation with Raoul, but suffice it to say that it kicked off the six-month research project that has inspired and enabled this letter… and pushed my wife, Adrienne, and me to start buying some Bitcoin of our own… not as an all-out bet on Bitcoin’s future but as an option on its development. Either Bitcoin becomes a new foundation stone of the global financial system – delivering a handsome return in the process – or it will give way to something even more powerful. It’s a pretty binary range of outcomes, but it’s worth taking on some exposure with a small percentage of our savings.
In an effort to understand how Bitcoin could continue to mature, I sat down with Barry Silbert, founder of the Bitcoin Investment Trust. As one the most active venture capitalists in the industry (with investments in over 30 bitcoin-related portfolio companies through the Bitcoin Opportunity Corp), Barry has gone all-in on Bitcoin and Bitcoin-related businesses.
He believes the halting rise of Bitcoin from 2009 to 2014 is just the beginning… and that the virtual payment system may be approaching a big inflection point as Wall Street takes the baton from Silicon Valley.
Barry thinks about Bitcoin adoption in five general phases:
- Experimentation phase (2009 – 2010)
- No real value associated with Bitcoin. Hackers & developers playing around with the source code. Experimenting with Bitcoin as a medium of exchange.
- Early adopters phase (2011 – 2013)
- Interest from investors and entrepreneurs started to grow with substantial press coverage in the wake of the Silk Road bust. First generation of Bitcoin-related companies (exchanges, merchant processors, wallet providers, etc.) started. Potential began to shine through poor management.
- Venture capital phase (2013 – present)
- World-class VCs started investing in Bitcoin companies, and rapid ramp-up is already outpacing the early days of the internet. VCs poured more than $90 million into Bitcoin-related businesses in 2013 and are on track to invest more than $300 million in 2014 (compared to $250 million invested in internet-related businesses in 1995).
- Wall Street phase (2015?)
- Institutional investors, banks, and broker-dealers begin moving money into Bitcoin. Rising price and volume (in addition to development of derivatives) become the catalyst for mass adoption as retail investment follows.
- Global consumer adoption phase (?)
- Only happens if (a) companies continue to innovate and make it easier for consumers to buy, hold, and spend Bitcoin, (b) volume expands dramatically so that large merchants can start accepting payment in Bitcoin, and © Bitcoin awareness continues to rise with these developments.
If Barry is right, Bitcoin’s continued rise depends on (1) Wall Street money flowing in to deepen the digital currency’s trading volume and fuel the development of hedging instruments, (2) continued innovation to make Bitcoin more secure and more user friendly, (3) broad acceptance by merchants as a medium of exchange, and (4) an explosion in public awareness.
It’s impossible to know for sure yet… but it looks like all four of those are taking place.
Satoshi’s Revolution Crosses the Chasm
While
