A Bitcoin for your Thoughts
Forget about cat videos and dating. The latest Internet creation could actually change the way you do business
by Max Fawcett
With all the good fortune he’s had this year, Joseph David might want to buy a lottery ticket. Then again, it looks like he’s already holding a winning one. David is the 39-year-old entrepreneur behind Calgary-based VirtEx, the first bitcoin exchange in Canada. And bitcoins, as you may have heard, are suddenly very popular – and very valuable. It stands to reason that his company, which he created in 2011, probably is too.
Photographs Colin Way / Illustration Jesse Koreck
That’s something of a surprise, given that it looked for a time like the bitcoin was destined to join MySpace and Friendster in the online graveyard. After a couple of high-profile hacking incidents and the failure of a bitcoin exchange, its value crashed by nearly 90 per cent in the span of just a few months in 2011. But last May, as more users suddenly started using the currency to buy and sell online, it rose from the near-dead. As of late March, the market value of the approximately 10.8 million bitcoins in circulation was more than US$700 million.
But, first things first.
What is a bitcoin?
In essence, it’s a digital dollar that can be used to buy and sell goods and services. But because it’s based on an open-source, peer-to-peer Internet protocol, the bitcoin is beyond the control of any individual or agency – there is, in other words, no bitcoin central bank. Not surprisingly, then, it was initially popular among groups that actively dislike any form of centralized power, from principle-driven people like hacktivists and gold bugs to profit-driven (and prosecution-averse) ones like drug dealers and pimps.
In 2013, though, the bitcoin has expanded well beyond those demographics. Why? In part, its proponents say, because central banks continue to engage in competitive devaluation in an attempt to stimulate their moribund economies and inflate away the national debts that their elected officials are unwilling to confront. It probably didn’t help when the European Union decided to levy a surcharge on the funds over €100,000 held in every bank account in cash-strapped Cyprus.
But while the bitcoin is an effective hedge against inflation (indeed, it has a built-in deflationary bias, as its original code caps the number of bitcoins that can ever be created at 21 million), David thinks its real power lies in the ability to make life easier for both businesses and consumers. “Merchants are going to be highly incented to accept bitcoins,” David says. “The current [credit card-based] model is bad for merchants – [their] business takes losses on fraud and chargebacks and payment processing. The bitcoin flips that around.” And once those merchants pass those savings along to their customers, David thinks they’ll be equally incented to learn more about the bitcoin. “You’re a consumer checking out an online website. Do you want to pay $100 with VISA, or $93 with bitcoin? The first question you’re going to ask is, ‘Why is it cheaper for bitcoin?’ and the second question will be, ‘What is a bitcoin?’”
David admits he didn’t know what a bitcoin was either when a friend who worked in online security introduced him to the concept in 2010. But the lifelong entrepreneur, who started his first business at the age of 19, spent a few months learning everything he could about the currency. When he was done, David realized there was a business staring him in the face. “I’ve always been an entrepreneur,” he says, “and I’ve always done whatever I thought would make the most money at the time. Lately, that’s been telecom and finance, and that turned into VirtEx.”
The problem with the bitcoin when David encountered it was that it was both complicated and inconvenient to buy or sell. Most of the bitcoin trading in Canada at that time took place through Internet Relay Chat (IRC) networks and depended on the ability of both sides of the transaction to trust each other. What the bitcoin needed was an intermediary, who could remove technical challenges and the risk associated with transactions. David decided he was just the guy to be that intermediary. VirtEx, which allowed buyers and sellers of bitcoins to meet online and do business in a convenient and reliable environment, charges transaction fees that range from as much as three per cent on deals involving fewer than 100 bitcoins to as little as 0.5 per cent on ones involving more than 2,500.
What’s to stop a competitor from coming in and creating their own bitcoin exchange? Nothing, David says. “We can’t keep out competitors, and there are competitors out there who are trying to get in right now.” Still, the intangible value of his head-start, and the $5.5 million in transactions that VirtEx has already processed as of mid-March, is considerable. Trust is still a scarce commodity in the bitcoin exchange, and the people who trade on it surely remember what happened just two summers ago when Mt. Gox, the biggest bitcoin exchange in the world, was compromised, with an estimated US$250,000 stolen by hackers. “We have a lot of traction, we have a lot of trust built up, and that’s hard for a competitor to replicate,” David says. “The biggest problem right now with bitcoin exchanges is trust and security.”
David isn’t about to give potential competitors a chance to catch up, either. In late March VirtEx launched two rounds of equity financing that sought to raise a combined $300,000. The first, a private placement, raised half that amount, while the second was a public IPO that took place a week later. And with the value of the bitcoin making a parabolic upward move, David is in no mood to wait for people to get comfortable with the idea of buying into his company. “Every investor we talk to requires months of research, and time and due diligence to look into this, but in the meantime we had a rally where the price tripled to almost $50 per bitcoin,” he says. “We’re getting busier by the day, our phones are ringing off the hook and we need to expand. We can’t wait around for investors to get up to speed.”
If investors need convincing they only have to look at gains that investors in Ottawa-based Havelock Investments Mining Fund have realized since its IPO last summer. The fund, which uses the capital raised in the IPO to pay for the costs associated with mining bitcoins, pays out a monthly bitcoin-denominated dividend. “When we initially launched Havelock Investments mining it was 4.6 bitcoins to buy a unit of the fund, and bitcoins were only worth about $5,” says Havelock Investments owner James Grant.
Today, after an increase in the value of the fund, a 10-to-1 split in its units and a massive increase in the value of bitcoins themselves, people who bought into the IPO have seen a 38-fold increase in the value of their original investment. Not 38 per cent – 38 fold.
Bitcoins have increased in value, but so far, at least, their usage hasn’t quite followed suit. They’re being treated more like a store of value than a unit of currency, like a digital version of gold. But James Grant, the owner of Ottawa-based bitcoin brokerage Canadian bitcoins (which buys and sells bitcoins directly from people rather than acting as the middleman in the transaction like VirtEx) thinks that’s about to change. He says we’re not far from seeing bitcoins deployed in legal commercial transactions in Canada. His best guess as to where you’ll first see it happen? Food trucks. “Dealing with credit cards and other electronic transfers at a food truck can be difficult,” he says. “With bitcoins, it’s a matter of scanning a barcode. Ding – payment is sent.” From there, he says, bitcoins will likely filter into smaller mom-and-pop businesses where the monthly costs associated with operating a credit card machine can be onerous. “If they switch to bitcoins all those fees go away, and with it the risk of fraud.”
Some merchants might be put off by volatility in the value of a bitcoin or by the system’s complexity, but David and other people in the bitcoin community have answers. “Put a merchant API [an electronic shopping cart] on your website, list everything in Canadian dollars as you normally would and we handle all the volatility,” David says. “We pay you in Canadian dollars, and all the volatility is for the bitcoin purchaser to handle.” He expects to see VirtEx’s own merchant API up and running some time later this year.
Despite the inroads that the bitcoin has made with both merchants and individuals, it still has some work to do when it comes to convincing governments of its merits. And it’s no wonder: bitcoins currently exist beyond the reach of governments, and are effectively draining away potential dollars they could be collecting in the form of sales taxes on goods and services. But Mark Anielski, an Edmonton-based economist and the author of The Economics of Happiness, doesn’t think that state of affairs will last long. “It doesn’t matter whether you’re establishing local currencies or time dollars – there will be efforts to tax those flows,” he says. “I don’t see bitcoins going any differently.”
He likens the situation to what happened with the income-trust structure, when the federal government suddenly and unexpectedly changed course and tightened regulations around who could use it, when it became clear massive corporations like BCE and Telus were planning to take advantage of the tax savings it offered. “Why did they come down hard on those? Because there was a perception of a loss of control of those funds,” Anielski says. “It was all about taxation.” For his part, David is actively trying to get taxed by the government. “That’s our mission: to get recognized and regulated in Canada,” he says, noting that he’s hired a team drawn from the ranks of lawyers at McLeod Dixon to help him do just that. He also brought on Taype International, a Montreal-based money service business that’s recognized by FINTRAC (Financial Transactions and Reports Analysis Centre of Canada) and AMF (Autorité des Marchés Financiers), as an early investor and partner. “We want to be regulated. We want to pay tax on this. We want to bring this to Canada legitimately.”
David may get his wish, too, if the recent publication by the U.S. Treasury’s Financial Crimes Enforcement Network of a list of guidelines that will apply money-laundering and record-keeping rules to companies that issue or exchange digital currencies is any indication. The Canadian government has yet to follow suit, but in an age where governments are staring at years of sub-optimal economic growth and demographic change that will see liabilities explode just as the size of the tax base shrinks, it seems unlikely that they’d ultimately choose to ban the bitcoin and push all its traffic – and potential tax revenues – onto the grey market.
Even if a government did try to ban the bitcoin, it’s not clear that they could do it effectively. “The government can pass policy against it,” Grant says, “but they can’t actually do anything to stop it. There’s no server to shut down, no central authority that issues bitcoins – no way for a government to stop bitcoin from existing.” David shares that view. “To shut the bitcoin down, you’d have to shut the Internet down.”
A Buyer’s Market
For the Bitcoin to truly go mainstream it will have to be used to pay for things other than its current mainstay of sex, drugs and other illegal goods and services. On that front, the digital currency has made some considerable progress in 2013. Here are just a few things – legal ones – that people can now buy using bitcoins.
In February, a U.S.-based startup called PizzaForCoins was created that allows people to buy pizzas from Domino’s (it’s since added Papa John’s and Pizza Hut) using bitcoins.
That same month the hugely influential website Reddit announced that people could purchase premium Reddit Gold accounts, which give users additional features, using bitcoins. WordPress members can also use it to pay for account upgrades and services.
On March 6, BitPay, which bills itself as “the world’s leading payment processor for bitcoin payments,” announced it had integrated its service with the Fullfillment-by-Amazon service, which allows sellers with inventory in one of Amazon’s warehouses to sell them on their own website and have Amazon fill the order for them.
Taylor More, the son of former NHL player Jayson More and a currency trader in his own right, put his Crowsnest Pass home on the market. The price? The equivalent of $405,000
Currency or Commodity?
Bitcoin’s proponents may envision a future where it serves as an alternate currency, but so far it’s behaved much more like a commodity – and a volatile one at that. After rising to almost US$32 per bitcoin in June 2011, it crashed to under $5 by November of that year. But it’s made a stunning comeback in 2013, soaring from around $20 to over $250 by the beginning of April before suddenly crashing down to $60 – and then just as suddenly recovering to $100 by the middle of the month. Memo to bitcoin owners: buckle up.
Q: What are bitcoins worth?
That depends. They’re traded on a market just like other currencies, but a better comparison might be commodities like gold, silver and oil, which can vary more in price based on supply and demand.
Q: Who creates them?
Anyone can. They’re created through a process called bitcoin “mining” in which computers (powerful ones, and often many at the same time) run a series of algorithms that seek to “solve” a mathematical equation. The first one to solve it is rewarded with a bitcoin – a process that’s repeated over and over again.
Q: Is there a central bank for bitcoins?
No, and that’s part of the appeal. As an open-source currency, nobody can control the bitcoin – for better and worse.
Q: Why would I want one?
Maybe you think the debt-laden global banking system is liable to collapse. Maybe you think they’ll increase in value. Maybe you want to engage in commerce over the internet. And maybe you don’t want people to know what you’re buying or selling. All are valid reasons, although advocates hope the first three prevail over the last one.
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