businessweek

Mar 25 2018

A Hedge Fund Billionaire’s Bitcoin Bet

Bitcoin continues to redefine the word volatility. The cryptocurrency is down more than 50 percent from its December peak; but that still leaves it up more than 600 percent from its value a year ago.

The Wildest of Rides

Bitcoin's rollercoaster journey shows no signs of stabilizing

Source: Bloomberg

On Thursday, it dipped below $8,000, marking a decline of more than a third this month alone. Its fellow digital currencies including Ripple and Ethereum have inflicted similar losses on holders — or hodlers, as crypto-fanatics call the ever-bullish aficionados who grin and bear their losses in expectation of a renewed rally.

The renewed slide comes after my Bloomberg News colleagues Alastair Marsh and Nishant Kumar reported on Wednesday that billionaire hedge fund manager Alan Howard made "sizable personal investments" in cryptocurrencies and associated technology last year. Some of his fellow partners at Brevan Howard Asset Management have also put their own money into the new-fangled structures, they reported.

There's a warning here to others: billionaires can afford to dabble where mere fiscal mortals should fear to tread.

The ultra-rich can almost certainly afford to lose every cent they punt on digital currencies without affecting their lifestyles. A survey of Bitcoin owners published by Lendedu in December, however, found that 22 percent of those using credit cards to finance their purchases hadn't repaid their balances.

Using borrowed money to speculate on cryptocurrencies is the equivalent of taking your entire personal net worth to the casino, where the odds are always in favor of the house. No wonder some major financial institutions such as Bank of America Corp. and JPMorgan Chase & Co. have outlawed crypto purchases using their plastic.

Secondly, digital currencies remain speculative gambles rather than investments, at least for now. Hedge-fund managers (well, the successful ones) will be well-aware of the academic literature in behavioral economics of tendencies such as confirmation bias, fear of missing out and loss aversion – something that devotees of Bitcoin and its ilk seem to be blissfully ignorant of.

Thirdly, the regulators are circling. The U.S. Securities and Exchange Commission is investigating hedge funds set up specifically to participate in digital-token sales. Markus Ferber, the lead European Union lawmaker on the MiFID II suite of rules, said earlier this week that virtual currencies should be classified as financial instruments and fall under those regulations to protect investors.

One avenue open to the overseers of finance would be to restrict cryptocurrencies to sophisticated investors. That would anger the many libertarians who extol the virtues of the likes of Bitcoin as offering a store of value outside of the purview of central banks; but it would instantly shrink the pool of subscribers available to the purveyors of initial coin offerings, to the detriment of their subsequent valuations.

"Let me tell you about the very rich," F. Scott Fitzgerald wrote in a short story published in the 1920s. "They are different from you and me." That statement is as correct today as it was almost a century ago; and it should serve as a warning to anyone planning to belatedly jump on the cryptocurrency bandwagon.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Mar 23 2018

Is Your Blockchain Business Doomed?

Blockchain, the technology behind Bitcoin and Ether, can securely record transactions, store huge amounts of data forever, and offer transparency by letting anyone view the information it contains. That makes it ideal for virtual currencies and some applications in insurance, health care, and other industries—and a thorny problem for a new European law on privacy.

Under the European Union’s General Data Protection Regulation, companies will be required to completely erase the personal data of any citizen who requests that they do so. For businesses that use blockchain, specifically applications with publicly available data trails such as Bitcoin and Ethereum, truly purging that information could be impossible. “Some blockchains, as currently designed, are incompatible with the GDPR,” says Michèle Finck, a lecturer in EU law at the University of Oxford. EU regulators, she says, will need to decide whether the technology must be barred from the region or reconfigure the new rules to permit an uneasy coexistence.

Compliance headaches could afflict thousands of companies. More than 1,000 apps are being built on the Ethereum blockchain alone, according to the stateofthedapps.com directory. “I think it will impede some of the applications,” Greg McMullen, a lawyer based in Germany and blockchain expert, says of the law. “We’ll get a bit of a reality check on what the right kinds of applications are to build on a blockchain.”

Under GDPR, the definition of personal data is deliberately a very broad one. In principle, it covers any information that relates to an identifiable, living individual, such as a person’s name or social security number. But it could also include any type of data that could directly or indirectly identify an individual.

“Some of the most important areas of guidance have been issued in the last two, three, four months,” says Jules Polonetsky, chief executive officer of the Future of Privacy Forum, a privacy think tank that works with chief privacy officers, academics, and policymakers. “There’s a lot of detail, but still a lot of subjective interpretation.”

It’s possible that even an individual’s public Bitcoin address—a string of letters and numbers used to send and receive the digital currency—could be considered personal information. “Encrypted data will often qualify as personal data and not as anonymous data,” the law firm Hogan Lovells said in a recent note. “This means that in most instances the privacy rules will be applicable to at least some of the data involved in blockchain systems.”

Some companies may have to redesign their software and buy costly traditional databases to move any personally identifiable information they possess off a blockchain. That would help with compliance, but it could remove some of a blockchain’s benefits. It will be harder to ensure that documents stored outside a blockchain haven’t been tampered with, for example. And moving off a blockchain could be expensive, especially for startups. Maintaining their own databases costs more, and such companies might need to raise funds to build IT infrastructure.

Not everyone sees GDPR as blockchain’s death knell. Some of the technology’s boosters say the features that appeal to blockchain users could be used to assist businesses in meeting the law’s requirements. “This is all something a blockchain can be quite helpful with,” says Brian Behlendorf, executive director of Hyperledger, a consortium of companies that builds blockchain software. Software provider Cambridge Blockchain and security company LuxTrust SA are testing this idea. Together they are developing software to help businesses—banks, for example—better manage personal data in compliance with “know-your-customer” rules. That information might have to be managed differently because of GDPR.

The consequences for companies that can’t or don’t want to adapt could be huge. “I think you are going to see quite a few industries and companies completely pull out of Europe, and many that shut down, and you are going to see bankruptcies,” says Mark Rudnitsky, CEO of HealthHeart, a Chicago startup that’s working on managing electronic health records via the Ethereum blockchain. Of course, since GDPR has yet to be implemented, it’s hard to know what the precise regulatory expectations will be.

“I suspect that GDPR will also have to adapt to the blockchain in a way,” says Winston Maxwell, a privacy lawyer at Hogan Lovells in Paris. “GDPR is robust, but it’s also flexible. It doesn’t close the door on blockchain. It means people have to slow down and ask, who is responsible for what, what safeguards go around which data, and are we getting consent?”

BOTTOM LINE – Companies that use blockchain to develop applications could have extra trouble complying with Europe’s new data protection regulation.

Mar 08 2018

Exchanges Make Millions a Day Off Crypto Fees

Traders and miners aren’t the only ones cashing in on the cryptocurrency boom. Digital-asset exchanges are emerging as one of the biggest winners with the top 10 generating as much $3 million in fees a day, or heading for more than $1 billion per year, according to estimates compiled by Bloomberg. “The exchanges and transaction processors are the biggest winners in the space because they’re allowing people to transact and participate in this burgeoning sector,” said Gil Luria, an equity analyst at D.A. Davidson & Co.

Feb 10 2018

The Crypto Candidate for Congress

Over the past year, Bitcoin’s meteoric rise—and recent plunge—has captivated the financial world. The political world? Not so much. Washington remains stubbornly ignorant of cryptocurrency and blockchain technology. But that may soon change. A roster of prominent crypto investors has piled in to support a first-time Democratic congressional candidate, Brian Forde, who’s looking to unseat the incumbent Republican in a pivotal Orange County, Calif., race that could determine which party controls the House of Representatives after November’s midterm elections.

Forde’s appeal isn’t hard to discern. Before running for Congress, the 37-year-old coder was director of digital currency at MIT’s Media Lab and a technology adviser in Barack Obama’s White House. Forde says his tech and business background is a good match for California’s 45th District, an historically GOP area currently represented by Republican Mimi Walters, but one whose well-educated, minority-rich populace also chose Hillary Clinton over Donald Trump by 5 percentage points. “Tech is one of the fastest-growing economic sectors in the district,” Forde says. “In addition to our fair share of unicorns—from Broadcom to Blizzard Entertainment—Amazon, Google, and others have offices here, too.”

It’s Forde’s expertise in cryptocurrency that’s attracted marquee Bitcoin evangelists such as Pete Briger of Fortress Investment Group; Brad Burnham of Union Square Ventures; the investor Mike Novogratz; and famed Facebook litigants Cameron and Tyler Winklevoss, who founded the Gemini cryptocurrency exchange. “Brian understands the power of emerging technologies and how to foster and shape them in a way that has a positive impact on people and organizations,” says Tyler Winklevoss. Bitcoin’s recent roller-coaster ride—falling as much as 70 percent after hitting a high of $19,511 on Dec. 17—has only intensified the industry’s desire to have an ally in Congress.

Forde’s Bitcoin bona fides are so strong that many of those donors have contributed actual Bitcoins to his campaign rather than write a check, the old-fashioned way. Federal Election Commission records indicate that although his campaign is barely six months old, Forde has already amassed more Bitcoin contributions than all previous congressional candidates combined.

“He’s walking the walk and speaking our language,” says Stan Miroshnik, chief executive officer of the Element Group, an investment bank focused on digital-token capital markets, who last summer gave Forde 0.656 Bitcoin (then the equivalent of the FEC’s $2,700 limit on primary campaign contributions). “If you’re willing to go through the pain of actually taking cryptocurrency, it’s a great endorsement of the philosophy we’re all pushing.” These contributions flow to a Bitcoin wallet and are converted by Forde’s campaign to U.S. dollars through a Bitcoin exchange. Powered by cryptocash, Forde’s fourth-quarter fundraising total beat the entire field of candidates—including Walters, a sitting congresswoman.

Yet there are reasons beyond a shared enthusiasm for blockchain decentralization that so many Bitcoin investors would like to send Forde to Congress. As cryptocurrency has exploded from a fringe passion into an $800 billion capital market, regulators are taking notice. “By and large, the government has been very quiet on cryptocurrencies and Bitcoin,” says Justin Slaughter, a former top aide at the Commodity Futures Trading Commission who now consults on fintech regulation as a partner at Mercury Strategies LLC. “Partly because it’s so new, partly because a lot of people don’t understand it yet.”

The high-profile collapse of several cryptocurrency exchanges, fears of fraud and price manipulation, the susceptibility of exchanges to hacking, and concerns of an asset bubble have all led to the expectation of more government oversight. In recent days, Bank of America, Citigroup, and JPMorgan Chase announced they would bar customers from using credit cards to buy cryptocurrencies, and Facebook said it would ban ads promoting them, including Bitcoin. “It would benefit the crypto sector to have one of our own in Congress,” says Fred Wilson, a Forde donor and partner at Union Square Ventures.

Forde, with his parents in Tustin, Calif.

Photographer: Angie Smith for Bloomberg Businessweek

Forde is no stranger to emerging tech that falls into a regulatory gray area. In 2005, after serving as a Peace Corps volunteer in Nicaragua, he co-founded Llamadas SA, a low-cost internet phone service provider that used Voice over Internet Protocol, then a new technology. “That tech wasn’t legal or illegal—it was just new,” he says. “So my biggest concern was that the government would end up on the wrong side of history with how it regulated VoIP.”

Forde sees the same risk in how the U.S. government tackles crypto, and he wants to make sure that overly aggressive regulation doesn’t drive the U.S. industry overseas to somewhere like Switzerland with more accommodating rules. “You have to protect consumer rights and consumer safety,” he says. “But we also need to allow for innovation. You want to create ‘regulatory sandboxes’ for these emerging technologies to grow. My concern is that when you apply strict regulations to small startups, they’ll be forced to apply so many resources to compliance that they won’t have the resources to build and innovate.”

Those like Forde and his backers hoping to nurture the nascent U.S. crypto industry see two primary hurdles. One is government ignorance. “I’ve been working on crypto with policymakers for years,” says Jerry Brito, executive director of Coin Center Inc., a nonprofit focused on public policy issues involving cryptocurrency. “The good news is the level of awareness has improved dramatically, and there’s real curiosity. But they still could not explain to you how Bitcoin works.” In December, the crypto community got a scare when Senators Dianne Feinstein and Chuck Grassley—both 84 years old—introduced an anti-money-laundering bill aimed at terrorists and counterfeiters that appeared to criminalize concealed ownership of cryptocurrency. (The bill hasn’t advanced.) “So much of what could go wrong with Washington and this technology would not happen out of malice, but out of ignorance,” Brito says.

The other hurdle is the balkanized U.S. regulatory structure overseeing this technology. “We have a regulatory breakdown,” says Slaughter, the former CFTC aide. “There isn’t consistency between agencies. Most countries have a single market regulator, but ours is split between who regulates futures and who regulates equities.”

Recently, the agencies have appeared to move in opposite directions. In December, the CFTC allowed two futures exchanges, CME Group Inc. and Cboe Global Markets Inc., to begin offering Bitcoin derivatives. At the same time, the Securities and Exchange Commission has cracked down, halting initial coin offerings and disappointing companies eager to launch exchange-traded funds tied to Bitcoin, including one backed by the Winklevoss brothers. In January, Bloomberg News dubbed SEC Chairman Jay Clayton “Washington’s chief cryptocurrency skeptic.”

Bitcoin’s steep selloff over the past two months has added urgency to the push from regulators as the psychology among retail crypto investors shifts from FOMO to “Oh, no!” Says the Element Group’s Miroshnik: “Regulators are all trying to catch up to what’s happening.”

Having an ally in Congress to push for clarity and consistency would help smooth out this regulatory tangle. Forde himself has been caught up in the confusion. The FEC has offered little guidance about how candidates should handle Bitcoin beyond a 2014 advisory opinion that said candidates may accept a total of $100 in Bitcoin currency as contributions. Forde’s campaign has asked the FEC for guidance on how to report contributions as high as the maximum limit of $2,700 and whether they’re acceptable. But it’s unclear whether any guidance will soon be forthcoming. “It’s really a microcosm of where our government is on this stuff,” says Joe Bowen, Forde’s campaign manager, who adds that he believes all Forde’s donations comply with FEC rules.

Those donations could be critical to Forde’s candidacy—and to Democrats’ chances of winning the seat if he finishes among the top two candidates in the June 5 primary. (Under California’s “jungle primary” system, all candidates run in the same primary regardless of political party, with the two top finishers facing off in November.) “We’ve had a lot of success raising cryptocurrency,” Bowen says. “Proportionately, it’s a significant part of our fundraising program, around 20 or 25 percent of what we’ve raised.”

Whichever Democrat prevails—Forde’s main rivals, David Min and Katie Porter, are law professors at the University of California at Irvine—will need a substantial war chest in November. The incumbent, Walters, is one of 23 Republicans nationwide in districts Clinton won and a top target of national Democrats, who will probably need to capture the seat if they’re to pick up the 24 necessary to win back the House.

Should Forde become part of a Democratic wave in November, he says, he’ll usher in more than just a new majority. “We’ve got all these emerging technologies that are going to have a big impact on our economy and our lives,” he says, “yet we don’t have the folks in Congress who understand that.”

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BOTTOM LINE – Some of the top cryptocurrency investors have given money to Forde’s campaign for Congress in hopes he can be an ally in Washington.

Jan 27 2018

Ripple Wants XRP to Be Bitcoin for Banks. If Only the Banks Wanted It

Every day, companies and consumers around the world send more than $76 billion in payments through a vast network of banks. Without the flow of money, container ships stay in port, workers don’t get paid, and supply chains break down. For the past six years, Ripple, a tech company in San Francisco, has vowed to use the blockchain wizardry behind Bitcoin to rewire this global circulatory system with what it calls an “internet of value.”

That in itself would be a fairly interesting business story. But then Ripple became a part of the great cryptocurrency melt-up of late 2017. The company owns a lot of a digital token called XRP. From late September to early January, XRP saw an astonishing 1,300 percent increase in value, blowing away the gains of rival virtual currencies Bitcoin and Ether and turning its executives into paper billionaires. One rationale for buying XRP is that unlike Bitcoin, the token has one narrowly defined but clearly useful purpose: to help banks move cash from point A to point B faster and more cheaply, especially across borders.

The problem is that banks say they have no interest in using XRP. Current and former executives at seven global banks—some of whom have partnered with Ripple—say there was scant chance they would ever entrust their corporate clients’ payments to a cryptocurrency. The executives requested anonymity.

“It’s bewildering,” says Joseph Lubin, the founder of ConsenSys, a startup that develops applications based on the Ethereum blockchain, the technology used for Ether. “Effectively it’s a totally useless token except that it is being used by that company to make a lot of money to fund some of their activities.” There are 100 billion of the tokens and, according to Ripple’s website, the company holds about 61 billion—with a value of $1.31 each on Jan. 25, or about $80 billion total. Most are held in escrow and can be sold only in limited chunks over time to avoid crashing the market. Ripple has sold more than $185 million in XRP since September 2016, according to reports the private company publishes.

Chief Executive Officer Brad Garlinghouse says Ripple is working with more than 100 banks to overhaul the way they handle payments for their clients. “Ripple is trying to be a catalyst to mature a whole industry,” he says. “The current system is fraught with friction and is measured by a lack of transparency and speed.” There’s a difference, however, between Ripple, the company, and XRP, the token. XRP is “absolutely at the core of what Ripple is doing,” says Garlinghouse, but at the moment the company’s main product, RippleNet, doesn’t rely on it.

RippleNet takes on an entrenched competitor, the Brussels-based Society for Worldwide Interbank Financial Telecommunication, or Swift, a messaging system that acts like an air traffic control system for money as it moves across the globe. It connects about 11,000 financial companies. “This is a relatively standard David vs. Goliath Silicon Valley story,” says Garlinghouse. With trillions of dollars of asset flows at stake, the competition between the two companies is fierce.

Ripple set out in 2012 to create a streamlined, decentralized payments system using technology inspired by the blockchain. From the outset, it hoped XRP would be an important part of it. For example, the token could be used as a bridge currency—pesos in Mexico City could become XRP, which could then be turned into baht in Bangkok. Having a lingua franca of payment could help banks avoid the hassle and expense of tying up money in different currencies in accounts at other banks.

Banks, however, balked at XRP. They said there was no way they could use an instrument that regulators may never approve, according to an executive in the cross-border payment industry familiar with Ripple’s business. Moreover, the real power in the cross-border payment system wasn’t banks but the big companies that used it for their cash needs around the world. A corporate treasurer for a Fortune 500 company wasn’t going to tell its bank to use a startup with a digital currency, the person says.

So Ripple pivoted away from XRP and focused on RippleNet, which is similar to Swift in that it’s primarily a messaging system that tells banks where to send the money. It also has a service that helps banks settle transactions.

Ripple has signed a lot of banks onto its network and sold equity stakes in itself to Standard Chartered Plc and Banco Santander SA. Influential names from Wall Street such as Zoe Cruz, the onetime co-president for institutional securities and wealth management at Morgan Stanley, joined Ripple’s board. Of the more than 100 companies, though, Garlinghouse would specify the transaction volume of only one, Stockholm-based Skandinaviska Enskilda Banken AB, which he said moved just shy of $1 billion in payments over RippleNet. Even investors Standard Chartered and Santander haven’t taken the plunge and are only testing the technology.

Which isn’t to say it’s not working. Santander’s U.K. division has been testing an app that uses Ripple technology to send payments internationally from mobile phone apps in just a few seconds. In November, Standard Chartered started a program to send payments between Singapore and India for its corporate clients. Even though neither bank plans to use XRP in these projects, both are optimistic about Ripple’s technology.

Ripple isn’t the only company trying to innovate payments. Earthport Plc, a London company that manages a payment network in 65 countries used by TransferWise Inc. and other customers, has been steadily building volume. Nor is Swift taking the challenge lying down. It recently rolled out its own major upgrade called Global Payments Innovation, or GPI. It allows banks’ corporate customers to make payments in a couple of hours and to track transactions on their journeys the same way FedEx Corp. customers can. “This is a giant leap forward,” says Harry Newman, head of banking at Swift. “Is there another giant leap that someone else has made? I don’t think so.”

Shirish Wadivkar, the global head of correspondent banking products at Standard Chartered, says RippleNet was one of the first entrants to make payments traceable across a network. But GPI does this, too.

As a consortium owned and managed by the world’s banks, Swift has a home-field advantage. The one-year-old GPI system, which uses cloud computing but not blockchain, already has 36 banks using it to make more than $1 billion in cross-border payments. Ripple’s Garlinghouse says comparing GPI to his company’s offerings is like racing a horse and buggy against a car. “What GPI is basically trying to do is use the existing architecture to try to make it go faster,” he says. “And can you whip a horse faster to make it go as fast as an automobile?”

As for XRP, it’s been used by at least one financial company. Cuallix is a credit and payments processing provider based in the U.S. and Mexico. Since October it’s used XRP in 10 to 12 transactions to send money between the two countries, says Nicolas Palacios, the company’s chief financial officer. Each of those has averaged from $500 to $1,000, he says. On Jan. 11, Ripple announced that MoneyGram International Inc. would begin testing the currency for sending remittances. Two more remittance companies have signed on to test XRP since.

XRP has fallen 55 percent from $2.92 in early January. Swift’s Newman says such volatility is bound to turn off bankers and their clients. “If the value of a cryptocurrency is going up and down like a yo-yo, this isn’t a serious medium of exchange,” he says. “It adds unnecessary complexity. The solution is worse than the problem.” Garlinghouse says XRP’s first adopters won’t be big banks, but companies sending money in less common currencies.

The subtleties of the global bank payment system may be lost on traders who just want to get in on anything crypto. “It’s important for investors to be aware of the qualitative differences between XRP and other cryptocurrencies,” says Angela Walch, a research fellow at the Centre for Blockchain Technologies at University College London. Among them: Ripple’s outsize role in XRP.

Ibrahim Alkurd, a university student in Wales, scooped up some XRP at under $1 in December after he heard rumors it would be listed on Coinbase, the big U.S. exchange. That didn’t happen, but Alkurd also liked that Ripple had partnerships with banks. The likelihood of XRP “doubling or more when it was at 30¢ was far more probable than Bitcoin doubling,” he says. Michael Jackson, a partner at Luxembourg-based Mangrove Capital Partners and a cryptocurrency investor, has a different take on XRP’s rise: “I haven’t found anyone who gets it.”

For more on cryptocurrencies, check out the podcast:

(Corrects the 10th paragraph to show that Garlinghouse specified the transaction of volume of only one customer. In a previous version, the number of years Ripple has been in business was corrected in the first paragraph.)

BOTTOM LINE – Ripple wants to change how banks move money around the world. That may or may not have anything to do with the digital currency XRP.