Topic: {2016-03-031]Forbes: Uncertainty In Bitcoin Doesn't Extend To Startups (Read 319 times)

Infighting in the Bitcoin community has made headlines in recent months.

Political disputes between individual developers have been exposed. Programmers have split off into new competing teams. At times, the network has strained to process a flood of transactions. And the community’s inability to agree on how to increase the network capacity has periodically generated news.

“Bitcoin has almost been a victim of its own success,” said Adam White, vice president of business development at Coinbase, over coffee in New York City’s Union Square, describing how transaction volume is reaching the network’s limits.

And yet, while some large, well-funded startups in the space, including Coinbase, have publicly disagreed with decisions made by the core developers over how to increase network capacity, the drama and uncertainty over the future direction of the technology has not only not affected their business or partnerships, but it has also ironically demonstrated the advantages of using a trusted brand even with a currency that initially became popular precisely because its users wanted to bypass third parties.

An Ecosystem in Bloom

The community has now grown far beyond the initial group of enthusiasts who fueled its early growth — technophiles, libertarians, profit-seeking “miners,” who maintain the network in exchange for new bitcoin, and, to be frank, criminals who used it to pay for illegal goods online — to include several new constituencies quite different from the original vested parties.

The Bitcoin ecosystem now includes millions of everyday people investing or transacting who are essentially represented by the startups that have created user-friendly apps and websites. “Startups play a pretty integral role in the sense that we represent most of the end-users. If you look at users of Bitcoin on the network, most of them are represented by one of the major Bitcoin companies,” says Peter Smith, chief executive of Blockchain, adding that five or six companies, including Coinbase and Blockchain, represent about 80% of transaction volume on the network. Numerous startups are also using Bitcoin to enable their users to more easily send remittances, cross-border payments and peer-to-peer payments, as well as make mobile in-app purchases.

In addition to venture capitalists who have so far invested $1.1 billion into the space, Bitcoin has attracted Wall Street investors such as hedge funds, mutual fund managers, family offices and ultra high-net worth individuals who have invested in the currency or related investment vehicles, as well as financial advisors serving Main Street investors who are putting such securities into their retirement accounts. One investment available to them is GBTC, a publicly traded security invested in Bitcoin, that is supposed to trade at one-tenth of a Bitcoin, but is usually priced higher than that due to scarcity and the demand for tax-advantaged exposure to Bitcoin in accounts such as IRAs. Additionally, ARK Invest’s ETF Web X.0 includes a small percentage of digital currencies. And investors in Bitcoin can track the price on the New York Stock Exchange Bitcoin Index, NYXBT. By and large, many of these investors are betting on the potential for Bitcoin to become a major payment rail, which should further increase the demand for the currency, thereby boosting its price.

Coinbase’s diverse business shows just how broad Bitcoin’s appeal is now. Founded in 2012, it is one of the earliest, largest and most well-funded startups in the space, with $106 million total raised from investors like Andreessen Horowitz and the New York Stock Exchange. Serving as an easy, safe way to obtain Bitcoin, it helped bridge the gap between the tech-savvy early adopters who are comfortable dealing with the Bitcoin software directly and the financially savvy early adopters who do not necessary want to handle the technology themselves but are eager to invest or use the currency and want a reputable company they trust to manage their Bitcoin. With 3.5 million users, it and other startups such as Blockchain, which has 6.6 million wallet holders and $30.5 million in venture investment, represent the large and growing group of Bitcoin investors and consumers who are not necessarily interested in the technology, but in either making a speculative investment with the currency or in moving money anywhere in the world within roughly 10 minutes.

Coinbase has brought everyday consumers and Wall Street professionals to Bitcoin with a range of products, services and partnerships. White says customers of Coinbase.com, the retail site for novice users, “usually say, I heard a lot about this, I want to buy some Bitcoin.” Coinbase Exchange is an institutional exchange with advanced trading orders such as a recently added a stop order feature that allows customers to buy or sell Bitcoin when the price exceeds a certain threshold. “We see more institutional traders like hedge funds, programmatic or algo traders — people who are looking at Bitcoin as just a new asset class,” says White, “They say, I trade all these other asset classes. Why shouldn’t I be trading this?” Currently, 80% of Coinbase’s customers buy bitcoin as an investment, and 20% transact with it, though that balance is currently shifting more toward transactions. Additionally, the company offers merchant processing services for companies such as Overstock.com and Dell, as well as a developer platform that helps programmers and startups create Bitcoin apps. An example of Coinbase’s efforts to make Bitcoin more mainstream is a recent announcement by partner and investor USAA, a financial services company serving members of the military, that it is now possible for all 11 million members to check their Coinbase balances within their web and mobile accounts, as they would traditional investments such as real estate.

Despite Conflict, Partnerships Proceed

All this consumer activity has brought the average number of Bitcoin transactions close to what the network can handle at any one time. Transactions on the Bitcoin network are processed in batches called blocks, with a new one making its way through the network roughly every 10 minutes. Currently, each block has a limit of 1 MB. As Bitcoin’s popularity has grown, the blocks have now become, on average, 70% full, with some blocks hitting the limit, causing delays that, during the worst network congestion periods, have left some transactions stalled for more than 48 hours. Small block sizes also pose a risk to the network, because it makes the cost of a spam attack really cheap. As Smith puts it, “if the glass is 80% full, you only need a little bit of water to make the last run over, so the cost of filling up the glass is really cheap.”

A number of developers and other leaders in the community, including Smith and the CEO of Coinbase, Brian Armstrong, have advocated for increasing the block size to 2 MB to resolve these problems, at least temporarily. But development of the Bitcoin protocol is primarily in the hands of a group of core developers, who also consult with the miners who keep the network running. While they would eventually like to increase the number of transactions per block, they prefer to first make an improvement to the protocol that would not change the block size but is still projected to effectively allow 1.6 MB of transactions through in one block. They are concerned that moving up to 2 MB blocks might cause some miners to drop out, making the network more centralized, and therefore more susceptible to various attacks.

“There’s no real big need to push developers. They should do it as they always did it — clean and stable,” says Jonas Schnelli, one of the five core developers who can make changes to the protocol official. “And they should not be pushed by market needs, in my opinion.” He describes market pressures as, “they want to have maximum 10 minutes confirmation [time] to pay for a coffee,” and doesn’t see any urgency: “First, there’s still plenty of space left in blocks. … On the other hand, should the market really decide what quality the developers bring out? If you want to see Bitcoin survive the next 20 or 30 years,” he says, “I strongly advise to let developers do the work they did until now, which is very high-quality of software.”

Facing developers whose prerogatives differ from their own, startups have begun to take more public stances on the direction of the protocol. “Prior to about six months ago, Coinbase’s methodology for operating was heads down,” says White. “What we were going to do is be more focused on executing and building more products that people love than anyone else. We almost purposely didn’t take a vocal stake inside the Bitcoin community.” However, over the last six months, Armstrong has made public his opinion on a number of issues related to the direction and governance of the protocol through a series of posts on Medium. Blockchain and Coinbase have also thrown in their lot with a new group of developers calling themselves Classic, as opposed to the original team of developers now called Core. “We feel this friction occurring where decisions can’t get made — that there are a lot of questions around how consensus is going to be created,” says White. “Coinbase is saying it’s our job as one of the most well-funded and largest Bitcoin companies to step up and help unblock that logjam.”

Compounding the sense of urgency is the fact that, due to a rule in the Bitcoin software, in July, miners will begin to receive only half the number of bitcoin that they are currently awarded when they process a block of transactions for the network. Some fear this so-called block halving will decrease the miners’ profitability, causing some to drop out, thereby decreasing the security of the network, which in turn could create a downward spiral that depresses the value of the currency, causing more people to flee Bitcoin.

The risks of not accommodating the increased transaction volume quickly enough became apparent in early March when a spike in transactions caused extreme network delays. Ironically, the situation ended up demonstrating the benefits of some centralization, albeit of a different kind — not of the mining network but of third-party Bitcoin services.

Several startups said that the network congestion enabled them to improve their services. Coinbase developed an algorithm that optimized fees paid to miners to ensure that its users’ transactions would go through in a timely fashion — at negligible cost to the company. “Internally, we worked to optimize around how to batch and process transactions so we were using kind of — machine learning is a stretch — but an algorithm that would look at the way the transaction is being processed, and whether it’s a period of high activity or low activity, and from that, intelligently attach miners’ fees or transaction fees to these users’ events,” said White. “That’s a way for us to make sure that our users get their transactions in blocks without overpaying.”

Stephen Pair of BitPay, a Bitcoin merchant processing company that also offers a personal wallet called Copay, says, the spikes in transaction volume have allowed it to improve the wallet: “It’s actually been very instructive and useful for us to have 1 MB block size limit and then to have the network bump up against it, because then we can observe how the system behaves and where the issues are, and improve the software to better cope with that. Because even when you go to 2 MB blocks, at some point you’ll hit that limit.”

In contrast, people with so-called user-controlled wallets who handle the software themselves were more prone to experiencing long delays.

Smith says, “When you think about who a small block impacts, it’s not really the Blockchain.infos and Coinbases of the world. We have a big engineering team, a lot of money, we can develop systems to get around this problem. We can also quite frankly pay the miners to confirm our transactions ahead of everybody else’s through special negotiated contracts with the miners, because we’re a bulk purchaser of block space” — though the company has not done that. “So you could say that this throttling of the network that Core is currently doing is a great thing for us. It gives us an opportunity to consolidate the market. But I firmly believe that it’s bad for Bitcoin, and is bad for our users,” he says.

The seeming turmoil within Bitcoin hasn’t spooked Coinbase’s partner financial institutions. “It actually hasn’t been that large of an issue — surprisingly almost,” White says. “From the outside in, these large financial institutions have great insight into what Bitcoin and blockchain are doing, but are not so in the weeds that they’re tracking the block size debate and scaling issues.” Many of them continue to see potential in the technology and the currency. White says, “A couple big-name partnerships — without giving away too much — will signal that Bitcoin is really a legitimate, paradigm-shifting technology that’s not going to go away.”