One of the most remarkable points taken from the most recent Bristol (UK) Bitcoin meetup was an excellent diagram/concept (which I will share with you shortly) from Javier Marti, CEO of Bitcoin Global Investments who hosts and sponsors the meetup.
The diagram itself provides an interesting overview& timeline charting Bitcoin adoption from its conception back in 2009, to present day, as well as a potential scenario for future adoption.
Most importantly it puts focus on the ‘requirements’ needed to facilitate Bitcoin adoption, with user groups that have yet to participate or invest in Bitcoin.
In addition, it is particularly useful as an insight into the technology investment cycle, such as the process of technology adoption and various investment stages that drives this growth.
I have added observations on investment risk at each stage of adoption, annotations on key events and contributed partly to the requirements which I believe each user group will need at each stage.
Visualising Bitcoin Adoption:
Geeks, Nerds, Techies, Smart money:
As with all new technology, due to its complexity, it is always the most technologically literate and those that have the most interest in new technology that become the initial adopters.
Bitcoin is no exception and we can see from the diagram that so called ‘geeks’, ‘nerds’ and cryptographers followed by I.T professionals ‘techies’ were the first to work on, develop and invest their time and resources into Bitcoin. These are the first user groups to understand Bitcoin’s huge potential, along with smart money and investors of a libertarian/anarchic capitalist persuasion. These investors see Bitcoin as a currency that directly fits in with the libertarian ideology and a move towards the Austrian economic frame work for how markets should operate.
Investment risk: Extreme/Very high –
- Experimental protocol,
- No social proof of acceptance,
- High opportunity costs,
- Greater threat of 51% attack,
- Potential threat from government agencies in early stages, Very high volatility.
Venture Capital (VC’s), Bitcoin Businesses/services
The previous user groups drive adoption and market value to a point where (VC) looking towards Silicon Valley in particular for investment opportunity start to take note.
The VC tipping point came in early 2013 when the Bitcoin market spiked to $260 aided by the Cyprus bank bail-ins.
(Figure 1) taken from the ‘CoinDesk’ State of Bitcoin Q2 2014’ report, (1), shows that from this time period in 2013, VC capital increased 1200% YOY and the number of VC-backed startups increased 700%.
Following the influx of VC capital is the creation of Bitcoin Businesses and services that provide platforms that make it easy for early adopter investment and for merchant adoption to take place.
Investment Risk: Very high – High
- Young protocol and growing need to keep up with scalability,
- Increased risk from legacy financial system lobbyists and government regulations due to increased profile,
- speed of innovation,
- Competition from alternate protocols/coins.
- Potential for revenue streams and cash flow to partly offsets risk.
All the prior stages of adoption has led to and facilitated a massive increase in merchant adoption. This has been especially rapid due to companies like Bitpay and Coinbase that can mitigate the volatility risk of accepting bitcoin by converting transactions back to fiat currency almost instantaneously.
(Figure 2) also taken from the ‘CoinDesk State of Bitcoin Q2 2014’ report, (1) highlights this rapid expansion.
It was estimated in market commentary that at the beginning of 2013 there were only 1000 companies accepted bitcoin payments and this grew to an estimated 10,000 towards the end of 2013. Already by Q2 2014, we have seen this number balloon to around 63,000 and the number is now estimated to already be around 80,000+ as we near the end of Q3. In addition to this the acceptance by large Merchants such as Dell, Overstock, DISH, Expedia and the recent announcement of ebay subsidiary Braintree and Paypal will be providing their clients with a way to integrate Bitcoin merchant processing has the potential to bring in other major retailers into the Bitcoin economy.
Investment Risk: Low*
- Instant conversion back into fiat can mitigate high risks of holding Bitcoin.
- Easy to integrate relatively small opportunity costs.
The ease and rapid growth of adoption by merchants it could be argued, is arguably one of the main contributors that has led to the continued downward pressure on the market price in 2014 due to increased sell side pressure on the exchanges as merchants convert their bitcoin transactions back to fiat currency.
This raises the question, when will the next wave of user adoption occur to offset the current sell side pressure?
And what are the requirements needed in order to bring in the new user groups to facilitate this?
Users/Retail Investor adoption:
It must be noted here that all potential future Bitcoin adoption patterns are speculative due to the large amount of potential ‘Wild Card’ scenarios listed in the chart that could have a significant positive or negative affect on the market price.
Bearing this in mind, let’s take a look at some of the requirements we can expect will be needed to bring in adoption from general users and retail investors:
Requirement 1: Need for Bitcoin
It could be argued that the vast majority of the general public simply doesn’t see the need for Bitcoin at the present time. One of my previous articles ‘Bitcoin V UK Retail Banking- David and Goliath’ highlight’s that despite the many advantages of Bitcoin (well known by the Bitcoin community as a whole), the current retail banking system still provides a low cost transactional network that meets the day to day requirements of most of the general public, especially with regards to domestic payments.
Add to this a profound level of cognitive dissonance & lack of understanding to the extreme level of fraud and risk in the legacy financial system and you have a largely disengaged public; a public that are dangerously unconcerned about investment or future wealth preservation.
However, there are 3 major uses of Bitcoin we have identified that we believe will fuel the need from this user group in the future. They are the following:
- Inflation hedge against the debasement of fiat currency.
- A way of mitigating counterparty risk to the extreme leverage and risk in the current banking and financial system.
- ZIRP/NIRP (zero or negative interest rate policy).
All three reasons stated above are becoming more and more prevalent.
The Cyprus Bail-ins in 2013 was a prime example of counterparty risk and a major contributor to the April 2013 Bitcoin price surge. In addition we are seeing the continuation of long term ZIRP; and now NIRP is looking to become a growing trend (2). This means not only will depositors fail to get any meaningful interest on savings and deposits to offset inflationary pressures of fiat currency. But they may soon find themselves being charged simply for depositing in the first place. This makes holding any form of fiat currency increasingly undesirable in the long run and may help spur people into alternate holdings of inflationary hedge assets and alternate currencies.
Requirement 2: Trust
Another need that Javier Marti identified as a prerequisite for adoption from this user group is trust.
Key areas of trust that are required:
- Trust that Bitcoin as a currency has longevity.
- Trust in the infrastructure/core protocol.
- Trust in the security of key services built around the core network (e.g wallets and exchanges)
- Trust that potential government legislation will not have a terminal detrimental impact upon the practicality of Bitcoin as an investment/currency.
Despite a series of events in 2014 that damaged the trust requirement of Bitcoin to this user group, the most prolific of which being the loss of Bitcoin from ‘Mt.Gox’; the notorious crack down on financial services in China and their restrictions on Bitcoin involvement; and the recent ‘BitLicense’ proposals from the NYDFS.
There are many reasons to be optimistic that the ‘trust’ requirement will continue to grow.
Firstly, the Bitcoin protocol is now approaching the 6 year mark and whilst still young, every day increases the perception that Bitcoin has a solid framework to become a competing transactional network. Coupled with the fact that large household names such as Dell, Paypal, Expedia, Overstock and DISH are also adopting the technology, gives much needed credence that Bitcoin will have longevity.
Secondly the bankruptcy of Mt.Gox has led to an increased implementation of auditing for the exchange services, pushed by user demand for proof of holdings.
Thirdly, whilst some jurisdictions have been draconian with their approach to Bitcoin regulation, there are 200 competing sovereign states and the UK in particular, has currently had a hands off approach to Bitcoin regulation; and is taking real interest in its innovative potential.
Another key factor that must be taken into account when looking at trust as a requirement for Bitcoin adoption, is the loss of trust in the current financial system and with the governments that regulate these institutions.
In the last 6 years since the financial crisis, we have seen little meaningful reform in terms of regulation, deleveraging or accountability for the 2008 crash. As a result it’s been well documented that trust in the banking system has hit all-time lows; barely a day goes by without new reports of fraud and manipulation.
As a result of this and the negative impacts of monetary policy on the economy to compensate for the extreme leverage; governments are increasingly desperate to raise tax revenues to fulfil interest payments occurred through the monetised debt from these policies.
In essence you now have a general public waking up and finding themselves stuck between a predatory Banking system and desperate governments.
This is an observation that Javier Marti highlighted in a recent conversation, he stated:
“ You have banks on one side, governments on the other, and the common citizen in the middle. This will create pressure that will make more and more people escape into Bitcoin”
A recent article by Siri Srinivas from the Guardian ‘Americans Chased by IRS give up citizenship after being forced out of banks accounts’ (3); highlights some of the consequences the pressures that both of these entities can have on American citizens in particular.
The article focuses on the Foreign Accounts Taxation Compliance Act (FATCA) and how its pushing foreign banks to reduce cooperation and services with American Expat’s; acts that could lead to loss of trust in the banking system and increased adoption of Bitcoin as a viable alternative.
Siri Srinivas writes:
“Steep penalties add muscle to the law. If a foreign bank – not just in Canada, but anywhere – fails to report even a single US citizen as a customer to the IRS, the US Treasury department would withhold 30% of the banks’ US income as penalty.”
“Scared of running afoul of US banking laws, foreign banks are taking extreme steps to limit US citizens to a narrow range of services. The result for expats has been a chaotic brew of closed bank accounts, mysterious excuses and a scramble to find local banks that would allow them to park their money.
Increasing amount of these actions, could lead to a pivotal point where the trust in Bitcoin begins to exceed the current trust in the toxic relationship between big finance & government .
Requirement 3: Opportunity\ Ability to invest
Another key requirement that Javier, notes for this user group, is the prerequisite of having the ability and opportunity to invest in Bitcoin.
It is very easy for established, long term or early investors to take for granted the skills and knowledge needed to understand, facilitate and safely secure bitcoin holdings.
Without outsourcing these services and paying a premium, it requires a certain level of technical aptitude that most members of this user group do not have.
In order for this to change, retail investors and general users need highly refined user interfaces and applications that greatly reduce technical barriers for adoption.
There are two significant areas in particular that are looking to address this requirement:
- Institutional/Retail Investment funds
- Bridge services (Circle, Wallet providers, Merchant processors)
The first, (which I annotated on the chart) and could be of great significance are retail investment funds.
Bitcoin investment funds such as OEIC’s and ETF’s will provide an easy way for retail investors to gain exposure to Bitcoin in a way that’s familiar to them and generally has more liquidity than bitcoin holdings stored in hot or cold wallets. These funds can provide an investment vehicle that removes all technical knowledge required to store the bitcoins; which partly offsets the negatives of centralised risk and service premiums.
Secondly, the increase in professional bridge services such as ‘Circle’ that provide general users with a way to exchange, transact, store and Bitcoins through one simplified user interface (UI); have the potential to drive adoption from this group. Whilst the centralisation of these services comes with a risk, it has the potential to provide a stepping stone for general users, before the same level of services can be provide in a decentralised manner.
Requirement 4: Utility
The condemnation of Bitcoin as a viable currency is evident almost daily through the Main Stream Media (MSM).The main reasons stated, are always associated with market volatility and Utility.
What the MSM often fail to recognise, is that the utility of Bitcoin will centre round its use as an investment asset, long before it widely used as a currency.
The primary reasons for this? As a way to hedge fiat currency debasement and counterparty risk in the legacy financial system.
As the network affect from this adoption takes hold, we will potentially see an ‘S-Curve’ pattern in Bitcoin utility; as adoption from both users, merchants and services expand. Increased utility and network size draw in more and more users in behavioural patterns that are seen from adoption in social media giants, like Facebook and twitter.
Institutional Investors, Private Equity, Hedge Funds :
Whilst 2014 was touted as the year of Wall Street participation in Bitcoin, as we enter Q4, this has not come to pass.
One of the main reasons for this is that Wall Street is interested in trading, not investment. They do not care about investing in evolutionary technology and the benefits it can bring; especially when the technology is detrimental to their own margins and their far reaching control over the financial system.
This point was highlighted in an interesting article by Jack C. Liu ‘Why Wall Street has yet to enter Bitcoin’ (5);
Jack C. Liu writes:
“The motto for Wall Street has always been to find an edge – an arbitrage model, a high frequency algo, a long/short pair trade, credit vs. equity, offsetting risk to retail investors, fundamental analysis, event-driven plays etc – and then to lever up and trade on that edge. Rinse and repeat”.
In order to maximise the profits from the processes listed above they ultimately desire complete control over the markets in which they operate; another reason that might help explain why Bitcoin adoption by this group has yet to be realised.
However, this is not to say that they will not participate without control in the future. Something that myself and Javier have discussed and will feature in a future article.
Whilst the price of Bitcoin remains supressed due to the weakness in chart technicals, market tone, asset allocation and sell side pressure from merchant adoption. It is important to focus on the growing strength in the fundamentals that have driven Bitcoin to date. It is these fundamentals that will likely address the requirements needed to bring in mass adoption and trust from user groups currently outside of the Bitcoin economy.
Q3 State of Bitcoin: except for the price, every key adoption metric is up pic.twitter.com/Uay6GGuoMh
— Tuur Demeester (@TuurDemeester) October 8, 2014
The diagram itself also puts Bitcoins first mover advantage into perspective. Whilst many (especially in in the MSM) are now claiming Bitcoin was a trial crypto currency or the ‘Napster’ if you like; and only its underlying technology has value. It will be a big task for another Coin/protocol to compete and capture the same human and monetary investment that has moved the Bitcoin economy to this stage.
Whilst there are many wild card scenarios that could cause extreme positive or negative shifts in the pattern and or speed of adoption, than those listed shown in the diagram.
It is important to remember that the main fundamental behind Bitcoin, as an alternative to the controlled Banking and Government issued fiat, has never been more important.