Bitcoin Goes Mainstream

12 Dec Bitcoin Goes Mainstream

Posted at 21:25h in Securities Litigation & Regulation by

Bitcoin.  The very mention of the name conjures the tripartite faces of fear, greed and the unknown.  To many it is an unfamiliar economic engine that produces both financial volatility and enormous riches in the Internet’s equivalent of the wild west.  But what are the real opportunities Bitcoin presents that makes an ever-increasing number of people willing to take the wild ride?

First, Bitcoin operates on blockchain technology.  A “blockchain” is a transparent digital ledger on which each transaction is posted for every member to see.  Once posted, a transaction cannot be altered or copied.  Transactions are grouped every 10 minutes into a block which is then added to the chain of prior blocks, becoming part of a continuous permanent record.   Technologists (i.e., engineers, techies and early adopters) and an increasing number of financial service institutions believe blockchain technology represents the future of business transactions in the digital environment, analogizing Bitcoin’s relation to blockchain technology to email’s relation to the Internet: a single function enabled by technology having a far wider capacity.  Second, the number of businesses and exchanges that have begun to accept or trade Bitcoin is increasing, helping to ordain its ubiquity as an accepted medium of exchange and alternative to government fiat, i.e., cash, or bank-issued cards.  Third, the fact that the two factors just noted are helping drive the value of Bitcoin – as more people seek to acquire Bitcoins either to get on the decentralized blockchain or to participate in a new technology – making them more valuable due to their finite number.  And, it is their rising, indeed supersonic, increase in value that has captured popular imagination.

But, Bitcoin is only the first of many different “cryptocurrencies” – i.e., an encrypted digital or virtual currency having no physical properties – now in the market.  By being first and seizing the first movers’ advantage, however, it is the most well-known and most widely followed, and is now being traded in the futures markets.  Its closest competitor is Ethereum who’s “Ether” tokens enable access to a blockchain that offers more functionality than Bitcoin’s.  The advantage Ethereum offers over Bitcoin is the enabling of “smart contracts.”  Where Bitcoin enables a simple point-to-point exchange of value, i.e., transfer of goods or services for payment of money, Ethereum’s smart contracts allow businesses and individuals to condition that exchange of value/payment on the occurrence of triggering events.  Both eliminate the need for intermediaries; only the two parties to a transaction are involved.

Because of the recent startling rise and fluctuation in the price of a Bitcoin in Q4 2017, most have focused on its desirability as an investment vehicle.  But, that was not the primary purpose for its creation, which was to institute a medium of exchange independent of the fluctuations of national currencies and fiscal policies.  Nonetheless, because Bitcoin and other cryptocurrencies are used and being seen by many as an investment vehicle, made available through initial coin offerings (“ICOs”), it may soon become the subject of regulation.  Just this past July, 2017, the Securities and Exchange Commission evaluated the characteristics of one cryptocurrency on the Ethereum platform and found that it bore all the hallmarks of a security, and therefore would need to be registered or qualify for an exemption from registration.

Considering that there have been more than 160 ICOs in the past year, and that Bitcoin’s market capitalization is valued at nearly $300 billion, with the value of a single coin having recently topped $18,000 – there may soon be either a wave of registrations and requests for exemptions, or a wave of enforcement actions.

The number of Bitcoin supporters continues to grow.  Just yesterday, December 11, 2017, the Chicago Board Options Exchange began trading Bitcoin futures.  Next week, the Chicago Mercantile Exchange, the world’s largest derivatives market, will follow suit.  These new markets will likely lead to the creation of exchange traded funds (“ETF’s) tied to the value of Bitcoin.  These regulated vehicles will allow large institutions to begin investing in Bitcoin while hedging their downside risk.  This will further accelerate Bitcoin’s universality and acceptance by large institutions.  Bitcoin is already accepted for many types of transactions, and is supported by the payment app Square.  It also has inspired other companies, such as Disney and Overstock.com, to set-up and test their own blockchain-based cryptocurrencies, Dragonchain in Disney’s case, and tZero in the case of Overstock.com.

It also has prominent backers, like Goldman Sachs’ CEO Lloyd Blankfein, as well as detractors, such as J.P. Morgan CEO Jamie Dimon, who famously has referred to Bitcoin as a “fraud,” and Saudi investor Prince Al-Waleed Bin Talal, who believes Bitcoin is another “Enron in the making.”  There have been events that could engender such skepticism.  Most notably, in 2013, Mt. Gox, formerly the world’s largest Bitcoin exchange, suffered a theft of more than 850,000 Bitcoins worth more than $450 million.  The coins were stolen directly from Mt. Gox’s digital wallet.  Some 200,000 were later found, but it was too late to save Mt. Gox from bankruptcy and liquidation.

While this episode caused many to become spooked and skeptical about Bitcoin, and has lingered as a risk factor in the minds of many about cryptocurrencies generally, others philosophically maintain that any new technology presents unforeseen risks, but with the passage of time, such risks, once manifested, are often addressed and reduced.  There was one ICO that turned out to be a Ponzi scheme. Though that did not involve Bitcoin, because it was a blockchain cryptocurrency, many see analogous risks.  Considering that Bitcoin has now had nine years of history, with no real enduring or damning scandal, it appears to be the real deal.  At least that’s what today’s futures purchasers want to believe.

Ron Wood

Ron Wood

Ron Wood is a partner with Brown White & Osborn LLP. A former Assistant Director in the SEC's Division of Enforcement, Executive Director in the Law Division at Morgan Stanley, and litigation partner with Proskauer LLP, he practices securities law with a focus on regulatory and enforcement matters. He also conducts internal investigations and complex commercial litigation.
Ron Wood

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