Coinbase Raises Venture Funding to Capitalize on Bitcoin Exuberance

Among the companies providing cloud Bitcoin wallet services, Coinbase has some of the greatest momentum over the last few months, which is a long time in the Bitcoin world.

And today, they are doubling down on that momentum with a $25 million round of funding from prolific venture capital firm Andreessen Horowitz.

Buying Bitcoin is hard. It’s hard to setup an account, it’s hard to send money into an exchange, and it’s hard to get USD back out.

Much of these liquidity challenges have stressed the Bitcoin market over the last year. Japan-based Mt.Gox was once the world’s leading exchange and now it’s been eclipsed by BTC China.

Read: Bitcoin Wallet Comparison: Security and Liquidity

Coinbase entered the scene with a simpler value proposition: ACH bank transfers to buy and sell Bitcoin. Technically, they are not an exchange but just a hosted wallet with an relatively easy onboarding.

Coinbase has also had its share of challenges.

A month ago, after the positive U.S. Senate Committee hearing, the price of Bitcoin skyrocketed to $900. Coinbase, along with most of the other exchanges in the world, fell apart under the increased trading volume. The company suddenly announced that it was hitting its normal buy limits and warned users that, while they could place orders, these orders would not be priced for up to 5 days.

Related: Read our full summary of the Senate Committee hearing on Bitcoin

Also, since Coinbase operates on bank transfers, buying Bitcoin is not instant. It takes 5-6 days after making a purchase to have the Bitcoin in your wallet.

Coinbase’s mobile strategy has also been hit. The company launched an iPhone app that was taken down by Apple after a few weeks.

However, even despite these challenges, it is clear that Coinbase is growing. The company now has over 600,000 customers transacting with them, and much of that growth has been in the last few months.

This round of funding and endorsement from Andreessen Horowitz is sure to both put Coinbase in a position to take bigger bets on growth and kick off a wave of venture funding for other Bitcoin startups.

At the Inside Bitcoins conference, BTC China CEO Bobby Lee explained why China is so hot on Bitcoin and shed light on the implications of the recent regulatory statements made by the Chinese authorities.

Looking back at the last 3 to 6 months, BTC China has quickly become the leading Bitcoin exchange in the world, surpassing Mt.Gox, Bitstamp and other exchanges.

Much of it is cultural, explained Lee.

First, China is a nation of savings. In the US, the national savings rate is less than 10% of GDP, while in China, the rate is upwards of 35% to 50%. Bitcoin, as a virtual commodity, presents an opportunity to store value and preserve purchasing power. This is novel, and Chinese citizens are eating it up.

China is also a nation of engineers. The leadership of China, from Jiang Zemin to Xi Jinping, all have educations in engineering from elite Chinese universities. Generally speaking, at the upper ends of Chinese society, indivudals are more likely to have a tehcnical educational background versus Western coutnires. This lends itself to an environment in which the upper rungs of the socioeconomic ladeder are more comfortable with a technical commodity like Bitcoin.

“I guess in the US, they are all lawyers,” Lee joked.

These cultural factors have led to a herd mentality of buying Bitcoin at large volumes. Lee said that his exchange has reached 150,000 Bitcoins per day in trading volume and he is expecting a 100X increase next year.

Regulatory Landscape in China is Open to Bitcoin

On December 5, the People’s Bank of China published a notice clarifying the legality of Bitcoin. Banks were banned from owning and trading Bitcoin in this notice. The price of Bitcoin crashed on this news and related activity in China.

Lee, tongue-in-cheek, said he was on a plane when the announcement from People’s Bank of China came out. He went on to explain the implications of the notice.

En masse, the press wrongly published that Bitcoin was banned or made illegal. “That’s not the case,” said Lee.

Yi Gang, Vice Minister of the People’s Bank of China (China’s Central Bank), articulated 3 statements:

1. The central Bank is not ready to recognize Bitcoin as a legal currency in the near term.
2. However, Bitcoin trading is a legitimate form of online buying and selling, and everyone should be free to participate.
3. Bitcoin’s unique characteristics and said the development of the digital currency was inspiring and he will keep following it.

The implications as follows:

Bitcoin is not a legal currency and will not be regulated as a legal currency. Instead Bitcoin will be treated as a virtual good or virtual commodity.

Further, Bitcoin buying and selling constitutes a form of online commodities trading and individuals are free to participate so log as they are willing to assume the risk.

That means that goods and services cannot be paid for by Bitcoin. “Think of Bitcoin as eggs in the supermarket,” said Lee. “It’s not a currency.”

In terms of regulatory compliance, Bitcoin Exchanges must comply with relevant AML (anti-money laundering) and KYC (know your customer) regulation. Websites whose primary business is Bitcoin trading must register with the telecommunications authority.

So the restrictions are actually limited to certain types of organizations. Chinese insurance companies cannot provide services to trading firms. Financial institutions and payment institutions cannot conduct transactions or price goods or commodities in Bitcoin and cannot act as a central counterparty.

“Certain business models will not work in China,” said Lee.

The Road Ahead for Bitcoin in China

Given the dramatic increase in trading volumes at BTC China, security is important. Close to 90% of Bitcoins are held in cold storage. Fiat currency is held outside of BTC China’s reach with other parties.

BTC China also proactively implemented an additional layer of KYC, requiring internationally verifiable forms of identification.

Malcolm CasSelle, CEO of Timeline Labs and an investor in BTC China, took the stage after Bobby Lee to explain how BTC China is pioneering new regulatory perspectives and where Bitcoin companies fit in.

Authorities are still trying to understand how Bitcoin businesses fit in with the regulatory framework, said CasSelle, especially because of the volumes flowing in.

“BTC China is the equivalent of a noodle stand from the regulators perspective, so why does he have 10 million RMB this month,” said CasSelle. He explained that the window is still open for multi-billion dollar businesses to grow in the current regulatory environment in China.

CasSelle also highlighted that mining is alive and well in China.

“Mining is insane”, said CasSelle. “I can’t tell you how many Bitcoin millionaires I’ve met. They are pretty funny characters. They like having a machine in their basement that spits out money.”

In the next 90 days, expect to see major activity in ASIC mining for Litecoin, said CasSele.

There are also threats to the Bitcoin ecosystem. Bad actors — theft, money laundering, and drugs for example, brings regulatory reactions which can be stifling to adoption. Also, fragmentation of crypto-currency and the emergence of alternative coins will slow down growth of Bitcoin.

At the same time, volatility and investment losses can cause bad publicity.

Thanks to Bobby Lee and Malcom CasSelle for a great presentation!

Marco Santori is a senior associate at New York-based Nesenoff & Miltenberg, LLP, and very familiar with the nuances of Bitcoin regulation. In a presentation at the Inside Bitcoins conference in Las Vegas, Mr. Santori provided a thorough overview of money transmission regulation on the federal and state levels.

Money services businesses (MSBs) are regulated by FinCEN, whose goal is to prevent money laundering.

MSBs are required to register with FinCEN on a federal level. While it’s a free, online process to register, there are an assortment of requirements, such as:

• Collect, verify, record report customer information
• Check identities against watch lists (terrorists, criminal, enemies of the state)
• Deny service for some customers
• Sometimes secretly report transaction activitiy to fincen and continue servicing the customer
• Undergo yearly audits

In March 2013 FinCEN published regulatory guidance surrounding Bitcoin. While this guidance left some confused, the overall takeaway was that Bitcoin is not inherently illegal and Bitcoin companies are fine to operate as long as they comply with applicable laws.

Santori provided examples of businesses that would be under the veil of regulation:

• Hosted wallets that permit exporting private keys
• Paper wallets
• Exchange digital currency for government currency
• Exchange one digital currency for another
• Mine digital currency and convert to government currency
• Accept value from person A and give to person B
• Accept value from person A and give to person A at another time or place

While it’s easy to register on the federal level, it’s another story on the state level. There are 48 states that provide licenses for money transmission. The states regulate money transmitters separately from the federal government. So, for a company to operate in the United States, they need to separately attain 48 licenses, which is a timely and costly endeavor.

While it’s more complex to apply for licenses in 48 states, the scope of regulation appears to be slightly less cumbersome. The states have not adopted all of FinCEN’s categories of money transmitter. Specifically, only these two categories are relevant:

• Accept value from person A and give to person B
• Accept value from person A and give to person A at another time or place

Given the ambiguity and cost of regulation, what should a startup do?

Circle Internet Financial, a company formed by serial entrepreneur Jeremy Allaire, publicly stated that they will be seeking licenses in all states and raised $9 million in venture capital to fund that initiative.

However, there are a plethora of startups that don’t have the funds or capabilities to attain licenses. Here are some other options.

First, a company could send a “no action” or “request for ruling” letter, which explains the nature of the business and why it should not require a license. Drafting this letter can be costly due to legal fees but can also result in certainty if authorities respond.

There are also avoidance strategies. You can incorporate overseas and geofilter IP addresses to block US customers. By documenting this process and having appropriate policies in place, a company can protect themselves from regulatory backlash if some US customers get through. For example, a company should check if the customer registers a US bank account, makes transfers to US accounts or subsequently accesses the company’s service from US IP addresses.

Santori said that most companies restructure their companies to either fit into an exception in the regulation. Exceptions include:

• Providing network services to a money transmitter
• White label exchange
• Physically transporting value that substitutes for currency
• Operating a settlement business between MSBs
• Performing payment processing services

If a company wants to get a state license, how long does it take to get approved? For a regular business, just a few weeks. But for a Bitcoin business, it’s not clear.

In a packed room at the MGM Grand Hotel in Las Vegas, seemingly everyone who knows anything about Bitcoin is attending the Inside Bitcoins conference.

Read: Inside Bitcoins Conference Leads the Way to the Future of Money

Jared Kenna, founder and CEO of Tradehill, took the stage to keynote the conference and presented a look back at the major milestones for Bitcoin over the last few years.

In an entertaining presentation, Kenna described some of the “early” milestones, looking back less than one year ago. Here are the highlights:

• In February, Bitcoin digital wallet Coinbase generated $1 million when Bitcoin was worth $22 per coin.
• In March, FinCEN issued guidance describing Bitcoin as money transmission, pushing the regulation to the states. Coinbase passed 50,000 users in the same month and the price rose to $100.
• In April, Bitcoin cloud wallet provider Blockchain.info broke 200,000 users. The price rose to $260 and then crashed to $70.
• In May, gift card provider Gyft launched a service that brought Bitcoin to 50,000 brick and mortar stores. Coinbase acquired its 100,000th customer. Seattle startup CoinLab sued Bitcoin exchange Mt.Gox for $75 million
• In June, the Bitcoin foundation received a cease and desist letter from California, and responded.
• In July, the Winklevoss twins announce their plans to launch a Bitcoin fund.
• In August, Mt.Gox had millions of dollars seized, knocking the exchange and paving the way for BTC China to take a leadership position among Bitcoin exchanges.
• In September, Coinbase grew to 250.000 users and Mt.Gox continued to lose market share.
• In October, international drug marketplace Silk Road was shut down and its owner arrested. Bitcoin broke $200 for the second time.
• In November, Coinbase and Blockchain.info both grew to 500,000 customers. The price of Bitcoin climbed from $200 to $1200. And the U.S. Senate held hearings on the digital currency.
• In December, Roger Ver donated 1000 Bitcoin to charity. Switzerland is preparing to vote on Bitcoin as a currency. The price hit a new floor of $580 and then grew again.

Stay tuned for news from the rest of the conference!