Safe as houses?
The next big issue that bitcoin is yet to fully overcome is security. Instances of security breaches, or ‘heists’, involving bitcoin exchanges have been well-publicised. The most high profile case involved the now infamous exchange Mt. Gox, which in early 2014 announced that approximately 850,000 bitcoins were missing, presumed stolen. The value of these coins, which belonged to both the company and its customers, at the time accounted for over $450m. In more recent months, 200,000 of the coins have been found by the company on an old hard drive, yet the rest remain at large.
This incident highlights a separate issue: namely, the anonymity that cryptocurrencies offer. Although any transaction that occurs will appear in the block chain (the decentralised public general ledger) for that day, the lack of identifying information available and the lack of forensic tools to analyse the block chain can make following transactions extremely difficult, if not impossible. Hence why they are often associated with ‘dark net’ trades.
Corporates holding bitcoin will also need to be aware of the myriad security issues as the cryptocurrency cannot be held in a bank account, with the long established security protocols that support this kind of structure. Instead, it is held in a bitcoin wallet. The digital wallet can come in multiple guises including in the cloud, on a hard drive, or even on a device locked away in a safe. All current methods have their own issues, firstly the security of the cloud solution needs to be optimal, as security around bitcoin has been under the spotlight with a number of high profile breaches and ‘heists’. So-called ‘cold storage’ (storing the bitcoin on a device that is not connected to the internet) may be a safer option as the wallet is disconnected from the internet and therefore away from hackers. That said, it poses its own challenges because it is neither easy to access the wallet quickly nor conveniently to make and accept payments.
Progress is being made in this space, however, including the development of multi-sig technology. “Multi-sig technology is the equivalent to a safe deposit box that requires two people to access what is inside,” says O’Brien. “This means that one person with one key to the bitcoin wallet can’t access it and steal what is inside – it is an extra layer of security.”
Whether developments such as these will do enough to ease corporate fears over bitcoin security remains to be seen, however.
Regulation in uncharted territory
Elsewhere, regulation around bitcoin is a genuine concern. In early 2014, US Federal Reserve Chairperson Janet Yellen announced that; “It’s important to understand that this (bitcoin) is a payment innovation that’s happening outside the banking industry. The Federal Reserve simply does not have the authority to regulate bitcoin in any way.” With this statement many in the industry breathed a huge sigh of relief that they did not have to worry about the Fed cracking down on the currency. However, bitcoin has gained the attention of other global regulators both at state and local level.
“Regulation is incredibly important, ultimately it will make or break bitcoin,” says Nathalie Reinelt, analyst with US Boston based research firm Aite Group. And while many experts who commentate on the currency also share this view it remains a bone of contention in the cryptocurrency community. Cryptocurrencies, by their very nature, are decentralised and not tied to governments, yet as they become more popular, and are used more by consumers, there will need to be regulation. “It is a catch-22,” says Reinelt, “as much as those in the bitcoin industry are concerned about regulation and don’t want it, they ultimately need it in order to attract more mainstream users.”
But who can, and should, regulate the space? “There are questions surrounding whether it should be regulated on a country-by-country basis, or if there should be the creation of a global framework,” says Standard Chartered’s Jain. Currently the currency falls under the watch of a wide range of regulators at both national and local level. For example, New York State has been cracking down on those in the industry and in the summer of 2014 issued subpoenas to many bitcoin executives, in order to understand their business practices. Following this, the state launched its BitLicence, a licence that will be required by bitcoin companies operating in New York in order to do business and send the currency to residents. To be awarded the licence, companies must be in compliance with anti-money laundering and consumer protection requirements.
At the other end of the spectrum, in China, a country that bitcoin was once very popular in, the regulators have come down hard and restricted its use. Other countries such as Iceland have been even more extreme and classed bitcoin as a foreign currency that cannot be bought or sold in the country.
The Iceland example throws up another interesting question: what is bitcoin? Is it a currency, is it a commodity or something else entirely? And the lack of agreement from regulators seems to suggest that they really don’t know. In the UK, it is classed as private money. In Australia it is seen as property. Inconsistencies such as this place a huge burden on companies accepting bitcoin when it comes to reporting, auditing and tax.
“Ultimately, these issues need to be resolved – otherwise, there will not be mainstream consumer or business adoption,” says Reinelt. “Many bitcoin companies, especially those in the financial institution (FI) space, are in legal limbo regarding being banked and what to do with their earnings. Banks are not banking them because they just cannot stand up to their AML KYC standards.” In essence, bitcoin FI firms are asking to play in the same space as traditional financial services companies but not by the same rules. “This just isn’t going to happen,” notes Reinelt.
Benson thinks regulatory frameworks are what is needed to overcome these hurdles, as a means to standardise its use, as FinCen in the US and BaFin in Germany have started to do. Reinelt doesn’t see this as a realistic proposition, however. “I don’t think it will be possible to get that many regulators to agree,” she says. “I think the best outcome will be if countries watch what the big nations do; the US, UK and China for example, do and then augment those regulatory concepts to meet their own needs.”
A true alternative?
With so many question marks hanging over cryptocurrencies, is bitcoin ever going to be part of day-to-day treasury business? “It’s hard to say,” says Jain, “like with any new technology you really can’t predict what will happen. It may fizzle out, remain a niche, or it may become one of the world’s key technologies moving forward. And this will only happen with wide adoption across the supply chains – and won’t happen without regulation.”
Benson believes that bitcoin’s future rests on the development of the decentralised ledger and its ability to transform the transaction space. “At the beginning of the dotcom era, there was lots of confusion around what it would actually be. Was it going to be a new sector or something else? If we then look at how the internet has radically transformed all facets of life over the last 15-20 years – you can say a lot about that in relation to cryptocurrencies.” Benson doesn’t believe that banks and traditional currencies will disappear but he does expect to see some fairly significant changes. “Bitcoin is the same as the internet – it will just become another way that we do business and construct business models, it will add another dimension to commence.”
Bitgo CEO, Will O’Brien, believes (somewhat unsurprisingly) that bitcoin will be more revolutionary. “I think bitcoin will become more integral to our lives than we can possibly imagine. If you look at the early days of the internet who would have thought we would have companies like Google, Facebook and Twitter and all the effects they have on our world,” he says. “Bitcoin is following the same trajectory. Not everyone will know what it is or have one, but it is superior to our current financial system and it will eventually displace and replace the backbone of finance, capital markets and commerce.”
For Reinelt, it is the platform, built around the concept of a decentralised public ledger (block chain) and not the currency that will be the main talking point moving forward. “We are starting to see companies emerge, like Ripple, who have shifted away from making their cryptocurrency the primary product and focused more on offering the platform as a business to business service that allows FI to move money internationally for lower fees than traditional systems. So just in the way that Napster paved the way for digital content platforms, cryptocurrencies will lay the platform for cheaper, quicker and safer international monetary exchange built around the block chain concept.”
Work has also already begun on looking at how the decentralised ledger can assist corporates outside of the payments space. “At its most basic level, the block chain is used to securely transact. So this doesn’t have to be a monetary value that gets exchanged, it can be exchange of any value,” says Jain. “Theoretically, whenever there is any exchange that needs to be done securely, it can happen on the block chain. eBAM is one area that the block chain may fit comfortably into to; as are agreements and certificate exchanges, such as bonds and share certificates. Transferring letters of credit, and all the instruments associated with this, could also be built around the block chain moving forward.”
While investigations into the full potential of block chain technology are in their infancy, it is certainly an interesting space – and one that may eventually eclipse the debate on cryptocurrencies altogether.