The 31-year-old CEO of Coinbase, Brian Armstrong, on his plan to becomethe world payment processor for the virtual currency. Could this be the end of credit cards?
As I drive into San Francisco to meet tech entrepreneur Brian Armstrong, reminders of the California Gold Rush pop up everywhere, from Levi Strauss to the San Francisco 49ers. Various modern gold rushes have periodically swept the area for the past few decades, and the 31-year-old Mr. Armstrong is at the forefront of the latest frenzied scramble: virtual currency.
Bitcoin is the dominant player in the field, and Mr. Armstrong, as the CEO of Coinbase, thinks he has found a rich vein to mine. He wants to be the Visa and MasterCard of Bitcoin payment processing, taking those behemoths out of the picture as merchants and customers move to virtual transactions.
Credit-card companies "collect $500 billion in fees" today, he says confidently as we meet in the company conference room overlooking San Francisco Bay. As commerce eventually turns increasingly virtual and credit-card fees drop to match cheaper technology, he says, "it's going to be $50 billion."
But wait . . . Bitcoin? A lot of people still aren't sure what a virtual currency is, much less what a "Bitcoin wallet" like Coinbase might be. Mr. Armstrong offers a working Bitcoin definition for starters: "It's a distributed digital currency. There's no central authority. It's based on a consensus of people working on this around the world. It's both a currency and a payment method and a protocol, a commonly agreed-upon language so that computers can talk to each other and exchange currency or payments, at least at first."
The number of Bitcoins is capped at 21 million (about 12 million have been generated so far by an algorithmic method using Bitcoin's agreed-upon protocol), making them immune to the sort of government money-pumping or -restricting policies that can send real-world currencies up or down. Bitcoins are simply worth whatever those who trade in them agree they're worth.
The peer-to-peer payment system has suffered some public-relations disasters: In 2013, the FBI shut down the platform Silk Road, which may have earned $80 million in commissions from allegedly facilitating more than $1 billion in drug trafficking. The biggest Bitcoin exchange—Mt. Gox in Japan—collapsed in February. In the process Mt. Gox lost $450 million in Bitcoins, though they seem to have been later rediscovered—it's still not clear, which reflects the moving-target reputation of Bitcoin that still makes many investors wary.
Still, the buzz continues: Earlier this week, investors including billionaire Richard Branson and Yahoo co-founder Jerry Yang put $30 million into BitPay, a payment-processing rival of Coinbase. Mr. Branson's Virgin Atlantic airline accepts Bitcoin and uses BitPay for processing. World-wide, about 20,000 merchants accept Bitcoin, stored by customers in virtual wallets like Coinbase's. In December, Mr. Armstrong's company raised $25 million thanks to the heavyweight venture-capital firm Andreessen Horowitz. There's gold in them hills.
"There are still people who we meet who say there is no way the government is going to let this happen," Mr. Armstrong says, "but they don't have the information we have." So far, he seems to have embraced the prospect of regulation in a nascent industry with an all too Wild West reputation.
When he founded Coinbase two years ago with Fred Ehrsam, Mr. Armstrong says, "our risks were fraud and compliance." But in March last year, the Treasury Department's Financial Crimes Enforcement Network, known as FinCEN, offered some clarification, providing guidance on virtual currency.
"A week later we registered with FinCEN as a money-services business. A good first step," Mr. Armstrong says. "Compliance is a large cost of our business. Our method is not battling, but embracing and educating regulators, building relationships with them." He notes that "New York state is thinking about how they can create a specific 'bit license,' " sort of a money-transmitting license for virtual-currency companies. "Even the IRS released guidance on how they will collect taxes on Bitcoin gains. The regulatory environment is much clearer today than it was a year ago and it's all been very positive."
It's rare to hear a CEO so chipper about the U.S. regulatory environment, but then participating in the Bitcoin world requires a certain faith in the benevolence of strangers. That was certainly the case at the company where Mr. Armstrong worked before starting Coinbase: Airbnb, the do-it-yourself lodging-booking business that is roiling the hotel industry. Mr. Armstrong, who graduated from Rice University in 2005 with degrees in economics and computer science, had spent a few years working for the Deloitte professional-services firm and for a few startups in Silicon Valley before going to Airbnb in 2011, when the company had just 35 employees.
Working on fraud prevention and proprietary payments for 190 countries as the company grew with dizzying speed, he says, "I had a front-row seat to the pain point." When Mr. Armstrong left after 18 months to start Coinbase, Airbnb had 600 employees. Growth has been slower for Coinbase, but the trend line is clearly up. Coinbase says it now administers 1.2 million Bitcoin wallets.
Here's how the company got there in two years. Mr. Armstrong, who speaks with the intensity of a seasoned entrepreneur but none of the bravado of many Silicon Valley players, relates how in December 2010, while home in San Jose for the holidays, he printed out a copy of the Satoshi white paper, the original Bitcoin manifesto published in 2008 under a still-mysterious pseudonym. He became engrossed. His mother, he says, told him "all our relatives are here, you need to come spend time with the family." But he stayed upstairs reading. "I couldn't put it down, it was the most important thing I've read," he recalls. "I saw right away this could be a big open payment network for the world. Very much like the Internet was for distributing data."
Six months later, he slapped together an app for Android phones, a "wallet" to store Bitcoins. More than 15,000 people installed it in the first week, and others translated it into German, Russian and Chinese. It was the moment he realized he was onto something. But the app was flawed. It stored money on a phone, which is breakable, and, worse, the app hogged so much data that transactions were painfully slow. So he moved the business to servers in the online cloud and, voilà, the virtual transactions were easier than a credit-card swipe.
Processing Bitcoin transactions requires two key players: miners and payment processors. Miners solve complex algorithms and are rewarded with Bitcoins when they do. They accomplish this by installing vast arrays of personal computers that run day and night. (Some are located in Iceland to defray electricity bills.) Mining adds transactions to a public ledger, where the buying and spending of Bitcoins is recorded. The ledger is called the "blockchain"—a giant public accounting of every Bitcoin transaction ever. The systems being used to mine Bitcoins must agree on the accuracy of the ledger to prevent cheating, at least in theory. "The more mining there is, the more security there is," Mr. Armstrong says.
Few people were interested in installing expensive machines to mine Bitcoins—until the currency began trading above $100 last year. Now thousands of miners assume that they are digging for virtual gold. In reality, they are building a global payment processing network for Bitcoin.
Payment processors like Coinbase borrow the miners' Bitcoins for a short time to conduct a transaction. The processors enter the transaction into the network, which crunches on it until it is deemed legitimate, and records it in the blockchain.
The financial industry, at first leery of Bitcoin, has slowly relented. "We became the first Bitcoin company to get a deal done with a U.S. bank"—Mr. Armstrong says, declining to name the bank—"which allows us to have anyone connect a bank account in the U.S. and convert dollars in and out of Bitcoin." When Coinbase made the deal in December 2012, the company had 100,000 wallets, a number that increased tenfold in a year.
Bitcoin wallets are mostly about speculation, the hope that the currency will rise in value. That seemed promising for a while. Last year, the value of a Bitcoin soared to $1,100 in December, from $13.30 in January. It's now $448, though transactions are still growing. And now with some 1.2 million Coinbase wallets, customers have Bitcoins to spend. It isn't Visa, but it's a start.
Mr. Armstrong says much of Coinbase's efforts now go into signing up merchants to accept Bitcoins. The roster of sign-ups includes the online retailer Overstock, the Sacramento Kings basketball team, the dating site OkCupid and hundreds of other businesses. Why would they bother? Because Bitcoin payment processors offer a value play: Visa and MasterCard charge merchants about 3% on every transaction, but Coinbase charges 1%—sometimes not even that. "Overstock pays a number less than 1%," Mr. Armstrong confides.
What about the currency's notoriety as a criminal favorite because of its assumed anonymity? "There will always be bad actors," Mr. Armstrong says, noting that Bitcoin lends itself to transparency: "Because, of course, it is a public ledger. In the blockchain, if you see a path here and here," he says, spreading his arms apart, "you can find a path and a connection." And Coinbase is willing to work with law-enforcement to help out.
Mr. Armstrong also doesn't seem worried about Bitcoin's price volatility. "Like the beginning of the Web, there are periods of high expectations and hype that aren't met. . . . There is clearly a gold rush going on right now, and we'll have these cycles of hype and declines."
Yet even with professional backing, how can a roller coaster like Bitcoin disrupt a reliable, predictable payments system offered by credit cards? "Payments flow to the path of least resistance," Mr. Armstrong says. "If there exists a more efficient network, payments will begin to flow to that network."
He sees other opportunities, beyond challenging the credit-card companies by offering lower fees: "A lot of countries don't have a stable currency and people don't have access to banking at all. And everyone has cellphones"—which can be used for access to Bitcoin wallets. "If the world did have access to a stable currency, Bitcoin could help bank the world, bank the unbanked."
It's a nice dream, but Bitcoin fans would do well to keep their focus closer to home for now. Regulatory capture is the way financial services operate. Congress now even sets debit-card fees. Coinbase should be wary of just "embracing and educating" regulators. The companies that collect $500 billion in fees annually can afford a lot of lobbyists, nothing virtual about them.