The surging popularity of bitcoin has some brand-name venture capitalists investing real money in the controversial virtual currency.
Just since April, notable firms such as Andreessen Horowitz, Founders Fund, Google Ventures, Lightspeed Venture Partners and Union Square Ventures have invested $9 million in three bitcoin-related companies: BitPay, CoinBase and OpenCoin.
And this week saw the launch of two dedicated bitcoin venture funds. Liberty City Ventures of New York said it set up a $15 million fund to back bitcoin and other digital currency companies. Likewise, Adam Draper, the 26-year-old son of Draper Fisher Jurvetson co-founder Tim Draper, said his Boost VC accelerator had created the Boost Bitcoin Fund in partnership with Lightspeed, Rothenberg Ventures, The Bitcoin Opportunity Fund and Ben Davenport, an entrepreneur and self-described “bitcoin evangelist.”Bitcoin, for the uninitiated, is a decentralized digital currency that is created using cryptographic techniques. Like any other currency, it can be used to purchase items or services online. Bitcoin is particularly popular among people who want to mask their identities, like users of the black market site Silk Road, which sells illegal drugs.
As big as the bitcoin opportunity is, it is equally rife with risk. The very thing that makes bitcoin compelling – that it is not controlled by a central authority, such as a government – also makes it vulnerable to speculators. The value of a single bitcoin went from 5 cents on July 17, 2010, to a high of $230 on April 9 of this year, according to Mt. Gox, which operates the world’s largest bitcoin exchange. The price fell to just under $118 on May 13.
Other risks confronting those who back bitcoin companies:
- Fragility of bitcoin exchanges. Of 40 such exchanges created over the past three years, 18 have failed, “with customer account balances often wiped out,” according to a research paper published in April by two computer scientists at Southern Methodist University.
- Hackers. They understand that if they can disrupt service at an exchange, they can cause prices to drop, making money by shorting bitcoins. The SMU research paper found that nine of the 18 exchanges that failed had suffered security breaches. And in April, Mt. Gox was hit by a distributed denial of service (DDOS) attack that made the exchange unavailable for four hours.
- Government regulation. As bitcoin grows more popular, so does the likelihood that it will be regulated by the U.S. or other governments. In fact, the Department of Homeland Security on Tuesday seized the Mt. Gox account of mobile payment network Dwolla. DHS said it believes Mt. Gox is running an “unlicensed money transmitting business,” a crime punishable by up to five years in prison, according to a warrant obtained by Ars Technica.
Because of all the risks associated with bitcoin, most VCs aren’t eager to jump into the space. “The opportunity for disappointment and misunderstanding is very high,” says Kate Mitchell, a co-founder of Scale Venture Partners who led the launch of Bank of America’s online banking program in the early 1990s.
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