Bitcoin Winklevoss Twins Discussion
Kim-Mai: So, 2013 was the year that Bitcoin kind of crossed over from being the fascination of hackers, anarchists, general skeptics of the global financial system as it stands, into something that’s actually more broadly accepted by the mainstream public, and by the financial community at large. So this year was the first year that we started seeing investments from VC’s and Bitcoin-related startups, and there was this incredible run-up in the price after the Cyprus banking crisis. So today we’re going to talk to a handful of Bitcoin enthusiast investors to get a sense of where the ecosystem is going. So maybe I’m going to start with you guys, Winklevosses. Do you went from, you went to , you accumulated what is probably one of the largest stakes in Bitcoin probably globally, like you have 1% of Bitcoin in circulation. So I’m kind of wondering, how did that happen, and what sparked your interest in it to begin with.
Cameron: We actually kind of found Bitcoin totally unexpectedly. We were on vacation two summers ago in Ibiza and ran into a guy. Of all places, right? Not really expecting to come across new investments. But we ran into a guy from New York, and we started talking about virtual currencies. And we sort of got this feeling right then as if like we had a time machine and could have been teleported back to the early days of the internet. And the promise was just enormous that it captured our excitement right away.
Kim-Mai: And how did you go about accumulating that stake? How long did it take you? When did you do it? I hope you weren’t doing it earlier this year when it was like at $200.
Tyler: Oh, no.
Cameron: Thankfully not.
Tyler: Some of it we bought on exchanges, some from direct from people. It was kind of a scrappy process because there wasn’t a lot of liquidity, or rather volume at the time. It was a small market cap. So just through, we just accumulated through certain different ways.
Kim-Mai: And how, if you could estimate your return on your Bitcoin holdings so far, what would it be? Have you lost money on it?
Cameron: Definitely made money.
Kim-Mai: Definitely made money. Can you say kind of how much?
Cameron: It’s been a very good investment for us. I don’t want to get too much in specifics, but we haven’t sold anything.
Kim-Mai: You haven’t sold any.
Cameron: We’re still very bullish.
Kim-Mai: And then some of it you made like a 10X return on, right?
Cameron: That’s probably fair to say, yeah.
Kim-Mai: I guess the question I have for the broader panel is, Bitcoin has these kind of mysterious origins. It’s founded, created by some guy, guys, woman, collective. The name Sitoshi Nakamoto, who disappeared and hasn’t appeared since. And so, when you’re looking at the space, how do you get over the fact that no one knows really who created it.
Naval: Yeah, I don’t really think about Tim Berners Lee every time I surf the world wide web. I guess it doesn’t matter to me. Lots of people have examined the Bitcoin protocol, spec, the encryption schemes underlying it, and have come away with the realization that it’s one of the most brilliant innovations in the protocol and financial space that they’ve every seen. So the underlying thing is sound. It’s probably the case that Sitoshi or the group that purported to be Sitoshi probably holds somewhere around 10% of underlying Bitcoin, making these guys look small time. But that’s okay. It’s an incredible invention for mankind, if it works.
Kim-Mai: What made you finally comfortable with it?
Naval: What made me comfortable with it? It took me a while to warm up to it. I just read through all the different pieces. Underlying Bitcoin, there’s at least four different technologies that are combing to make it possible. And you know, as Paul Graham says, you’ve got to live in the future. If you don’t understand what’s on the cutting edge and you’re in the tech business, then you’re sort of missing out. So I sort of forced myself to learn about it. And underneath you’ve got digital signatures used in a very clever way. You’ve got a peer-to-peer network. You have a distributed block chain, which is this concept that every transaction, the history and record of every transaction is in everyone’s wallet. And then you’ve got this proof of work system to prevent double spending, the application of which is very brilliant. So you’ve four different great concepts coming together. And I wanted to understand it just because I like technology. I like things that engage, that enhance personal freedom. This seemed to be one of the cases that was doing both. And so it took me a few months to dig through everything, get comfortable with. Are there loopholes? What are the failure modes? What are the incentives and the motivations underneath? And I came away thinking that it was the most fundamental thing to come along since the underlying internet protocols like TCPIP and HTP. And I think people think about Bitcoin incorrectly. They think about it as currency, or about gold, or about hoarding, or speculation, or how much money do you make, when really what it is, it is an API for programmable cash and financial transactions. For the first time, the hackers in the audience have access to a protocol that allows them to program wills and escrow and notaries and payouts and dividends. There are fun things you can do in crowd funding with Bitcoin that you just cannot do with normal cash. So this idea of programmable universal cash is what is really, really fascinating.
Balaji: I’d elaborate on that a little bit. So one of the things about it. If you go to gethub.com\bitcoin\bitcoin, you can clone it and you can actually inspect the source. You can look at it yourself. Sitoshi wrote a paper on it. And in general, the validity of a mathematical theorem is not really a function of who did it. It can be independently checked. Moreover, Sitoshi actually has pretty good reason for remaining anonymous, or else he’d be hunted like Edward Snowden or something, right? This is something where every regulator in the world is kind of, or at least in the U.S., is after Bitcoin now. The other thing is that in terms of the fundamental computer science breakthrough here, it’s a solution to the Byzantine general’s problem, and it’s actually a breakthrough which can be used to turn a variety of things that we previously thought could only be done via centralized systems into things that can now be done in a distributed fashion. So there are these alt chains. I’m not saying any of them are the final answer or anything. But like Namecoin, that would be like a distributed domain system, like a domain name system. There are other things you can do, like a distributed public key infrastructure, and so on. So technologically, it’s really a step forward.
Kim-Mai: Do you believe that Bitcoin is the end game in an of itself? Or is it a predecessor to maybe a future math-based currency that doesn’t have so many limitations like the 50% attack.
Naval: First of all, the 50% attack limitations are far less than people make it out to be. There’s a lot, even if you take over…
Kim-Mai: To be fair, I mean, just to explain it, the 50% attack means that if you control more than 50% of the notes in the Bitcoin network then you can destroy a currency.
Naval: There’s still not a lot you can do. You can’t destroy the currency.
Kim-Mai: You can’t destroy the currency. Okay.
Naval: You can reject future transactions, but you can’t go back and change past transactions. And your incentives at that point are actually more to just mine more Bitcoin and make money for yourself rather than to destroy it.
Naval: So there’s a lot of…It’s a very complicated topic. You cannot get educated in Bitcoin listening to this panel. It’s like, if you’re starting here, try something else. Go read Bitcoin for Dummies. But take the time. Like if you were in 1995, you didn’t understand how TCPIP worked or how the world web was going to work, you were really missing out. Take the time.
Balaji: Yeah, the other thing is that, with respect to the 51% attack, that would lead to a fork in the block chain, and effectively like multiple currencies kind of co-existing, which should potentially have some exchange rate. You could imagine China, at some point in 2016, and Bitcoin has risen exponentially and they decide that they are going to turn a significant fraction of their semiconductor manufacturing over to controlling a lot of mining capability. That’s a possibility. But in terms of the son of Bitcoin, like Bitcoin 2.0 that could replace it, I actually think that it’s going to be augmentations to Bitcoin.
Balaji: If you think about it, HTP is actually a stateless protocol, but we’ve built all this state-full stuff on top of it like cookies, and then eventually like web apps, and whatnot. So you don’t actually think about that. You can actually go and log in and people have built all this state-full stuff on top of it. In the same way with Bitcoin, there’s a few different things that people are working on now. One of them would be one of the most technological, important developments since Bitcoin itself, which is something called Zerocoin. Zerocoin basically turns Bitcoin into a truly anonymous currency where there’s, it basically turns the entire network into a mixer. So you can teleport arbitrary amounts of money anywhere in the world. And right now, that’s not a practical patch, but eventually something like that will probably be incorporated into the block chain, and that will be sort of to what we call Bitcoin 1.0 what Bittorrent was to Napster.
Kim-Mai: Yeah. One thing that I hear a lot from investors is that Bitcoin is going to be, it’s a binary outcome. It’s either going to be worth a lot, or it’s going to be worth nothing.
Naval: Yeah, that’s right, because money is the ultimate network effect. So either it works and goes to infinity, or goes to zero. I don’t think the intermediate outcomes matter. So in that sense, asking someone today, “Have you made money in your Bitcoin?” They’ve only made money if they’ve sold it, if they’ve cashed out. If they’re still holding on to it, it’s like buying a hyper-volatile option on a startup stock. Not for the faint of heart.
Kim-Mai: So what are the risk factors for you, that you’re thinking about personally?
Naval: I think the biggest one is regulatory and government risk. I think there is some small decryption/encryption risk. If it turns out there’s a back door in RipenD or in one of the protocols used underneath. But I think the main one is essentially just the adoption curve. How long will it take to adopt? Because network effects need a tipping point. The established, entrenched dogma of how money is supposed to work is very, very strong. That tipping point could be two years out. It could be 20 years out. It could be 200 years out. That’s the hard part.
Kim-Mai: Speak of regulation, that’s something I wanted to ask both of you about. You were recently subpoenaed, and New York regulators are kind of looking at how to understand Bitcoin, how to manage it. So what’s going on with that?
Cameron: Basically it looks from our standpoint to be a fact-finding discussion. And I think, we’ve always been sort of welcoming of healthy regulation. I think that it helps erase a lot of the uncertainty out there. Especially banking relationships with startups, a lot of the banks, I think, are unclear, should we sort of bank these Bitcoin startups, and what do we need to do to be compliant. Our view has always been when you’re dealing with, whether it’s Bitcoin or money, that sort of the regulation KYC, know your customers, AML, anti-money laundering, should be really treated identical across the board, whether it’s Bitcoin or U.S. Dollars or something else. So we’re sort of all in favor of healthy regulation. I think that those discussions are happening now. And as they progress, we’ll get sort of more certainty of where things are going. And a lot of people potentially who are on the sidelines with respect to investment, or whether they want to start a company, will enter into the Bitcoin world.
Kim-Mai: And you’re also trying to start an ETF, a Bitcoin ETF, right? And that’s also under review as well, right?
Cameron: That’s correct, yeah.
Kim-Mai: And there are some, there are other investors out there who are looking at it and saying, “Man, like this could take years to figure out, years for New York regulators to approve in Bitcoin ETF.”
Tyler: Only the FCC knows that answer to the question.
Kim-Mai: So I wanted to talk about the startup ecosystem. So when we saw that run up to that peak high price earlier this year, we started seeing a lot of funding rounds. The biggest one that I can think of right now is probably Coinbase, $5 million. Where are all these startups now, and for you as investors, what’s an attractive place to go? Is it in wallets? Is it in exchanges.
Naval: Yes. I personally haven’t done any Bitcoin startup investments outside of just leverage plays on Bitcoin itself. The reason is, if you look at the total value of all the Bitcoin ecosystem right now, it’s about $1.5 billion.
Naval: So if you have a company that shows up and states a post money of $30 million, you’re basically betting that that company is going to capture 2% of all the value in the Bitcoin ecosystem over time. Otherwise, you’re better off investing in Bitcoin itself. So you always have to look at the opportunity cost of investing in Bitcoin itself. And investing in Bitcoin itself is not some anti-ecosystem thing. Rather, what you’re doing is, you’re allocating your money across the entire ecosystem, and you’re creating incentive for all the startups, including the ones that might be in Russia or France, or just in someone’s backyard. Because they’re all motivated by the price of Bitcoin. It’s just like when the price of oil goes up, you buy oil. What happens? The oil companies go drill more. They go extract shale, and so on. So you just create incentive for the whole ecosystem. So in most cases I think it’s just better, you start off by buying the Bitcoin if you’re interested. It’s an extremely high-risk investment, so you would put a very, very small percentage into it. And then after that, if you find a great startup to invest in, you can sort of play with a little bit of money on the edge. You know, one cynical point of view is that the venture capital community right now is probably buying Bitcoin with their own accounts, and then investing their LP’s money into the Bitcoin ecosystem. But that’s also because as a VC you can’t call up your investors and say, “Oh, by the way, I just wrote a check for your money into buying Bitcoin.” You’re not supposed to go buy currency, and it’s kind of viewed as that right now. Although if the Lp’s have the underlying Gp’s buying Bitcoin stocks, they should also be holding some Bitcoin to bet on the broader ecosystem. Personally, I think the most interesting plays are the exchanges, because they actually have a built-in network effect, whereas everything else in Bitcoin resists network effects. And some concept of a simple local mobile wallet that is useable by the average human, because Bitcoin is still too difficult to obtain, transact, and secure for the average person.
Kim-Mai: At what threshold does the market cap in Bitcoin become interesting enough to invest in a startup because, in the startups around it.
Naval: It’s starting to get there. When it kind of hits the $3-5 billion range, at that point you’re probably going to be balancing your portfolio as much into Bitcoin startups as you are into Bitcoin itself. But remember that Bitcoin is designed from the ground up to resist centralization. And one of the dirty secrets of Silicon Valley is that our big money makers are all monopolies in their ecosystems. And Bitcoin is designed to resist monopolization. So it’s hard to imagine how any single Bitcoin-related startup captures a huge chunk of the ecosystem.
Balaji: You can elaborate on that by thinking of at least three categories of Bitcoin investments, mining, direct purchase of Bitcoin, and then investing in the Bitcoin ecosystem. And one can conceptualize mining as the attempt to purchase Bitcoin below market price with some probability, with high risk in general. Then you can just buy Bitcoin at market price itself. And finally you can invest in the ecosystem, and that can be conceptualized as, among other things, investing in increasing the price. And you can actually calculate this as a portfolio strategy where you do your Legrange multipliers, or whatever, and you get your coefficients. And if you have large enough holdings, then it’s worth investing some fraction in boosting the price. And actually it boils down to your CAC, your cost of customer acquistion, how efficiently the companies you’re investing in can get more users into Bitcoin, and thereby drive up the price, assuming that each user holds a Bitcoin balance and becomes a Bitcoin user. In terms of the appreciation of Bitcoin, currently it’s around a a hundred-something bucks. Where could it eventually go? So unlike many startups, you actually can potentially calculate this. I mean, you can do market cap estimations. If Bitcoin gets to $1,000, like all Bitcoin all time is $21 million, so let’s just take that number. So it would be $21 billion if we mined everything. If it got to $10,000 it would be $210 billion, still less than the market cap of existing publicly traded companies. If you go up to $100,000, now you’re talking about something that’s on the level of gold, like $2.1 trillion worldwide. You go up one more order of magnitude to $1 million per BTC, and you’re talking U.S. GDP, and then $3 million per BTC, you’re talking world GDP. So that’s what winning looks like. But as surreal as that sounds, that’s a 30,000X growth over where it is today. Now when Peter Teal invested in Facebook.
Kim-Mai: What scenarios are you imagining that would produce an outcome like that?
Balaji: Here’s the thing. So Facebook, in 2004, Peter Teal invested in that and got 10% at $5 million valuation. And when it IPO’d, that was about a 10-15,000X return. So there is a comparable historical precedent in the sense of, if you invest early in a startup you actually can get that level of return.
Naval: That said, no one should invest with that expectation.
Balaji: No one should invest with that expectation, but I’m just saying.
Kim-Mai: Well, I’m just wondering, what does the global economic picture look like in a world that drives Bitcoin to that level.
Naval: Well, if you think about it, Bitcoin has a lot of advantages, for example, over gold, except that gold’s been around a lot longer.
Naval: So all the things that gold does, Bitcoin kind of does better. But everybody believes in gold. People have been using gold for thousands of years. Gold is just a speculative store of value. It actually has very little intrinsic value. It’s intrinsic value is probably around $200 per ounce. And then the rest is all speculation. And so if Bitcoin replaces, or comes alongside gold as a speculative store of value, it’s going to be worth thousands of times what it is worth today. So that’s actually a very simple one to throw out there.
Balaji: That’s right. And you ask what scenarios would result in that. The reason the Cyprus thing drove up the price of Bitcoin, just yesterday for example, Poland announced seizure of half the pensions in the country just by fiat, right? And what you can do is, with the mortgage crisis, there was a failure to incorporate the possibility of TL risk scenarios, unlikely events with extremely negative outcomes. So let’s say that a TL risk scenario, whatever country you live in, is a bail in, where some fraction of your savings is expropriated, just like in Cyprus. In fact, there’s a document, you can see the Federal Reserve and the Bank of England have actually published a document on GSFIs, globally significant financial institutions, which they talk about the bail in procedure, and what fractions they’ll do for various countries. So let’s say that a bail in may happen at some point. Then what you can do is you can say, all right, if you just have cash in the bank, that is vulnerable to a command line sort of thing like they did in Cyprus where they just expropriate bank accounts. If you cash under the mattresses, they can’t just get it with a command line, but they can, obviously, print currency and so on. If you have gold, you can’t easily carry a gold brick through the TSA’s screening processes, and you can’t go to Starbucks and chip off a gold flake and use that as a negotiable instrument. But if you have Bitcoin, that actually defeats all capital controls.
Naval: You can actually cross a national border with $1 billion in Bitcoin entirely in your head.
Kim-Mai: Speaking of which, how do you store your whole…You have a very complicated system for storing.
Cameron: Yeah, well so I just want to add quickly to what Balaji was saying. In July, the only country in the world where actually Bitcoin client downloads increased and they doubled was in Argentina. And the inflation rate right now is about 25%. At least, that’s what the government, what’s being reported. And so basically people are trying to convert their pesos into because. If you look at the quote on localbitcoins.com, there’s a huge delta between the price of buying Bitcoins locally in Argentina, than on the exchanges. So it’s an interesting sort of development in sort of the capital controls, just like Balaji was saying. The metal detectors trying to pick up the gold bars, or the peso sniffing dogs don’t really work for Bitcoin. And it’s a fascinating development in that part of the world. But with respect to storing, we actually basically put in on our wallets in cold storage on USB sticks in banks across the country, and we probably…
Kim-Mai: How many banks are you storing all of your Bitcoin things in?
Cameron: I don’t know.
Tyler: More than two.
Kim-Mai: More than two? More than 10?
Naval: I’m assuming there’s some secret twin code where they both have material. Advantageous to be a twin.
Tyler: It’s actually safer than gold, because then you need a password for the USB. So you’ve got to break into a bank, and then break a password. So it’s actually better than just plain old bank vault.
Naval: That said, it’s not for the faint of heart. If you use a bad pass phrase, or a bad seed, your Bitcoin will get stolen. The returns to hacking are going on.
Kim-Mai: Have you ever had your Bitcoin stolen?
Naval: No, but I ran a fun experiment with some friends, which is, you can create Bitcoin wallets entirely as brain wallets, you just generate them out of simple pass phrases. And then you generate your keys from that, and you put money in there. So we basically said, “Hey, is it worth going into the block chain and then mining the entire things for simple pass phrase wallets and trying to see if you can just find money lying around?” And then before you go to effort, you just say, “Hey, let’s see if somebody else is doing it.” So we just created a wallet out of Hello World, and we dropped it into the block chain. It was empty an hour later.
Naval: So there’s somebody out there already mining the block chain for simple seeds.
Balaji: With that said, one of the biggest things about Bitcoin is Bitcoin, you can conceptualize it as Bitcoin is to money what e-mail is to physical mail. Right? Just like with e-mail, if anyone has your public e-mail address, they can send you money and only you with your private e-mail password can send it out. And the same with Bitcoin. Anyone who has your public Bitcoin address can send you money, and only you who have your private Bitcoin key can send it out. So you can actually bring all the BTC onto your local computer, and then transfer it, and then print out a private key. As long as you’ve synced that change to the block chain that thing can be on like a fortune cookie size piece of paper or hidden in a bunch of different ways. So in many ways, it’s much more secure than any other bank account, because banks don’t even know you have the money.
Naval: So I think the analogy to e-mail is really important, because when e-mail was first showing up, there were a lot of analogies to postal mail. And we sort of thought that it would replace postal mail and kind of stop there. But obviously we use e-mail in unimaginable ways today. So in the same way, it’s important not to just think about Bitcoin as replacement for cash or gold or something that works alongside that. It’s to think of it as programmable money. And we just cannot even imagine what it will be used for. If there was an AI, an artificial intelligence that existed today, it would not work in dollars. It would work in Bitcoin. You can have self-contained pieces of code that live in the cloud, that never activate on the internet for years, that can hold Bitcoin in there, and they can transact in money when they wake up and go back to sleep. You know, you can do a crowd funding campaign where we could all do a kickstarter, and then the shareholders of the kickstarter, in other words, the people who have contributed, get to vote to release money as different milestones are hit. You can do that in Bitcoin, and it’s all programmable in the protocol. It has a built-in scripting language that let’s you do all kinds of things, that today we devote 20% of the economy for. What Wall Street does can be done in code by Bitcoin. I hate to tell Wall Street, but you know, let’s not clue them in too fast.
Naval: We can program wills, escrows, trusts, notaries, revocable charge backs, proofs of contracts, intellectual property enforcement. Sitoshi Dice, this is an interesting company, and no one really pays attention to this. But this guy, he took a company public, which was a Bitcoin sort of gambling site. He took it public. He sold shares anonymously entirely in Bitcoin to anonymous shareholders. No regulators. No registration. No costs. No bankers. He paid dividends. And then when the company got sold, he actually paid them their return and then some. These people made money on a Bitcoin investment that was run completely off the normal financial grid, with no oversight.
Kim-Mai: But you’re still investing it.
Naval: I’m buying Bitcoin. That’s how I invest. It’s a small amount. To me it’s much more about the personal freedoms and the programmable cash part than it is about currency or making money.
Balaji: I would just add to what Naval was saying about programmable money. Here’s like a couple of applications that you could invision. So, fast forward five years or something, and there’s the uber Google-Tesla merger of dispatching and automatic cars and you know it’s built in to Tesla cars. And you’ve got them running on the freeway. And one car, you want to accelerate, and you pay in because automatically to the cars in front of you a passing price. Right? So you can just boom like this and just go through the fast lane and just move up there.
Naval: It’s got to be anonymous, and it’s got to be cash. Because if you’re doing credit, you could charge back as soon as you passed them.
Kim-Mai: So you’re very confident in the security of the Bitcoin protocol itself. But if you look at the history of the startups that surrounded it, there’s just been a litany of security issues, with the exchanges, liquidity problems.
Balaji: But it’s the difference between a bank robbery versus being able to counterfeit currency. Right? So the former is a function of the bank that is the particular startup, and the latter actually being able to do significant double spending has not happened.
Naval: It’s far easier and cheaper to counterfeit $100 bills than it is to counterfeit Bitcoin.
Cameron: When Tyler and I were sort of trying to wrap our heads around it, one of the things. I’ve heard a lot from like Naval, saying this is highly speculative. And it is. As investors, you can’t just pick up the phone and talk to the founder, right? Because we don’t know who he is. Then what we did was basically go to all the people in Bitcoin or people who are highly fascinated with it, like these guys. It’s hard to wrap your mind around all aspects of it. But as investors we felt like it was just the promise and potential was just way too large that we couldn’t afford to not be a part of it. So it is highly speculative. But at the same time, when you think of it as programmable money, or cash, or e-mail of cash, we’re literally at the early days of this financial internet, which is unbelievable.
Kim-Mai: So as you’re setting up this ETF, what are you, what’s your advice to just regular retail investors? How do they play in Bitcoin.
Cameron: I think that’s sort of, that was one of our ideas, is sort of bringing retail investors to Bitcoin, and allowing them to have at least the investment exposure. Because what we noticed, and Tyler feel free to elaborate, but there’s so many sort of hoops of fire and pain points in sort of accumulating Bitcoin and buying it, that we wanted to make it more accessible to the average user.
Tyler: And certain investors can’t just buy Bitcoin, mutual funds, pension funds, 401Ks. So just like VCs are having trouble buying Bitcoin. They have to invest in companies. With the ETF, we open up Bitcoin to a whole new world of investors.