Bitcoin: Will Europe's VCs embrace the phenomenon?

Bitcoin, a decentralised digital currency or "cryptocurrency" was created as an alternative to fiat currency and is shrouded in mystery from its very roots. Its founder is the pseudonymous and seemingly untraceable Satoshi Nakamoto, who appears to have abandoned the project from 2010 onwards. The currency has a capped number of coins that can be generated – once 21 million bitcoins have been distributed, the ability to generate new coins will cease. The currency became a billion dollar market in March last year, when only half of its limit was in circulation.

Its value is largely determined by supply and demand. The value per coin fluctuated wildly throughout 2013, lending credence to the sceptics who view the current frenzy as a very fragile bubble. In December, the currency reached its peak of almost $1,200 per coin, having started the year with a value of just $13 apiece.

"I see bitcoin as a very powerful thing," says Michael Jackson, partner at Mangrove Capital Partners, "or at least, I see virtual currencies as being very powerful. But with a currency, you need stability. You need to know that the pound in your pocket is still going to be worth the same tomorrow, more or less – and that's not the situation with bitcoin at the moment."

Bitcoin is largely unregulated as authorities do not regard it as legal tender, though this is quickly changing as countries are forced to take notice of the increasingly prominent cryptocurrency. In August 2013, the German Ministry of Finance announced that bitcoin is now officially recognised as a financial instrument in the country.

China's central bank, on the other hand, has forbidden the country's financial institutions from handling bitcoin transactions, which caused a sharp downturn in the currency's value in December. China's attempt to impose rules on the currency means that US venture firms could already be feeling the sting of investing in such a risky and volatile space – Lightspeed Venture Partners backed Chinese bitcoin exchange BTC China in November last year, just weeks before the People's Bank of China imposed the ban.

Silk Road scandal
As well as this uneasy relationship with regulatory authorities, the currency's link to the "dark side" of the web has caused many to regard bitcoin with distrust. In October, the FBI seized approximately 1.5% of all bitcoins in circulation at the time (144,000 bitcoins, then worth $28.5m) following the shutdown of online black market Silk Road, which used bitcoins for transactions due to the currency's anonymity factor.

While the role it played in the Silk Road scandal catapulted the previously underground currency to fame in 2013, bitcoin's adoption as a means of anonymously buying illegal goods may also have made many sceptical of its validity as a genuine and controllable alternative currency.

"It's going to be very difficult to get broad acceptance for a monetary instrument that doesn't permit law enforcement activities to work easily," says Jackson, also referring to the lack of regulations such as anti-money laundering policies for bitcoin, as well as the inability to retrieve coins if a bitcoin wallet is hacked.

So far, investments in European bitcoin companies have been sparse. In October, Passion Capital backed Coinfloor, a London-based bitcoin exchange. "We've been looking into the bitcoin space since early 2013," says Passion Capital partner Stefan Glänzer. "We always had a sweet spot for marketplace models and screened all the UK bitcoin exchanges that were in the making.

"I've been in more and more talks with other European VCs about bitcoin," Glänzer continues. "So I'm bullish that we will see more focus and investments in the space."

Joel Eriksson Enquist of Swedish venture capital firm Creandum has just announced the creation of a global bitcoin start-up database, designed to give investors a quick overview of start-ups. According to Eriksson Enquist, just 0.7% of the 33 venture-funded bitcoin start-ups operating today are from Europe, while 85% are from the US.

Buck-ing the trend
Evidently, US investors are already much more convinced of bitcoin's staying power. San Francisco-based bitcoin e-wallet provider Coinbase recently raised what is said to be the largest investment in a bitcoin company to date, securing $25m from Andreessen Horowitz and previous backers Union Square Ventures and Ribbit Capital in its series-B round.

But Ribbit Capital partner Nick Shalek is not convinced that Europe is a long way behind the US: "If this is true, it won't be for long. There is an explosion of exciting bitcoin activity in Europe right now. Take Berlin, for example, where bitcoin meet-ups are routinely attracting hundreds of people. We see a lot of talented entrepreneurs working on bitcoin in Europe and will be looking to fund them."

US venture capital firms are not just investing in the space, but are going one step further by creating dedicated funds for the cryptocurrency. New York-based Liberty City Ventures launched a $15m digital currency fund in May last year, with a particular focus on bitcoin.

"US investment in the space seems to be centred around bitcoin exchanges," observes Jackson. "And there are a couple that are already established in Europe, but they don't actually need a lot of money to get going. The good thing about a bitcoin exchange is that it doesn't tend to require funding – it lives off the fees that it generates.

"The other area in this market is the teams who want to work around the bitcoin space. And, to be honest, we haven't seen any teams in Europe really working on this. We've got a good market here and we've got good potential, for sure, but we just haven't seen the projects yet."

Europe's fertile framework
In fact, Jackson believes that European regulatory framework makes for a more favourable environment for a bitcoin start-up, particularly compared with regulations in the US: "As soon as you have an operation in one country, you can passport your activities into other countries without any trouble, whereas in the US you have to apply in every single state for the relevant authorisation."

While the ingredients for a vibrant bitcoin start-up market are all present in Europe, it appears that the lack of new entrepreneurs in the space has caused an impasse on the continent. There are some bitcoin start-ups in Europe, but they don't appear to be seeking out venture funding.

"I would be very surprised if you met bitcoin companies that say they've been running around trying to raise money and can't," says Jackson. He puts this down to a large number of bitcoin exchanges being established by the currency's early adopters, many of whom self-funded their ventures with the skyrocketing value of their cheaply-mined bitcoins from the early underground years.

How Europe's venture capitalists will take advantage of this self-contained world is still unclear. And its attractiveness as a long-term investment will continue to be largely debated due to bitcoin's continuing value instability.

"There is clearly a huge regulatory risk and a likewise big market risk, but it correlates with the upside potential," says Passion Capital's Glänzer. "A great case for early-stage venture capital, in my mind. But as always, the future will tell."

Bitcoin's rising prominence throughout 2013 has brought to light the very genuine possibility of a widely-adopted digital currency. Says Jackson: "Bitcoin has got a great difficulty in achieving stability, but maybe a version two will have some better form of stability."

Indeed, there are already several other digital currencies in the ether, though none have yet gained the same traction as bitcoin did in 2013. "I think bitcoin might be a stepping stone, and these second-level opportunities are probably going to be showing up fairly soon," says Jackson. "And because of the global potential of these projects, they're going to become a very attractive venture investment."

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