Extracts from the 2015 shortlist

FT & McKinsey Business Book of the Year Award

Digital Gold

It was after midnight and many of the guests had already gone to bed, leaving behind their amber-tailed tumblers of high-end whiskey. The poker dealer who had been hired for the occasion from a local casino had left a half hour earlier, but the remaining players had convinced her to leave the table and cards so that they could keep playing. The group still hovering over the felt and chips was dwarfed by the vaulted, wood-timbered ceiling, three stories up. The large wall of windows on the far side of the table looked out onto a long dock, bobbing on the shimmering surface of Lake Tahoe.

Sitting at one end of the table, with his back to the lake, twenty-nine-year-old Erik Voorhees didn’t look like someone who three years earlier had been unemployed, mired in credit card debt, and doing odd jobs to pay for an apartment in New Hampshire. Tonight Erik fitted right in with his suede oxfords and tailored jeans and he bantered easily with the hedge fund manager sitting next to him. His hairline was already receding, but he still had a distinct, fresh-faced youthfulness to him. Showing his boyish dimples, Erik joked about his poor performance at their poker game the night before, and called it a part of his “long game.”

“I was setting myself up for tonight,” he said with a broad toothy smile, before pushing a pile of chips into the middle of the table.

Erik could afford to sustain the losses. He’d recently sold a gambling website that was powered by the enigmatic digital money and payment network known as Bitcoin. He’d purchased the gambling site back in 2012 for about $225, rebranded it as SatoshiDice, and sold it a year later for some $11 million. He was also sitting on a stash of Bitcoins that he’d begun acquiring a few years earlier when each Bitcoin was valued at just a few dollars. A Bitcoin was now worth around $500, sending his holdings into the millions. Initially snubbed by investors and serious business folk, Erik was now attracting a lot of high-powered interest. He had been invited to Lake Tahoe by the hedge fund manager sitting next to him at the poker table, Dan Morehead, who had wanted to pick the brains of those who had already struck it rich in the Bitcoin gold rush.

For Voorhees, like many of the other men at Morehead’s house, the impulse that had propelled him into this gold rush had both everything and nothing to do with getting rich. Soon after he first learned about the technology from a Facebook post, Erik predicted that the value of every Bitcoin would grow astronomically. But this growth, he had long believed, would be a consequence of the multilayered Bitcoin computer code remaking many of the prevailing power structures of the world, including Wall Street banks and national governments—doing to money what the Internet had done to the postal service and the media industry. As Erik saw it, Bitcoin’s growth wouldn’t just make him wealthy. It would also lead to a more just and peaceful world in which governments wouldn’t be able to pay for wars and individuals would have control over their own money and their own destiny.

It was not surprising that Erik, with ambitions like these, had a turbulent journey since his days of unemployment in New Hampshire. After moving to New York, he had helped convince the Winklevoss twins, Tyler and Cameron, of Facebook fame, to put almost a million dollars into a startup he helped create, called BitInstant. But that relationship ended with a knock-down, drag-out fight, after which Erik resigned from the company and moved to Panama with his girlfriend.

More recently, Erik had been spending many of his days in his office in Panama, dealing with investigators from the US Securities and Exchange Commission—one of the top financial regulatory agencies—who were questioning a deal in which he’d sold stock in one of his startups for Bitcoins. The stock had ended up providing his investors with big returns. And the regulators, by Erik’s assessment, didn’t seem to even understand the technology. But they were right that he had not registered his shares with regulators. The investigation, in any case, was better than the situation facing one of Erik’s former partners from BitInstant, who had been arrested two months earlier, in January 2014, on charges related to money laundering.

Erik, by now, was not easily rattled. It helped that, unlike many passionate partisans, he had a sense of humor about himself and the quixotic movement he had found himself at the middle of.

“I try to remind myself that Bitcoin will probably collapse,” he said. “As bullish as I am on it, I try to check myself and remind myself that new innovative things usually fail. Just as a sanity check.”

But he kept going, and not just because of the money that had piled up in his bank account. It was also because of the new money that he and the other men in Lake Tahoe were helping to bring into existence — a new kind of money that he believed would change the world.

http://www.ft.com/intl/cms/s/2/797fb592-7648-11e5-933d-efcdc3c11c89.html

Fintech is what’s really keeping bankers awake at night

The pressing issue for banks today is capital of course, and figuring out who will bear the cost of having more of it. Westpac, for one, has decided that the cost is to be shared between shareholders and customers; the others now have to make their decisions.

But while that problem is difficult it’s pretty straightforward, and it’s not the thing that’s keeping bankers awake at night.

The really mind-bending topic for banks is fintech, and specifically block chain, otherwise known as distributed ledger technology.

What’s more, the pressure on banks to hold more capital is making them more vulnerable to attack from fintech and peer-to-peer disruptors that can get by with little or no capital at all. That’s what is keeping bankers awake.

Block chain is the business end of bitcoin — it’s the ingenious technology that makes crypto-currencies happen, but while bitcoin might or might not change banking, block chain definitely will, and not just banking.

This new manifestation of the digital revolution will change every part of the financial services industry. Every bank now has a team of people working on it — experimenting with distributed ledgers to try to understand the threats and, perhaps more importantly, the opportunities.

The opportunity is cost reduction and the threat is disruptive competition, and it’s too early to tell which will win.

Distributed ledgers are a bit hard to get one’s head around, especially for bankers (and commentators) who are used to ledgers that obediently sit in one place — in one book or on one computer.

But block chains are everywhere, which is why they are called distributed ledgers. A good, but still imperfect, way to think about it is that it’s a bit like Wikipedia, with entries that can be updated by anyone and are available to all, except that with block chain it’s not encyclopaedic information written in English but computer code.

The code is public, and shared by many computers. Any computer in the network can propose changes and a consensus is arrived at about which changes are valid and what order they are made in.

The network then updates all copies and keeps them synchronised. The “blockchain” stores all the updates so that any user can trace back who made what changes and when.

It’s both incredibly simple and mind-bendingly complex at the same time, but the essence of it is that the system can be truly peer-to-peer, person-to-person, and at the same time verifiable, secure and fully transparent.

That means it can be used as a means of financial exchange, which in turn means that third party settlement will no longer be required.

The first use of the idea was to create bitcoin, the “crypto-currency” invented in 2008 by Satoshi Nakamoto and which is now starting to gain traction as an alternative to money created by banks or printed by central banks.

At the moment the bitcoin price is around $US250 ($342). It has been extremely volatile in past, rising to well over $US1000 per unit as some speculators bet that it would keep rising in value. That was before anyone had worked out whether it was an investment or a medium of exchange.

It’s now clear that bitcoin is not the former, but the latter, a sort of tool for barter outside the financial system, and as a result the price has been stable for about six months.

In fact, it looks like bitcoins will simply become a sort of front end for block chains: so far bitcoins have mainly been used in international currency transfers, where dollars are converted into bitcoins and then instantly converted back into dollars in another place — essentially using the block chain to settle a transaction.

It allows for secure domestic or foreign exchange payments that don’t involve a third party and is quickly becoming a crowded field. The leader is probably Coinbase, which claims to have traded $US2.5bn worth of bitcoins across 32 countries.

But it’s also quickly becoming clear that the uses of block chains are much wider than just bitcoin.

Commercial banks, central banks, stock exchanges and the technology companies like Samsung and IBM now have labs exploring the uses of distributed ledgers to settle transactions, whether they are shares, derivatives, bonds or even property.

There are also several fintech start-ups that have developed versions of block chain technology, such as Ripple, Ethereum, Eris Industries and HyperLedger.

What they all have in common is the use of the basic distributed ledger, or transparent and verifiable spreadsheets, to exchange data and assets securely.

The most immediate is likely to be streamlining securities settlement and allowing automatic, instantaneous clearing between the two parties to a transaction, without the need for a clearing house.

The savings for banks and securities exchanges could be enormous, through bypassing the cumbersome and time-wasting payment and settlement systems.

It’s also expected that distributed ledgers will be able to support all types of contracts, which would lead to a huge variety of uses. All lending could be settled by blockchains as well as trade finance, swaps and derivatives … wherever counterparty risk exists.

According to one analyst, there is no reason block chains can’t be used to settle property transactions without any intermediaries, dramatically cutting costs.

A study commissioned by Santander Bank of Spain estimated banks could save up to $US20bn in cross-border payments and compliance costs alone.

Using distributed ledgers as a prime record would dramatically cut back office costs for banks, securities traders and exchanges.

But like all big cost reductions through digital disruption, block chain technology and fintech generally will also lower the barriers to entry.

New operators in all aspects of banking will use the cheaper technology to attack the banks’ stronghold with less capital.

Oh yes — capital, which the banks are being forced to have more of, raising their costs, and prices, and making them even more vulnerable to disruption.

http://www.theaustralian.com.au/business/opinion/fintech-is-whats-really-keeping-bankers-awake-at-night/story-fnp85lcq-1227572212332