The first Bitcoin specification and proof of concept was published in 2009 in a cryptography mailing list by Satoshi Nakamoto, a pen name for an unknown person or group of people. The intention was to create a monetary system outside the controls of the government or a central bank. In just five years, the new cryptocurrency has been embraced worldwide. Individuals and businesses are using it to pay for goods and services, and now there’s increasing demand to trade Bitcoins and derivatives on exchanges.
Bitcoins are created electronically by software programs that follow a mathematical formula. New transaction data is permanently recorded in the bitcoin network through files called blocks. “Miners” confirm the transactions and write them into a general ledger called a block chain.
The Bitcoin Protocol only allows miners to create 21 million Bitcoins. As of mid-January 2015, 13,724,375 bitcoins have been created worth about US$2,491,111,306[i].
Ultimately, Bitcoins are just like any other currency. Individuals buy them using their credit or debit cards, cash, money orders, checks or direct from a bank account, and they store them in an online, mobile, hardware or paper wallet. When an individual makes a purchase in Bitcoins, they use their private keys in their wallet to access an address, which is then transferred to the seller.
Currently more than 60,000 retailers accept Bitcoins as payment, including mainstream companies such as Overstock.com, Dell, Expedia, Dish, OK Cupid and 1-800-Flowers.
Now owners also want to buy and sell Bitcoins for dollars, euro, yen or other currencies in an exchange environment, as well as speculate or hedge their exposure with derivatives. To this end, small startup marketplaces have been established for trading the crypto-currency in various parts of the world including the U.S., U.K., Singapore and Japan.
Bitcoins may be a new asset class, but the new marketplaces on which they’re traded have traditional technology needs. Some have already developed simple matching engines, but now they’re looking to migrate to more robust industry-standard technology. In addition, they need systems for clearing, pre-trade risk management and surveillance.
A priority for marketplaces is to acquire technology that will enable them to proactively respond to customer demands, economic conditions, competition, as well as comply with regulations. At the same time, the infrastructure must be optimized to provide the best possible total cost of ownership. We are starting to see interest from these venues in our Marketplace for Hire offering because it provides the entire exchange IT infrastructure, including market operations, as one fully-managed service.
In our opinion, exchange trading of Bitcoins has tremendous potential – that is, if certain issues are resolved. First, Bitcoins must be deposited with the exchange before they can be traded. Unfortunately, Bitcoin exchange depositories have been hacked recently, highlighting the need for tighter security.
Second, institutional participation could drive significant market growth, but investors will take a cautious approach and only trade on well-regulated, trustworthy marketplaces that operate on reliable technology. They’ll need confidence that the asset class isn’t going to disappear, be used for money laundering, or be vulnerable to hacking and market manipulation.
The U.S. Internal Revenue Service, Financial Crimes Enforcement Network and Commodity Futures Trading Commission continue to keep a close watch on market developments. Additionally, New York State’s Financial Services Superintendent has proposed comprehensive rules governing virtual currencies, including licensing for exchanges. That being said, institutional investors await more clarity from the regulators both in the U.S. and globally.
It’s not often that something as revolutionary as Bitcoins come into our world. We believe they are here to stay, and they present an exciting market opportunity.