Committee members,

I appreciate the opportunity to speak with you today and share my views on virtual currencies. I am a Partner with Magister Advisors LLP, an EU-based boutique investment bank we established in 2011 to focus on enterprise software and financial technology. Prior to establishing Magister Advisors, I spent five years at Goldman Sachs and, previously, helped build a billion-dollar product line at Oracle Corporation. This gives me a dual perspective on virtual currencies: that of a disruptive technology market and their potential implications for financial markets.

Over the past 6 months, we have spoken with many of the leading innovators in the ecosystem. Equity investment in these companies is approximately $1bn; we have covered roughly $600m of this and approximately 100 venture backed companies in the space. We published our initial learnings on December 12th, 2015 in our report ‘Blockchain and Bitcoin in 2016: a survey of global leaders.’

The initial interaction of Bitcoin with the regulated, fiat financial system occurred when early Bitcoin companies attempted to open commercial bank accounts as money transfer agents. Many banks refused, concerned with fulfilling their own KYC and AML requirements. As a result, in large Bitcoin companies today you will find up to 40% of the staff working in compliance. More interesting has been the birth of software products, such as Chainalysis and Elliptic, that apply machine learning to inspect the Bitcoin blockchain for suspicious activity and monitoring the dark web for illicit transactions. This is far beyond the capabilities of banks today to monitor cash deposits.

Additionally, questions arise within the community as to whether incumbents have emphasized these issues to prevent new entrants and the creation of new services that provide consumers access to the speed, efficiency and security benefits of the Bitcoin network.

More recently, we have seen the development of Bitcoin based financial products and services that are clearly ‘regulated activities’. One such company is LedgerX, who is building a ‘physically’ settled options exchange for Bitcoin. They are working with US regulators to ensure they comply to the existing regulations for options exchanges, including raising regulatory capital and working with well-known custodians.

In my view, there is no basis for generic Bitcoin or virtual currency regulation. The financial services and products offered by companies are typically covered by existing regulation, as these examples illustrate. Of course, the flexibility and cooperation of regulators to experiment and adjust existing polices to enable a high pace of innovation is appreciated. As a global network, Bitcoin would benefit from harmonisation of European policy, which would increase the reach of the network and services built upon it almost overnight. The view of the ecosystem, by and large, is that today regulators are moving quickly (for regulators) but significantly slower than ‘Bitcoin speed’.

Much has been made over the past few days about the potential ‘failure’ of Bitcoin and a rift in the ecosystem. This manifested from a post by one of the influential Bitcoin developers leaving the community. In particular, this highlighted the lack of resolution to increase the blocksize, which regulates the capacity of the Bitcoin network.

What has not been well reported is the response of the ecosystem leaders. Within 96 hours of the initial post, the majority of the largest bitcoin transaction processors in the world agreed to a ‘hard fork’ and doubling of the blocksize. I would like to highlight three key observations from this process:

  • The institutionalisation of Bitcoin is being led by the largest and most important companies in the ecosystem, working with a core group of developers. This is a big positive in terms of providing leadership and direction for Bitcoin overall.
  • The convergence of these players on a specific approach creates a natural platform for governance of the commercial Bitcoin ecosystem, and hopefully a formal industry body forms out of this group.
  • Importantly, this process involved the Chinese miners and addressed any concerns regarding the ‘Great Firewall’. China is a critical market for Bitcoin, and addressing any challenges with this market is therefore critical to fulfilling the mission of providing a globally robust value transfer protocol.

In short, the Bitcoin ecosystem is self-governing. Existing regulation typically applies to the services offered. Regulators are, by and large, viewed as supportive, if not capable of moving at the current pace of innovation. And the largest companies in the ecosystem are quickly providing the platform leadership required for a stable network. The net result of this is a flurry of innovation, delivering to European consumers new financial services and products, typically with lower costs and greater quality of service than existing products.

Jeremy Millar | Partner, Magister Advisors LLP

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