The U.S. Is Bitcoin Trading’s Next Frontier

The race is on to establish a U.S.-based Bitcoin exchange. Waiting beyond the finish line: acceptance on Wall Street.


The spectacular, near-$500 million collapse of Tokyo-based Mt. Gox in February, then the world’s largest and busiest exchange of Bitcoins, has left the virtual currency reeling. Analysts say an integral part of revamping Bitcoin’s public image is to get Wall Street and institutional investors on board with the currency. To do that, according to key industry players, there needs to be a secure and liquid exchange in place where traders can freely convert Bitcoins with other currencies.

The exchanges that have moved in to fill the void left by Mt. Gox are located in developing nations that, in some cases, lack the regulatory regimes that can provide the transparency and security that high-profile investors demand. A handful of U.S.-based entrepreneurs, backed by venture capital, are vying to create the kind of exchange they claim would lift the fog hanging over Bitcoin. The solution, they contend, is to create and operate an exchange based in the U.S. under federal regulatory oversight. This, in turn, will bring Bitcoin into the mainstream and accelerate its adoption within the global economy.

Barry Silbert, founder and CEO of New York–headquartered SecondMarket, calls the lack of a strong regulatory framework “ultimately the weakest link in the whole Bitcoin infrastructure chain.”

“There’s a huge class of investors who will not get in until they can do it in a safe way, where their clients are protected,” says Jesse Powell, co-founder and CEO of Payward, a San Francisco–based company that developed and operates the Kraken trading platform for several digital currencies including Bitcoin; Namecoin; Dogecoin; and Ripple, which resembles hawala, the ancient peer-to-peer money transfer system used across much of western and South Asia. Kraken is one of the leading euro-Bitcoin traders, made possible by its partnership with Fidor Bank, based in Munich. With euro trading on the rise, Kraken’s platform has found itself among the ranks of the world’s top Bitcoin exchanges. Because it does not have U.S. regulatory clearance, Kraken is not technically a U.S.-based exchange, however.

Regulatory hurdles notwithstanding, the volume in Bitcoin exchange trading has exploded since early May, and prices have risen sharply as new exchanges in Asia have emerged as dominant players. OKCoin, based in Beijing, has become the largest volume trader, whereas Hong Kong–based Bitfinex has surged to second place. China is cracking down on Bitcoin exchanges trading in yuan for Chinese customers, but so far this does not seem to have put a dent in overall volume. OKCoin is mulling setting up an outpost in Japan to help Mt. Gox customers get back on their feet.


Post-Gox, two European-based exchanges had emerged as the top two volume traders before OKCoin surged ahead. One is the Slovenia-based Bitstamp, which had ranked No. 1 for several months. Its founder and CEO, Nejc Kodric, moved the company’s headquarters to Reading, England, earlier this year, but it still remains a Slovenian exchange.

Until the surge in Asia, the second-largest exchange by volume was the mysterious BTC-e, which is based in Bulgaria, although CoinDesk reports that it operates under Cypriot law and identifies its founders only by their Russian first names (though, it should be noted, they are not Russian citizens), Aleksey and Alexander — programmers, CoinDesk also reports, who previously worked at the high-tech Skolkovo Innovation Center near Moscow.

The location of the leading exchanges in what are largely unfamiliar investor locales makes more compelling the calls for a thriving and functional U.S.-based Bitcoin exchange. “Bitstamp and all these other exchanges — they’re doing an admirable job,” says Silbert. “They’re providing a valuable service. But I think the models are just not what Wall Street and the regulators are looking for.”

The next question: What exactly does a vibrant trading platform entail? Well, according to Gil Luria, chief analyst for financial technology at Los Angeles–based investment banking and asset management firm Wedbush Securities, it would be one that provides traders with “any volume at any price at any type of exposure that they want.” A well-performing Bitcoin market would reduce the bid-ask spread.

A more efficient Bitcoin trading market would allow merchant acquirers — companies that accept Bitcoin sales from a merchant via a prearranged relationship such as San Francisco–based Coinbase and Atlanta-based BitPay — to reduce the fees they charge merchants to process transactions. “If we had the kind of more liquid and transparent market in the U.S. that was less volatile and had better visibility, it would assuage concerns of retailers as well, and that would spur more adoption of Bitcoin,” says Luria.

Enthusiasts for the digital currency contend that institutional investors can bring to Bitcoin the kind of standing it will never have if it remains confined to individual traders. “Once institutional investors can get in, it will raise the profile of Bitcoin and you’ll have more players with a stake in the outcome, which is helpful,” says Payward’s Powell. “Those guys have deep pockets and influence in Washington and elsewhere. Once they are in, Bitcoin as a whole will be much more secure.”

Right now, much of the Bitcoin trading in the U.S. is over the counter, with buyers and sellers being matched on existing trading platforms. Much of the trading activity is at companies like BitPay and Coinbase that make markets internally with help from overseas exchanges like Slovenia’s Bitstamp and Hong Kong’s Bitfinex. “I would guess, taking into account its work with other exchanges, Coinbase has the highest trading volume in the world; it’s just not published,” says Peter Vessenes, CEO of Seattle-based Bitcoin incubator CoinLab and chairman of the Bitcoin Foundation. Coinbase is one of the largest providers of digital wallets, which hold purchased Bitcoins in trust for customers. Coinbase reports it has 1.3 million registered Bitcoin wallets and 32,000 merchants that accept Bitcoins, including a newly added retailer, satellite TV company Dish Network.

Luria sees three top contenders to become the first headlining and published trading platform: Atlas ATS (alternative trading system), based in New York, SecondMarket and Kraken. “I’d say, right now Atlas ATS is probably ahead,” Luria says. “They have a platform. They have experience with the technology. They are moving toward getting the regulatory stature, and so far they’ve seemed to hold up in terms of security.”

Silbert says that SecondMarket, which engages in OTC trading, “already sees a lot of liquidity” and is making progress on building the technology infrastructure. “Because SecondMarket is a broker-dealer, it already has regulatory stature,” he adds. Also, SecondMarket has demonstrated it can provide investors with security by way of its management of its $62.45 million Bitcoin Investment Trust. Kraken has gotten a good start in Europe and is working its way through U.S. regulatory approval.

There are two paths to becoming a regulated U.S. Bitcoin exchange, according to Luria. “One is to get certification state by state,” he says. The other, and probably more important path, is to have a relationship with a federally chartered bank. This route is more expedient since the bank’s regulatory standing allows the exchange to avoid having to be licensed in every state. “If Kraken or Atlas or one of the others gets a relationship with a bank, that will be a giant step forward,” Luria says. U.S. entrepreneurs typically pursue both tracks, he says.

Atlas reports that it trades a combined 50,000 Bitcoins a month through private and public markets. “We’re very cautious in terms of the people we do business with and how we handle fiat currencies,” says CEO and co-founder Shawn Sloves. “We’re trying to make sure we are 100 percent compliant with the laws and everything else.”

The public markets are open only to trusted counterparties. All parties are compliant with “know your customer” and other federal banking rules designed to prevent money laundering and other prohibited activities, according to Sloves. Atlas runs two public OTC markets — in Hong Kong and New York — and last fall launched three OTC private markets. Its private markets do anywhere from 2,000 to 10,000 transactions a day, whereas its public markets range from 100 to 1,000 transactions a day.

Atlas also partners with Bay Hill Capital Management, a Duxbury, Massachusetts–based hedge fund firm and a “large market maker on our system,” says Sloves. To the extent a company operating in a private market needs more liquidity, it can turn to the public markets Atlas offers and trade with approved counterparties, according to Sloves.

Other companies in the running to be the first Bitcoin exchange include Coinsetter in New York and Buttercoin in Palo Alto, California. Coinsetter is planning to introduce a plug-and-play platform for Wall Street firms and is already trading up to 1,000 Bitcoins a day, according to Jaron Lukasiewicz, the company’s founder and CEO. Coinsetter has constructed an electronic communication network that matches buy and sell orders. It routes trades to Bitstamp for liquidity and may add overseas exchanges. Coinsetter is also building its own financial information exchange application programming interface. “We’re moving toward a brokerage model,” says Lukasiewicz. This month Buttercoin is likely to launch its trading platform, now in its test phase, according to a company source.

Kraken’s main advantage is its volume; its hurdles are regulatory. In the U.S. Kraken is licensed to trade national currencies and digital currencies in five states: Alabama, Massachusetts, Montana, New Mexico and South Carolina. In the remaining 45 states, Kraken trades only among the various digital currencies with no conversions to national currencies available. Powell expects Kraken and other exchanges to receive approval for licensing as money transmitters state by state in all of the remaining 45 states over the next six to 12 months.

The New York State Department of Financial Services, headed by superintendent Benjamin Lawsky, is seen by many market players as taking the lead among states in designing a regulatory regime for Bitcoin businesses. If New York were to approve Kraken’s license as a money transmitter, that alone would be a big breakthrough for the company, according to Powell. Even if Kraken has not by then established a relationship with a federally chartered U.S. bank, it could lead to a surge in trading by individuals and institutions in New York. “If we could legally service customers in New York, many would be okay with wiring money to our bank in Germany,” says Powell.

SecondMarket has a leg up in that it is already federally regulated as a broker-dealer. CEO Silbert proposes a spoke-hub exchange model, with the exchange serving as a central-clearing hub and the members of the exchange as the spokes. An investor would only have access to the exchange via its members, who would place the bids and asks and presumably would be trusted counterparties. (On existing exchanges, it isn’t necessarily clear what or who is the counterparty.) There will also be a self-regulatory organization to provide governance and monitor exchange activities.

Silbert hopes to have his exchange launched by the end of this year. “We have made fantastic progress with bringing up to speed all the regulators on how the exchange will be set up,” he says.

Silbert has also been in conversation with about a dozen banks to be potential founding members of the exchange. “Most of these banks have put together working groups and task forces to try to study digital currency and Bitcoin and what impact it will have on the business and, most important, what their strategies will be,” he says. Some of the banks are taking a wait-and-see approach, whereas others, he adds, “for whatever reason are going to try to do something more proactive, such as setting up trading desks in virtual currencies.” The banks in discussions with SecondMarket have “in a very short period of time kind of gotten their hands around what Bitcoin is and what the opportunity is,” says Silbert.

Will being the first U.S.-based exchange confer an advantage? Perhaps — but not necessarily. “Being the first gives it a big advantage, assuming the exchange can handle the attention, the traffic and the big target on their backs,” says Luria. “What I expect to happen if an exchange emerges in the U.S., and comes out with much fanfare, is that a lot of bad guys from a lot of different places will set their aim on that exchange and see if they can break it, take it down and steal from it. So the first week for an exchange will be critical.” Being first will only be an advantage, Luria contends, “if the first exchange can take the heat.”

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