Why venture capitalists are right to be crazy about Bitcoin

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by Dan Primack,

from Fortune Magazine,

Bitcoin is controversial. Some people believe that it’s the future of money, destined to relegate dollars, euros, and yen to the dustbin of history (along with German marks and shiny pebbles). Others argue that it’s nerd delusion, carelessly elevating new software over time-tested economics.

Unfortunately, this debate is focused on the wrong thing. Bitcoin’s primary significance is not about whether it supplants cash. It’s about a revolutionary computer-science breakthrough that has the potential to upend all sorts of established industries.

Here’s an analogy: Email was the Internet’s original application, but 40 years later we all recognize that the Internet has countless more uses than just the electronic exchange of text. Likewise, currency is Bitcoin’s original application, but Bitcoin will not ultimately be defined by currency.

The key to Bitcoin is that it enables verified transactions without requiring a centralized third party to do the verifications. Kind of like the difference between handing a merchant a $10 bill and handing him a Visa card. It does so via what computer scientists call a distributed ledger, in which users are entering (or exiting) a fixed number of ledger slots (i.e., the “coins”).

This system could obviously present a major challenge to the existing payment industry, which includes all sorts of intermediaries like banks, credit card companies, and wire-transfer services. Not only does Bitcoin dramatically lower the fees for making and receiving payments, but it also eliminates both consumer fraud (from the merchant’s side) and the possibility of information theft (from the consumer’s side, as we recently saw at Target).

What’s really fascinating, however, is that the distributed-ledger concept has all sorts of theoretical applications that don’t specifically concern payments. Take identity, for example. What if you no longer needed a phone company to create phone numbers? Or what if your web searches no longer needed to go through Google’s servers? It sounds crazy, but few predicted that the technology behind email would eventually destroy record stores.

“There are so many things that currently exist only in the confines of centralized, larger institutions that could become targets of this,” says Anders Brownsworth, a Boston-area Bitcoin technologist.

Not surprisingly, a number of well-known venture capitalists are paying close attention to Bitcoin and Bitcoin-related startups (most of which, so far, focus on payments).

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