The Finanser Interviews: Jon Matonis, Crypo-economist

Bitcoin still stirs up a huge debate about where it will go in the future; will it become institutionalised; what is the blockchain going to do to banking; and more.  In order to clarify the debate, we interviewed Jon Matonis, a renowned expert on bitcoin and cryptocurrencies, to find out what is the truth.

Tell me about yourself and your background Jon. 

I was involved with the Bitcoin Foundation since its inception, starting in 2012, as one of the founding board directors. At the end of last year I decided to retire from the Foundation board and give other people the opportunity to step forward and work on the board.

It was never meant to be a lifetime gig for any person.  Prior I was working in the payment space at Visa and VeriSign, working on the public key cryptography for online banking, and prior to that I was an FX and Derivatives trader for commercial banks. I have been blending all these skills into this new brand amazing field of financial cryptography.  

What’s the future of the Bitcoin Foundation?

In terms of the Bitcoin Foundation going forward, it still is an excellent institution. People should be encouraged to join it, as it does pay for some of the core developers’ compensation. It doesn’t pay for all the compensation, as no one entity controls Bitcoin development.  It is an open source project so it’s not a centralized power struggle, but does provide some compensation. The main focus of the Foundation today, which is slightly different from when it first founded, is to develop a standards body for Bitcoin Core, along the same type of protocol standards as the IETF. It is premature to just automatically throw that over the fence with the IETF standards process, as it would be lost. It has to mature, has to have more participation, more advocates to allow it to thrive in an IEFT structure. That is what the Foundation is preparing the protocol for, so that eventually it will go into a larger more rigorous standards body process.

You mentioned you’ve been a trader and involved with the payments industry so why did you get interested in bitcoin?

I had always been studying and focusing a lot of my research work on digital currencies and alternative monies. Even prior to Bitcoin going back to Digitcash and E-Gold days. In late 2009, I got introduced to Bitcoin by a random email from Satoshi Nakamoto.  I didn’t give it much thought at the time and then 3-4 months later I started to focus upon it. It seemed to solve a lot of problems encountered by the first generation digital currencies, primarily around the centralization issue for preventing double spends. That’s the real breakthrough and is what got me excited both as a trader and as a digital currency monetary theorist. Bitcoin came up with the way to solve the double spend problem, without having to go back to a centralized mint for reissuance or confirmation that the units weren’t double spent. The cryptographic principles for Bitcoin have been around prior to the launch of Bitcoin. There was nothing uniquely new about any of the individual components but it was unique in how it was assembled as a peer-to-peer distributed environment. That was the real breakthrough.

You say it’s decentralized, which often raises the question: is this money without government.

Well the decentralized and peer to peer computing capabilities are the wave of the future. So that is definitely going to last. I see that growing in fact rather than going in the other direction.

In respect to the ‘money without government’ phrase, we actually have always had money without government going back to the evolution of money, even gold and pre- gold barter days. Gold was the form of money without government before the kings and monarchs started stamping their image on them. So I don’t see concept of money without government as being something impossible to achieve.  Instead, we are regaining something that was lost. 

But regulators and government officials, when it comes to a value exchange that is unregulated, worry about drug runners and terrorists. Do you see that as a threat? 

I don’t see it as threat. It’s not specific to Bitcoin and other crypto currencies.  Any type of value exchange medium for small or medium transactions are subject to abuse.  The tradeoffs are that you have to severely clamp down on the benefits of having digital money in an absolute way, to prevent something happening on the negative side in an absolute way.  What I mean by that is that the so called drug and criminal communities that you’re labeling, dwarfs what’s happening in Bitcoin. You don’t blame the monetary unit for the actions of the criminals.

I agree with, although another problem of an unregulated value exchange system is that you get lots of hacking and issues like MtGox and Bitstamp failures.  These things give Bitcoin a bad name. Do you see a structure to give consumers more assurance that it is safe to use?

Let’s talk about MtGox and the episode of Bitstamp. Regulation cannot be a panacea for ‘caveat emptor’ (buyer beware). Regulation cannot be a panacea for everything. It rarely works in a way that a government intends it to anyway. Look at episodes in the United States where Lehman Brothers and MF Global were both regulated entities and meant to be safe.  They weren’t. So in terms of protecting consumers, that is just what the government regulators put forward for the justification of massive regulation in the Bitcoin arena. We are now seeing major areas of Bitcoin being involved with best practice though.  If you look at the recent BitStamp episode, that actually resulted in adoption of new multisig technologies for Bitcoin and cryptocurrency exchanges. So the solution with BitStamp generated a more robust and stronger exchange system, which happened outside the action of any government regulation.

Alongside that you are seeing firms like BitGo, which was the multisig company, and companies like Xapo, CoinBase and more adopting their own private insurance to provide customer security and peace of mind for any funds that they choose to leave there. So the market is stepping up, through best practices and through providing these solutions. The main take away from MtGox, which happened over a year ago, is that it demonstrated the exact opposite of too big to fail capitalism. It’s always curious to me that some the critics of MtGox would prefer a world where the tax payers always steps in and bail everybody out. That’s not the world we need to be moving towards, so that MtGox was allowed to fail on its own accord should be taken as a positive sign that the system is working.

It’s interesting that traditional value stores have started to pick up on Bitcoin since failed. A lot of institutions that have got licenses and government regulation are starting to try to incorporate cryptocurrency and blockchain technology in what they do.  That feels like a movement towards the institutionalisation of cryptocurrency. Do you think that will happen or would that be the opposite of the wishes of the community that created this capability? 

Well the wishes of the community don’t really matter here and the institutionalisation of Bitcoin will be jurisdiction by jurisdiction.  Going back to your other point though, the exchange environment has matured significantly over the 12 months since MtGox and that’s a beneficial sign.  Not only are they aware of this, but the service providers are a lot more robust.  Some of them are taking steps on their own in anticipation of future regulation but to present a more mature offering. Users of these services have also worked out that it’s not right to use firms like MtGox as a bank vault, which they should have never been using as such in the first place.  So Bitcoin gives you a way to control your own assets and not required to leave everything on balance.  It’s down to your own guidelines and comes back to what I said, caveat emptor, whether its regulated or unregulated. 

On the institutionalisation of Bitcoin, you will start to see that happen. I don’t think this is a negative and, as mentioned it will be jurisdiction by jurisdiction. Trading liquidity, increasing volume and depth of the market will lead to institutionalisation.  It is unavoidable that we will get to a phase where we see Bitcoin derivatives type instruments, which we are already starting to see evolve in certain markets.  It will be just like any other commodity that goes through stages and develops.  We are just seeing that on a faster time horizon with Bitcoin, which seems like it is moving a lot more quickly. We will get there. 

I can see it happening. That’s why you see innovators like Fidor Bank and Circle creating cryptocurrency consumer guarantees and assurances, similar to traditional regulated banking licenses, but in the new model world rather than the old model world.  Is this the correct view?

It is a correct view. We are also starting to see it on an international level. You will have the small local regional players, but you will start to see the ones that are large have a global footprint, which will end up only being beneficial because a global footprint for a cryptocurrency type operation really sets the stage for entry into the remittance market. When you have a global player that covers multiple countries you’ve pretty much displaced the functionality of someone like Western Union.

That’s where things get very interesting. For example, Ripple is working with Wells Fargo and other banks to have their technology capabilities incorporated but using other cryptocurrencies than bitcoin.  Will we see a different cryptocurrency arrive?  Is bitcoin the one?

Well there are already over 300 crypto currencies that come and go. Bitcoin has the majority share at almost 99% share. Bitcoin is the dominant player. Ripple is making a lot of progress with financial institutions, as they are making this area their main focus of attention. I don’t see systems like Ripple as being truly decentralized however. They have distributed deployment, but the currency unit itself is entirely pre-mined by the founders of the currency.  That means it is not decentralised, as there are people who work out where to deploy that initial currency unit. The Ripple currency XRP is what they use as a glue to hold everything together and the test as to whether something is truly decentralised is: who will be the financial winner with Ripple’s success? Ripple has lots of venture capitalists participating in it, and investors in XRP. Those people will be the winners. Because of that Ripple doesn’t take them away from a single point of failure. Their implementation with lots of financial institutions, and what they are trying to do with various asset webs and connections, is very appealing to banks as it makes it subject to oversight and regulation.  At some point, when you traverse everything in that world however, there is still a single point of failure. Regulators like to have that single point at the end of the day, because then they can regulate it. Bitcoin doesn’t give them any type of single point to focus on.  That’s why it’s democratized value.

So if Ripple is not the solution, how will banks manage cryptocurrencies into their operations?

This is actually a very interesting area.  I am starting to focus on it a lot more in my work as, in some ways, it’s the flip side of Ripple and alternative cryptocurrencies that want to do their own independent blockchains. What we are starting to see evolve are banks beginning to leverage the existing Bitcoin blockchains.  The blockchain that already exists, rather than trying to recreate something that will be a second or third tier chain. The reason this is interesting is that it's already there to be exploited.  The fact is that banks just have to figure out a way to connect to the Bitcoin network, which gives them the same type of liquidity and ability to do the large amount transactions they currently have on SWIFT.

An interesting company that illustrates this development well, came out of the SWIFT innotribe challenge last year coincidentally.  This is a company called epiphyte based in London, and with offices in New York.  They created an interface for commercial banks on both sides to be able to leverage and utilise the Bitcoin network, in lieu of using Fedwire or CHAPS or SWIFT, who are liquidity providers.  The banks never end up touching the cryptocurrency. This solves the challenges of correspondent banking for large global banks, who have to tie up a lot of capital in counterparty cover.  Equally, there are other parts of the world where banks do not want to leave a lot of money with their correspondent banks, due to the counterparty risk.  If they can leverage something like the Bitcoin blockchain then this will have significant impact on the future of correspondent banking worldwide.

That's one of the reasons I believe bitcoin as a cryptocurrency has more relevancy at the wholesale level, replacing both Hawala and correspondent banking structures at the same time.

So if I summarise what we have covered so far, you believe we will have a jurisdiction-based system that regulates usage at a national level but, because it’s incorporated by banks into wholesale bank structures, it massively reduces costs. Is that how this plays out?

Yes.   It’s important to look at jurisdictions, as jurisdictions do have the ability to regulate the in-and-out functionality of their own currencies into cryptocurrencies.  When you talk about a country having Bitcoin regulation, what they are really regulating is their own currencies exchanged into and out of another cryptocurrency. That’s what you’re seeing at bitcoin exchanges and banks, and will be one primary level of regulation.

Beyond that, you will have a whole parallel world which will exist person-to-person.  In some ways that world is more interesting than person-to-business use of cryptocurrencies as in a person-to-person environment, similar to using Skype or using encrypted email, you find new ways of doing things.  In this case, you have an independent financial messaging system which has allowed us to create a large global value exchange network. That secondary level of exchanges, person-to-person or otherwise, with a cryptocurrency like bitcoin is outside the control of regulators. That’s not even an area where the regulators have a remit, and is why they will have to focus upon when cryptocurrencies are converted into and out of their own national currency.

So that person-to-person exchange, what will be the protection mechanism that will take place in that the system? Will free agents manage the system?

Well ultimately this will rely on the Bitcoin blockchain, which is secured by the power of the overall mining participants. This represents the largest distributed and secure computing project in the world. In aggregate it exceeds the top 500 or 600 super computers combined. 

And here, I want to make a point about the price of bitcoin, as this comes up a lot. I don’t think watching the price is that important. It’s more important to look at the number of projects and developers working on building user friendly solutions. It is more important to focus upon the installed base of bitcoin wallets.

At the end of the day, the bitcoin price should reflect a price level that is sufficient to protect the aggregate value of transactions that are arriving over the blockchain. If you extrapolate that forward and say that a lot more economic activity is occurring on Bitcoin blockchain, then the security reaches a level that is consummate with the value riding across that decentralized value transfer network. As a result of this, that will tend to slowly increase the natural price of Bitcoin. That’s the only way to guarantee that the transactions riding across the network will be secure.  Then people will be willing to pay for that additional security in increased transaction fees.

It’s a feedback loop, as you won’t have those transactions occurring if the miners aren’t rewarded through a higher price of bitcoin. You won’t have the higher price of bitcoin if the transactions aren’t occurring in the first place. So it’s very much a feedback loop in a two-way structure.  That’s why I don’t put a lot of effort or thinking into the alternative cryptocurrencies, as they tend to be distraction for building the strongest leading network that we need for migrating economic activity and commerce.

Final question Jon.  If you were a betting man and you were betting on what will happen in the future, where would you put your money… or don’t you use money anymore?

I do have to still use money in some cases and also credit cards but, if I look at it from a Bitcoin investment point of view, I would bet on investing in the actually currency and using that as a proxy for the sector, rather than choosing individual companies. I think it’s unique and rare that we have an opportunity in the investment world to choose a currency as a way to invest into an entire sector. It is a proxy for the sector.  If there was a way to invest into healthcare through a healthcare currency, you have that now for investing in bitcoin as a cryptocurrency for the digital value exchange sector.

In terms of your portfolio, I look at this in the same way as gold.  If people are comfortable in having 10-15% of their overall net worth in something like gold and precious metals, then equally they should be comfortable in having 10-15% in bitcoin. It’s investing in assets and commodities on a portfolio percentage basis.  I think this whole transition that you describe as the ValueWeb  will be complete when we start calling gold an analogue version of bitcoin.